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The next perfect banking storm: Gadfly

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Those looking for when the next financial crisis might be should set a reminder for Jan. 1, 2018.

That’s when a host of new rules are scheduled to come into force that are likely to further constrain lending ability and prompt banks to only advance money to the best borrowers, which could accelerate bankruptcies worldwide. As with any financial regulation, however, the effects will start to be felt sooner than the implementation date.

Two key rules are slated for 2018: The leverage ratio set by the Basel Committee on Banking Supervision and International Financial Reporting Standard No. 9, defined by the International Accounting Standards Board. Other rules that require banks to stop using their own internal measures to assess risk start to be introduced from next year.

Basel III has already been blamed for reduced liquidity in global markets and slower credit growth. What’s about to be rolled out will be a steroid shot to that.

IFRS 9, for instance, will require earlier recognition of expected credit losses, a move that according to some credit analysts could increase nonperforming assets at some banks by as much as a third. As bad loans — or their recognition, for that matter — increase, so do capital requirements. In other words, it’ll be more expensive and difficult for banks to lend.

New Basel rules aimed at reducing the leeway banks currently enjoy on how they account for risk will come into effect over the next two years. The regulations imposed after the global financial crisis already require banks to set aside more capital for every dollar they lend, depending on a borrower’s credit standing. The trouble is, global regulators left the decision on creditworthiness mostly to the banks themselves. A 2013 Basel study found variations of as much as 20 percent in the risk weighting attached to similar assets.

Starting from 2017 therefore, financial institutions will no longer be able to use their internal models to assess risk for derivative counterparties. In 2018, that will be expanded to securitization and thereafter — though the exact date is yet to be determined — lenders will have to evaluate all of their loan clients based on standards set by the Basel committee.

According to the proposed rules, companies that have higher revenues and lower leverage will require less capital from banks, meaning banks will have an incentive to lend only to the biggest corporates with more established businesses. Good luck to smaller enterprises needing funds to increase sales. 

Before that rule comes into force, however, the leverage ratio takes effect on Jan. 1, 2018. From then, banks will be required to limit how much their balance sheet is leveraged overall, effectively putting a hard cap on loan growth.

It’s increasingly difficult for banks to help spur global expansion, no matter how low — or negative — benchmark rates are. But it’s about to get a lot tougher. Banks will tighten their belts and as they deleverage, so will the world. That means more bankruptcies, lay-offs and fewer jobs, which sounds very much like a recipe for a global crisis.

As former Bank of England Governor Mervyn King noted recently, the massively detailed banking legislation that was enacted after the last financial crisis has certainly created a lot of jobs for lawyers and compliance officers. Perhaps those two areas will be the only bright spots post 2018.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

See also:

How the recession has changed retirement planning

Deutsche Bank: This indicator is sending warning signs for household incomes


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