unquote" regulation update: Basel III

Anneken Tappe
23 March 2012

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In this week's unquote" regulation update, Anneken Tappe looks at the latest developments regarding Basel III.

Similar to the provisions introduced under Solvency II, Basel III does not have a direct effect on the industry, but its indirect impact is already being felt. The regulation is primarily designed to strengthen banks' capital safety net - a direct consequence of the latest financial crisis.

However, stronger balance sheets will have a knock-on effect for those that rely on banks for their business. Koos Teule of Gilde Buyout Partners believes Basel II could be problematic, pointing out that regulators tend to over or under compensate: "One problem is that risk weighing is done wrong. Either it's too low, or it's too high; it should be accurate." Excessive requirements could curb banks' ability to lend and invest, while lax regulation could encourage a second financial crisis.

Charles Diehl, of French mid-cap firm Activa Capital is also concerned about its impact, saying: "It will have a very negative impact on the economy and is not going to solve any problems."

The negative impact is already being felt in the form of leverage being more difficult to secure on favourable terms, since the higher capital requirements leave banks with less cash to supply the leveraged finance industry.

Banks cut back direct approach
Private equity, which has seen fewer direct investments from banks over the past decade, is also likely to see financial institutions further scaling down their commitment to the asset class. "It will definitely reduce the number of potential LPs investing in the industry," says Simon Havers of Baird Capital Partners Europe. Banks across the continent have already started selling off some of their PE assets.

Meanwhile, Ulrike Hinrichs, managing director of German trade body BVK, says she expects to see three different effects in Germany: "First of all, banks' participation in private equity as investors will decrease. There will also be more of a hurdle to leveraged financing. At the same time, it is possible that companies that are discouraged from getting financial support from banks turn to private equity as a substitute."

Indeed, market commentators have recently speculated on whether PE houses could replace the role of banks in providing capital to SMEs. As banks refrain from lending on the pre-Basel III scale, smaller businesses in particular may need to seek alternative funding options. PE could potentially step in and benefit from an enlarged target pool.

Charles Diehl disagrees: "I don't think PE will have the means to step in as a substitute for bank lending." A measure like Basel III will impact lending across the board and Diehl predicts that small businesses and PE houses alike will be hit by its effects.