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The Unintended Consequences of Basel 3.5 on Corporate Borrowing

basel 3.5 update consequences for corporates

by Lars Wallin

Basel 3.5, an update to the Basel III banking regulations, is poised to have a far-reaching impact on the world of corporate borrowing. While its overarching aim is to fortify the banking system’s resilience, the unintended consequences of this update may disrupt the funding landscape for companies, with potential winners and losers among corporate borrowers. This update could lead to increased corporate funding costs for non-rated and non-investment-grade companies, while potentially reducing the funding costs for investment-grade counterparts.

What is Basel 3.5?

Before delving into the consequences, let’s understand what Basel 3.5 is and why it has garnered attention. Basel 3.5 represents an evolution of the Basel III framework, which was introduced in 2010 in response to the global financial crisis of 2008. Its primary objective is to bolster the banking system by mandating banks to maintain higher levels of capital and liquidity.

One of the central changes introduced by Basel 3.5 is the implementation of a new risk-weight framework for corporate debt. Under this framework, corporate debt’s risk weight is determined based on factors such as credit rating. This shift in approach has the potential to reshape corporate borrowing costs significantly.

Basel 3.5 is still being finalized and the true impact of the regulations is still yet to be seen. However, the changes that have been proposed are likely to have a significant impact on the corporate debt market.

Impact of Basel 3.5 on Capital Allocation & Cost of Funds

The implications of Basel 3.5 are twofold: one for banks’ capital allocation and the other for corporate borrowers’ cost of funds.

Capital Allocation

The new risk-weight framework makes it more expensive for banks to hold non-rated or non-investment-grade corporate debt. Banks are required to allocate more capital against higher risk-weighted corporate debt. Consequently, they may rethink their exposure to such debt, potentially impacting the availability of loans for non-rated or non-investment-grade companies.

While some companies may find the higher cost of debt unattractive, others could benefit. The increased pricing for non-rated or non-investment-grade companies might make their own debt more appealing to investors. However, it’s likely that a significant portion of these companies will face higher borrowing costs or difficulties securing bank financing.

Alternative to Bank Financing

As borrowing costs increase and access to bank financing becomes more challenging, many companies may turn to alternative sources of funding, such as the private credit market. This shift could further elevate funding costs, especially for non-rated or non-investment-grade firms, as they compete for capital in an already competitive environment.

Mitigating Consequences on Working Capital

Basel 3.5’s impact on corporate borrowing extends to the realm of supply chain finance (SCF), accounts receivables (AR), and more. Here are some considerations for businesses engaged in SCF programs:

Understanding Funding Costs

Companies involved in working capital programs should closely examine what drives their funding costs, particularly under AR and SCF programs. This understanding is critical for adapting to changing financial landscapes.

Reviewing Accounts Receivables

To mitigate the potential impact of Basel 3.5, businesses should assess their accounts receivables to identify investment-grade assets and non-rated subsidiaries of investment-grade parents in their portfolio. Collaborating with clients to provide guarantees can be a strategy to enhance creditworthiness and reduce the bank’s capital allocation when funding these receivables.

Expanding Banking Relationships

In anticipation of increased competition and changing financing dynamics, companies should consider expanding their banking relationships. Diversifying banking partners can offer more flexibility in securing funding.

The Advantages of LiquidX’s Multi-Funder Trade Finance Platform

In an environment where adaptability and flexibility are paramount, platforms like LiquidX’s multi-funder trade finance platform with one legal agreement can provide significant advantages. This streamlined approach simplifies the process of securing funding from multiple sources, ensuring businesses can efficiently navigate the evolving financial landscape.

Basel 3.5’s impact on corporate borrowing is complex, with potential benefits for some and challenges for others. Understanding the nuances of this evolving framework and adapting to changing funding dynamics will be crucial for companies seeking to secure affordable financing in the years to come. As Basel 3.5 continues to take shape, the corporate finance landscape will undoubtedly see shifts, underscoring the importance of strategic planning and diversified funding sources.

To stay up to date on the Basel 3.5 update or learn more about mitigating the impact on your company, contact one of our experts.