Banks to Cut Corporate Lending

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Byline: Vivek Ahuja

Investment banks may reduce their corporate lending to focus more on structured products, such as asset finance, in the wake of the Basel II accord, which is due to be implemented at the end of 2006.Paul Ashley, a London-based director at Mercer Oliver Wyman, the financial services strategy and risk-management consultancy, warned that Basel II would have a profound impact on attitudes to risk in financial services and on the structure of corporate banking.

He said: "Many banks have spent much time and effort on the detailed compliance issues related to Basel II, but the focus is changing to look at how the business itself will be affected in the medium term and what needs to be done to prepare for these changes.

"What is clear is that we can expect to see the gradual demise of key structural elements of corporate banking, namely the systematic cross-subsidisation of unprofitable businesses, such as large corporate banking, by more profitable business segments, including retail banking."

Ashley said the concept of pure balance sheet leverage, where banks use their balance sheet deposits to fund plain vanilla loans to companies, was also under threat from Basel II. The accord is expected to include rules governing the capital banks must set aside to cover potential losses.

He said banks would face greater pressure from stakeholders to justify low risk-adjusted returns from their corporate loan books. The increased focus on risk-based valuations is likely to mean that banks will charge higher margins for lower-rated corporate borrowers. Banks could also concentrate more on lending to highly rated companies.

Standard & Poor's (S&P), the international rating agency, said last week that project finance loans were "substantially less risky than unsecured corporate loans", based on default and recovery rate data.

Michael Wilkins, managing director of infrastructure and leveraged finance at S&P in London, said: "Bankers, concerned that the Basel II models task force intends to impose higher risk weightings on project finance than on corporate loans, will be heartened by the findings. …