Capital adequacy of banks: impact on availability and cost of credit

The recent letter to the European Commission from the Directors General of the Treasury of France, Germany and Italy recalls an issue that has long been debated among practitioners: the benefits and costs of banking regulation (and supervision) and is certainly timely at this historic moment. There is no doubt that bank capital adequacy rules have made a substantial contribution to the stability and efficiency of the European financial system. But today there is an important issue of levelling, for competitive purposes, EU regulation with respect to other jurisdictions, as well as an issue of fitness between different categories of supervised entities and different areas of activity.

In his speech at last year's annual conference, organised by the World Bank, International Monetary Fund and Fed, Andrea Enria, still in his capacity as chairman of the ECB's supervisory board, emphasised that we must abandon the ambition to design ever more detailed rules to measure risks in their various configurations. This leads to excessive complexity. Instead, it is necessary to ensure - and the tools are there and should, if anything, be strengthened - that banks have robust internal governance, especially on the risk management front. It often escapes our notice that capital adequacy, to which European banks have always responded by significantly increasing their capitalisation levels over the years, produces, if pushed too far, effects on the availability (lower) and cost of credit (higher) for non-financial companies, a consequence that is not always desirable, especially in certain economic situations.

A case in point in this respect is trade receivables from companies and public administrations. In fact, payment times to suppliers, often represented by SMEs, are often long and such that they jeopardise the management of working capital. A European directive on late payments is in force, which has had some positive effects that are probably not decisive, so much so that a more stringent regulation is now being discussed in Europe. This undoubtedly has virtuous purposes, even if, as technically conceived, it runs the risk of creating counterproductive effects: it has been estimated that the additional financial requirements of companies to comply with the new regulation, once it enters into force, will be around two trillion euros!The assignment of trade receivables to banks and specialised financial intermediaries has always been a convincing solution for more than 300,000 European companies, and even the European Parliament has proposed amendments in the new Late Payment Regulation that enhance the role of factoring as a crucial liquidity support and collection and risk management tool for companies.

But the combination of the future regulation on late payment of trade receivables and prudential supervision of factoring risks having a paradoxical effect for all companies that complain about late payment of their receivables. The current application of the prudential rules on the definition of default, as outlined in the EBA guidelines, which may in turn be further specified in the supervisory practices of individual European countries (as in the case of Italy, the only one known to date on this specific point), in fact, seems to place financial intermediaries in the position of treating trade receivables acquired from their customers as impaired (even if in fact with a very limited credit risk), generating a vicious circle, which will be exacerbated by the stricter rules on payments introduced by the future Regulation, to the detriment of businesses that will have less credit and more unfavourable terms.

In this specific case, it would suffice to recognise the nature of factoring, adopting technical solutions that are already available and well known that allow for the appropriate fitness of regulation and supervision with respect to the case at hand. More generally, it is useful to follow the valuable suggestion of the three treasury directors: "without going beyond what is stricly necessary".