Basel IIIs liquidity rules mean European banks may need to raise as much as 2.3 trillion euros ($3.2 trillion) in long-term funding, according to McKinsey. Insurers, the biggest buyers of such debt, are being dissuaded from buying long-term bonds under the European Unions Solvency II rules, which makes them more expensive to hold.
The two bits of regulation are at tension with each other, said Simon Hills, an executive director at the British Bankers Association.
European Commission president Jose Barroso called for a new system of financial regulation built on common ground among countries, regulators and international organisations following the worst financial crisis in 70 years. His efforts, which were supported by leaders such as Germanys chancellor Angela Merkel and president Barack Obama, are being undermined by mismatching rules for banks and insurers, say industry executives and lobbyists, who are pushing to relax the new regulations.
Basel III, due to be implemented in 2019, proposes requiring banks to hold enough liquid assets to meet liabilities for a year. The aim is to wean banks off the short-term funding from other lenders that dried up during the crisis and sent Lehman Brothers Holdings into bankruptcy.
European banks will have a long-term liquidity shortfall of 2.3 trillion euros in eight years based on current business models, according to McKinsey. Thats about half the banks total capital and liquidity deficit under Basel III. US banks deficit is about 2.2 trillion euros, McKinsey said.
To make up these shortfalls, banks will have to issue more bonds with durations of more than one year or increase retail deposits, the management consultant said. In the past 12 months, European lenders sold $893 billion of debt with durations of five years or more.
Insurers hold about 60% of banks subordinated debt, making them the largest purchasers of bank bonds, according to Paul Achleitner, finance head of Allianz, Europes biggest insurer.
The European Unions Solvency II regulations, due to be implemented in 2013, may change that. The rules make holding long-dated corporate bonds more expensive for insurers, at a time when banks are planning on selling record amounts of debt.
Without selling corporate bonds, banks may be forced to increase borrowing through loan notes from other banks, boost longer-term deposits or lend less, said Simon Willis, a London- based analyst at Daniel Stewart Securities.
Its more likely that the Basel committee on banking supervision will soften the proposed rules to allow banks the freedom not to back their liabilities with assets of the same duration, said Simon Maughan, co-head of European equities at MF Global.
By removing duration mismatching, you are condemning many of them to an unprofitable future, he said. Politically, it will not wash.
Lloyds Banking Group, Britains biggest mortgage lender, is the UK bank most in need of increasing its long- term funding, Maughan said. About half of the firms 298 billion pounds ($477 billion) of wholesale funding has a maturity of less than one year, Lloyds said in a presentation last month.
In the eurozone, banks ability to tap bond markets is more determined by the credit worthiness of the country in which they operate rather than their wholesale funding profiles, according to Maughan. Banks in Greece, Ireland and Portugal will face the greatest difficulties, he said.
Solvency II provides the amount of capital insurers need to hold against corporate bonds is directly proportional to their maturity date, regardless of their relative returns, according to a report by Morgan Stanley and Oliver Wyman Group, a New York-based consulting firm.
Firms must hold 8.2% of the face value of a five-year bond in reserve in case the issuer defaults and 16.5% for a 10-year bond, despite the longer-dated bond returning just 200 basis points more over its life, the report said. At present, European regulations only force insurers to hold capital against their liabilities, not their assets.
That makes it unattractive for insurers to invest in long-dated bank debt, said Allianzs Achleitner. You have a situation where the demand for capital is going up, but the supply of capital will actually go down, he said.
Andrew Moss, CEO of London-based Aviva, the UKs biggest insurer by sales, said insurers are lobbying Brussels to relax the new rules.
The capital required for holding long-dated corporate debt is something that needs looking at, Moss said.
Eiopa, the organisation designing Solvency II for the European commission, said the rules didnt incentivise insurers to invest in longer or shorter-term bonds.
The fallout of Solvency IIs capital charges may also encourage insurers to hold more government bonds as they are classed as free of risk, according to Legal & General Group, the UKs biggest seller of annuities. The lower return will mean a 15% cut in pensioners income if it is implemented, the insurer estimated.