Total financing volumes and financing structures are important indicators for numerous
real economic and financial developments. Financing decisions are based primarily on
investment decisions, but also provide indications for financing conditions for
companies in the money and capital markets. The financial crisis starting in 2007 and
2008 affected these markets in Germany in various ways.
The spillover of the crisis to Germany can, to a considerable degree, be
explained by the fact that German credit institutions had reached the brink of collapse.
One central problem and cause of the crisis was poor risk monitoring, for instance
through rating agencies on the US securitization market. The burden on banks due to
crisis-induced write-downs as well as the drying-up of interbank money markets, which
resulted in refinancing problems for numerous credit institutions, created a fear of a
potential ‘credit crunch’ for companies or the economy at large.
This means the main macroeconomic concern was that the restriction
on credit supply might be severe enough to cause an economic crisis.
As a result of these disturbances, the regulating authorities put forth several new
measures, provisions and rules. As a lesson learned, one central
task should be strengthening the resilience of the financial system to future crises. The
work in hand, focuses on the effects of the Basel III regulations as these, on the one
hand, are already being enforced and, on the other hand, have a considerable impact
on corporate finance and corporate banking business models.
The Basel III Accords concerning higher capital requirements for banks were already
underway before the financial crisis hit, but the legislators and supervisory authorities
accelerated their implementation after the onset of the crisis. In its aftermath, the
economy experienced historically low levels of interest rates as a result of monetary
policy. Nevertheless, the conventional wisdom of scientists, consultants, and other
experts was shaped by the experience that bank loans tend to become more expensive
and scarcer when when new regulatory requirements are introduced. They advised
companies to shift their debt capital structures from major bank loan financing, which
has historically been the major source in Germany, to more capital market financing
instruments.
Contents
Abstract
List of Figures
List of Tables
List of Abbreviations
1. Introduction
1.1. Background and Motivation
1.2. Aim and Objectives
1.3. Chosen Approach
1.4. Structure of the Study
2. Review of Literature
2.1. Debt Capital Markets and Structures in Germany
2.1.1. Universal and Economic Reflections in View of Financing Decisions
2.1.2. Funding Considerations on Business Level
2.1.3. Recent Developments in German Debt Markets
2.2. Impact of the Basel III Regulations on Financing Terms
2.2.1. Key Contents of the Basel III Accords
2.2.2. Effects of Basel III on the Financing Terms for Companies
2.3. Review of Financing Instruments
2.3.1. Equity and Mezzanine Capital
2.3.2. Debt Capital
2.3.3. Off-Balance Sheet Instruments
3. Implications for Corporate Banking Models in Germany
3.1. Challenges of Basel III for Corporate Banking
3.2. Market Potential and Overview
3.3. Behaviour of Existing Market Players and New Market Entrants
3.3.1. Existing Market Players
3.3.2. New Market Entrants
3.4. Development of Bank Loan Portfolios
4. Empirical Analysis of Developments of Capital Structures since 2007
4.1. Research Questions
4.2. Research Methodology
4.3. Research Sample
4.4. Development of German Companies’ Debt Capital Structures
4.4.1. Multinational Companies
4.4.2. Large Companies
4.4.3. Medium Sized Companies
4.5. Key Findings and Qualitative Evaluation
5. Conclusions
5.1. Aim and Objectives
5.2. Summary of the Empirical Evidence and Outlook
5.3. Outlook and Possible Future Scenarios for Banks
5.4. Research Limitations
5.5. Implications for Future Research
Publication Bibliography
Appendix
Statement of Certification
List of Figures
Figure 1: Overview of Current Regulatory Changes on the Financial Market
Figure 2: Structure of the Master's Thesis
Figure 3: Credit Constraints Indicator April 2014
Figure 4: Financing Structure of Non-Financial Corporations
Figure 5: Bank Lending Rates Germany 2007 – 2014
Figure 6: The German Corporate Bond Market January 2008 - April 2014
Figure 7: Capital Costs for Banks and Consequent Loan Pricing
Figure 8: German Corporate-Banking Market at a Glance
Figure 9: German Corporate Banking Income/Profitability Index
Figure 10: Major Drifts in the German Corporate Banking Market
Figure 11: Total Loan Volume to German Companies
Figure 12: Loan Volumes to German Companies According to Duration
Figure 13: Development of Average Equity Ratios of MCs
Figure 14: Average Bonds to Balance Sheet Total Ratio and Total Bond Volume of MCs
Figure 15: Development of Total Indebtedness and its Term Structure by MCs
Figure 16: Development of Financing Structures According to Instruments by MCs
Figure 17: Development of Average Funding Costs of Financial Debt for MCs
Figure 18: Average Operating Leasing to Balance Sheet Total Ratio of MCs
Figure 19: Average Change in Receivables Minus Change in Revenues for MCs
Figure 20: Development of Average Equity Ratios of LCs
Figure 21: Development of Total Indebtedness and its Term Structure by LCs
Figure 22: Development of Financing Structures According to Instruments by LCs
Figure 23: Development of Average Funding Costs of Financial Debt for LCs
Figure 24: Average Operating Leasing to Balance Sheet Total Ratio of LCs
Figure 25: Average Change in Receivables Minus Change in Revenues for LCs
Figure 26: Development of Average Equity Ratios of MSCs
Figure 27: Development of Total Indebtedness and its Term Structure by MSCs
Figure 28: Development of Financing Structures According to Instruments by MSCs
Figure 29: Development of Average Funding Costs of Financial Debt for MSCs
Figure 30: Average Operating Leasing to Balance Sheet Total Ratio of MSCs
Figure 31: Average Change in Receivables Minus Change in Revenues for MSCs
List of Tables
Table 1: Selected Balance Sheet Data for the Financial Analysis
Table 2: Example for the Excel TRIMMEAN Formula used in the Financial Analysis
Table 3: Summary of Empirical Analysis
List of Abbreviations
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1. Introduction
1.1. Background and Motivation
“Corporate financing is a key metric at the interface between a country’s financial sector and its real economy.”[1]
Total financing volumes and financing structures are important indicators for numerous real economic and financial developments. Financing decisions are based primarily on investment decisions, but also provide indications for financing conditions for companies in the money and capital markets.[2] The financial crisis starting in 2007 and 2008, triggered by the insolvency of US investment bank Lehman Brothers and the near-collapse of the US insurer AIG,[3] affected these markets in Germany in various ways. The spillover of the crisis to Germany can, to a considerable degree, be explained by the fact that German credit institutions had reached the brink of collapse.[4] One central problem and cause of the crisis was poor risk monitoring, for instance through rating agencies on the US securitization market, in which mortgage loans of suspect value especially were securitized to so-called residential mortgage-backed securities, a subcategory of asset-backed securities.[5] The burden on banks due to crisis-induced write-downs as well as the drying-up of interbank money markets, which resulted in refinancing problems for numerous credit institutions, created a fear of a potential ‘credit crunch’ for companies or the economy at large, in other words, a situation in which the supply of bank loans is so limited that it represents a significant economic risk. This means the main macroeconomic concern was that the restriction on credit supply might be severe enough to cause an economic crisis.[6]
As a result of these disturbances, the regulating authorities put forth several new measures, provisions and rules as shown in figure 1. As a lesson learned, one central task should be strengthening the resilience of the financial system to future crises. The work in hand, focuses on the effects of the Basel III regulations as these, on the one hand, are already being enforced and, on the other hand, have a considerable impact on corporate finance and corporate banking business models.
illustration not visible in this excerpt
Figure 1: Overview of Current Regulatory Changes on the Financial Market[7]
The Basel III Accords concerning higher capital requirements for banks were already underway before the financial crisis hit, but the legislators and supervisory authorities accelerated their implementation after the onset of the crisis. In its aftermath, the economy experienced historically low levels of interest rates as a result of monetary policy. Nevertheless, the conventional wisdom of scientists, consultants, and other experts was shaped by the experience that bank loans tend to become more expensive and scarcer when new regulatory requirements are introduced. They advised companies to shift their debt capital structures from major bank loan financing, which has historically been the major source in Germany,[8] to more capital market financing instruments.[9] The German economy is shaped to a large extent by small and medium sized companies (SMEs), the so-called German ‘Mittelstand’.[10] These companies are focusing on their core competencies and tended to pursue organic growth in the past. Approximately 99 percent of all these German companies are generating revenues of fewer than 250 million euro per year. This implies that this class of German companies has only restricted or difficult access to capital markets or alternative debt financing instruments other than bank loans. As German companies have been advised to shift their financial structures to more capital markets based funding not just since 2007 and the introduction of Basel III, certain developments in this direction might have been observable before the observation period. However, if companies are shifting in this direction, such developments could be expected to be visible during the observation period of this work, i.e. from 2007 till 2013.
From the author’s own experience in banking and as stated before, German companies’ financing activities and terms of financing are linked to a large extent to the conditions prevalent in corporate banking. Basel III imposed new burdens on all banks, which forced them to review and, in certain circumstances, adjust their business models. Because lending to German companies is very attractive as an anchor product in times of a very strong economy, while some other European countries are struggling, more and more banks focussed on corporate banking and lending to German companies during the observation period. Therefore, it is interesting how German corporate banking evolved in terms of market conditions and earning opportunities, but also on the individual level of banks whose responses and strategic initiatives will be described in short case studies.
1.2. Aim and Objectives
The purpose of this study is to examine whether German companies anticipated the potential consequences of new banking regulation, especially the Basel III Accords, like possible rises in the cost of bank loans or the potential scarcity of bank loans caused by shifts in their financing structure. Furthermore, it is necessary to analyse the impact of new banking regulations on the German corporate banking market and the recent behaviour of the relevant market participants.
This defined aim will be achieved by the following objectives:
1. Reviewing relevant literature in the area of corporate finance in Germany in order to identify (a) the characteristics of German corporate funding and (b) the recent developments and conditions in the financing markets.
2. Reviewing relevant literature about banking regulations and how the new Basel III Accords could potentially affect financing markets in the future.
3. Considering the financing instruments accessible to German companies that could be used more or, indeed, less in the future.
4. Conducting an assessment of German companies’ balance sheet data in the observation period from 2007 to 2013 and examining identifiable developments and trends in their financing activities.
5. Conducting an assessment of the German corporate banking market. Revealing trends in the past and exploring how they could affect future financing markets for German companies.
6. Determining how the findings in the literature correlate with or differ from the empirical findings.
These objectives seem appropriate, as they cover the characteristics of the German financing markets, German companies’ debt capital structures, and dependencies with all relevant determinants regarding the corporate banking market.
1.3. Chosen Approach
To initiate the study, relevant secondary sources and documents were gathered and analysed. The primary research within this master’s thesis was a combination of a quantitative and qualitative approach. The reason for adopting such a mixed approach was, primarily, its ability to offer the author the ability to gain different perspectives regarding the topic and the possibility to substantiate the quantitative findings with qualitative data. Furthermore, the mixed approach is considered an appropriate and worthwhile means to generate reliable results, which are essential to answer the proposed research questions from the literature review and the background motivation. In addition, one can identify two central themes: the development of the capital structures of German companies and the development of corporate banking business units at German banks. The former is analysed by gathering and analysing data, whereas a descriptive approach is more adequate for the latter.
1.4. Structure of the Study
The structure of the master’s thesis is illustrated and described in figure 2. The work first addresses the characteristics and developments in the financing markets in Germany. It then presents an overview covering the contents of the Basel III provisions which are relevant for lending purposes. A brief outline of the common financing instruments, which will be considered in the subsequent examination, will be provided in the following chapter. In the main part, an empirical examination will consider whether the companies followed the external advice of shifting their debt capital structures since 2007. Several possible explanations of these findings could be observed in the recent developments in the banking market. Therefore, it is necessary to also analyse recent developments at banks in a descriptive examination, not least with a view to valid facts such as the development of the loan portfolios to German companies. This work will give an in-depth insight into the German corporate banking market with its past, current, and prospective future developments. Due to the complex interactions and the high integration of the finance economy with the real economy, it will not be possible to offer fully reliable forecasts of future developments. But this master’s thesis intends to find ways to prove and illustrate the diverse impacts of new bank regulations on debt capital structures and German corporate banking business models.
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Figure 2: Structure of the Master's Thesis[11]
2. Review of Literature
The following chapter will present current academic findings and practical evidence concerning recent developments in the debt capital markets and structures in Germany. Furthermore, it will give an overview of the substantive contents of the Basel III Accords and their expected influence on financing terms for German companies. Literature and recent findings about the German banking market, especially the corporate banking market, and its recent evolution will be examined in chapter 4.
2.1. Debt Capital Markets and Structures in Germany
The subsequent section will give an overview of the macroeconomic and microeconomic environment in which corporate finance is taking place. It gives an insight into external influencing factors and scientific findings about financing decisions on the level of individual companies. Furthermore, this chapter will describe recent developments in the debt markets in Germany. The available empirical evidence on company financing in Germany is quite limited due to a lack of adequate data sources. German disclosure regulations require stock corporations, limited liability partnerships, and partnerships completely owned by these two company forms to submit their annual reports to publicly accessible registers. Small and medium sized enterprises (SMEs) have to disclose their annual reports only if they satisfy two of three of the following criteria: They have a balance sheet total of more than 65 million euro, their annual turnover is more than 130 million euro, or they employ more than 5,000 people. Therefore, only a minority of SMEs discloses annual figures.
When analysing German companies’ financing, one therefore has to rely to a large extent on survey evidence, which means qualitative information. Most available studies, which are mostly released by banks, trade associations, and some academic institutes, provide information about the situation of the companies themselves and their economic environment, and only to a lesser extent about debt capital structures, financing cost, and other quantitative information of interest.[12] Nevertheless, several other data sources, like comprehensive statistics by the German Central Bank, are available. These figures and the above mentioned surveys will be consolidated and evaluated in this chapter. However, it its necessary to gather primary information, as it will be illustrated in chapter 4, to get a clear impression of and evidence for recent developments.
2.1.1. Universal and Economic Reflections in View of Financing Decisions
Companies’ financing and financial structures reflect various real economic and financial factors. Corporate financing data represents information about macroeconomic developments, as financing decisions are primarily based on investment decisions, while also reflecting financing conditions within the company’s sector of industry. Therefore, it is necessary to not examine corporate financing decisions in isolation, but in fact against the background of the economy at large. Corporate financing also has a lot of significance for the monetary policy of central banks, because it influences the effectiveness of monetary policy measures. Adjustments to the policy interest rate and therefore the ‘interest rate channel’ change funding costs and impact on investments, economic growth and price developments at the back end. Monetary policy can also affect companies’ access to funds through the ‘credit channel’ and thereby influence economic developments and prices.[13] In principle, an economy consists of the production, distribution, and utilisation of goods, the so-called real economy, and the corresponding financial activities and intermediation, the so-called financial economy. Financing is essentially the provision of funds for the purpose of financial or real economic activities. In the case of external financing, external funds are raised for this purpose, while own funds like profits are used for internal financing.[14]
In comparison to counterparts in other, especially Anglo-Saxon, countries, the financing behaviour of German companies in the past can be described in terms of five facts observed by Hommel and Schneider: low equity ratios, strong dependence on internally generated cash flow, equity deposits by owners, trade credit, and bank debt as the primary forms of external financing, and only minor relevance of alternative forms of financing, such as through capital markets.[15]
German companies have increased their total financing volume over the past two decades, not least since 2007. According to the Deutsche Bundesbank,[16] this can be attributed to overall economic growth. On the one side, internal funds have been the major source and have been increasing synchronously with the overall financing volumes. On the other side, external financing has been more cyclical and correlated to recent economic developments. In other words, companies demand financing funds as a consequence of investment decisions. These decisions are only made when these actors expect constant and stable economic growth, which is necessary for the returns on their investments. Furthermore, structural shifts have been observable within external financing, that is, the debt capital structures of German companies. Above all, there has been a change in the type of the lenders. While loans have been the most important instrument for external financing, they are offered more and more by substitutes of traditional banks. The intermediation services of the traditional credit business have declined as a consequence. The reasons for this trend can be found in the changing macroeconomic and institutional environment, the growing economic integration, more stringent regulatory requirements and changes in corporate taxation according to the Deutsche Bundesbank.[17]
2.1.2. Funding Considerations on Business Level
As already addressed in the paragraph before, companies have numerous financial instruments at their disposal. Some of them will be explained in brief in chapter 2.3. They differ in terms of the source of the funds, such as the distinction between internal funds and external funds, and the legal position of the capital providers, for instance debt holders or equity holders. When analysing the determinants of the financing behaviour of German companies, the question under examination is closely associated with the question of optimal financing volumes and structures. Generally, it is assumed in scientific discourse that companies and their managers will strive for the maximisation of their companies’ values. Based on the present value approach, the maximized company value equates the sum of all company’s future cash flows discounted by applying the cost of capital.[18]
Capital structure decisions would be irrelevant in a perfect world according to Modigliani and Miller, who defined fairly strict conditions for such a state.[19] But due to real-world imperfections, which will be addressed as part of the following theories, a certain level of equity and debt is actually desirable from a value-maximising point of view, because debt is, under normal circumstances and up to a certain level, cheaper than equity.[20] This is the case when an increase in the percentage of external capital lowers the average cost of capital. However, an increasing volume of net cash flows is now used to service interests on debts, and the residual claim of equity providers declines in turn. This increases the risks of the equity and as a consequence the required returns on equity.[21]
Using external financing in business is described in financial theory and, even more, in reality as a function of taxes, indirect bankruptcy cost, transaction cost, and the existence of information asymmetries, more specifically principal agent problems. Systematically, these determinants may be summarized with two different theories. One approach to explain financial decision-making in companies is the ‘Trade-Off Theory’. The core of this theory consists in considering the balance between the cost of bankruptcy and the tax shields of debt. The other, more practice-oriented approach is the ‘Pecking Order Theory’. This theory assumes that the cost of financing increases with asymmetric information and that companies should prioritize internal financing.[22]
Information aspects and the institutional set-up are important for decisions on the structure of external financing. Due to the advantages in monitoring borrowers, banks generally have cost advantages as compared to other providers of external funds. In addition to that, the access to market-based forms of financing, like the issuance of corporate bonds, imposes special requirements, such as higher transparency.[23] This and the structure of the corporate sector in Germany, which is characterized by many SMEs, are the reasons for why market-based financing played only a minor role in the past.[24]
Smaller companies face tighter financial constraints than larger ones.[25] Nevertheless, Müller et al. identified and defined seven criteria for financing decisions in general:[26]
1) Cost of capital
2) Impact on equity value and shareholders
3) Impact on liquidity or rather on cashflow
4) Availability of funds in the market
5) Disclosure or transparency requirements
6) Limited influence of the investors
7) Duration of the capital transfer
The costs of the different financial instruments can differ significantly. Furthermore, it has to be considered whether fixed or variable financing cost fit the corporate strategy better. Further explanations and definitions of the individual instruments are excluded at this point, as their mechanisms should be well known. A brief introduction will be given in chapter 2.3..
2.1.3. Recent Developments in German Debt Markets
For researching recent trends and developments in the German debt markets, this study relies mainly on reliable data from central banks, German Institutes, and selected academics publications. The historical developments of the debt markets can be commented on from two perspectives: from the supply side and the demand side. Starting with the supply side, it can be said that it has never been as easy as nowadays for German companies to access credit, according to the ‘Credit Constraint Indicator’ (CCI) of the Ifo Institute.
Since spring 2003, the German Ifo Institute has regularly surveyed approximately 7,000 German companies in the industry and trade on their assessments of bank lending policies. The CCI has been in the public domain since November 2008.[27] According to its survey for April 2014, only 18.2 percent of all companies reported problems with obtaining credit. This is the lowest value since the indicator was first produced in 2003. This fall was observable for all sizes of companies in manufacturing.[28] The following figure 3 shows the survey results since its beginning:
illustration not visible in this excerpt
Figure 3: Credit Constraints Indicator April 2014[29]
Although the sample period is comparatively short, which could be a reason for the fact that only a few studies concerning this survey have been conducted so far, several observations are possible. One observation which can be made is the fact that companies reported a sharp increase in difficulties getting loans after the beginning of the year 2008. This decline in bank lending to non-financial corporations happened in the aftermath of the financial and economic crisis of 2007 to 2009.[30] The reason for the time lag of one year between the Lehman shock, the starting point of the crisis, and the occurrence of a deterioration in bank lending supplies could be the fact that banks deleveraged initially through other asset positions than loans to the private sector.[31]
According to the Eurosystem’s Bank Lending Survey (BLS), which looks directly at banks’ credit supply, large companies were hit much harder than SMEs by the stricter lending standards immediately after the start of the crisis. This is presumably partly because saving banks and credit cooperatives, which are the most important lenders to SMEs, were initially less severely affected by the crisis and did not adjust their credit standards until the general economic situation deteriorated. The fact that interest rates for corporate lending in Germany tended to be lower than forecasted by models before the crisis also argues against a broad-based credit crunch in Germany.[32]
Because it is not obvious whether the slowdown in bank lending following the financial crisis was primarily attributable to a retrenchment in loan supplies or to weak loan demand caused by the contraction in economic activities, it is also necessary to comment on the developments on the debt market from the demand perspective.
As studies of the Deutsche Bundesbank whose aggregated findings are illustrated in figure 4 show, external financing of corporations has been developing dynamically since 2007. In common with the patterns mentioned in the discussion of loan supplies, a sharp fall in external financing was observable in 2008 and 2009 as a result of the crisis. It later recovered as the economic situation improved in the following years. However, with a short time lag to the onset of the sovereign debt crisis, external financing once again declined in 2012.[33] Against the backdrop of mean investment activities, the growth of external financing remained at a low level in 2013.[34] This should not be ascribed to reduced loan supplies, but to a demand driven situation. Companies were enjoying very good profits and have had sufficient internal financing opportunities to finance investments. Other companies have benefited from the low level of interest cost already beforehand and were now showing that they had sufficient external funds.[35] Also shown in the lower part of figure 4 is the dominance of credit financing, which was the most important financing instrument in the period under observation. Loans are here distinguished between ‘Loans from MFIs’ and ‘Loans from non-MFIs’, with MFIs referring to monetary financial institutions, i.e. mainly banks. Non-monetary financial institutions can, for instance, include other associated companies or loans from shareholders. When banks were restricting their lending practices more in 2009, other financial intermediaries and insurance corporations became more important as lenders. Trade credits have also been used to a greater degree in recent years. Conversely - and with considerable relevance for the work in hand - capital market-based financing largely played no significant role, as neither shares nor bonds were issued in significant quantities or with increasing proportions in Germany before 2011. While in other countries of the European Monetary Union, bank loans were substituted by capital market-based financing as a result of the financial crisis, Germany rather witnessed changes in the structure of the lenders.[36]
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Figure 4: Financing Structure of Non-Financial Corporations[37]
Another indicator for the developments on the debt markets are the interest rates charged for bank loans. The European Central Bank (ECB) has been collecting the interest rate statistics on a harmonised basis from the central banks in the Euro zone since 2003. The MFI interest rate statistics measure the interest rates applied by domestic banks and the volumes of new loan business on a monthly basis.[38] It is possible to collect such data on a very detailed level. The lending rate is the bank rate which usually meets the short and medium-term financing needs of the private sector. Even if it is not very accurate and also includes loans to households, it communicates the most important message, i.e. the trend of the interest rate prices, as shown in the figure 5. This average bank lending rate for Germany is based on data from the Deutsche Bundesbank and illustrates interest rate developments since 2007. It can be seen that the interest rates decreased constantly over a certain time. The all-time high was reached in December of 2007, whereas a record low was registered in August 2013.[39]
illustration not visible in this excerpt
Figure 5: Bank Lending Rates Germany 2007 – 2014[40]
For the examination of the importance of external financing alternatives to bank loans, it is essential to cast a glance at the bond market. Figure 6 shows the development of the outstanding amount of corporate bonds and the corporate bond yields since 2008, based on Deutsche Bundesbank datasets. The volume of corporate bonds in Germany rose in recent years to 117 billion euro in round numbers, whereas the yields on these bonds declined in recent years. One reason for this decline is the ubiquitously low level of interest rates. Another reason could be the growing demand for German corporate debt, issued in euros and backed by the financial strength of ‘Made in Germany’ companies with strong economics.
illustration not visible in this excerpt
Figure 6: The German Corporate Bond Market January 2008 - April 2014[41]
Further research of the Deutsche Bundesbank and its report on long-term developments in corporate financing in Germany show that bank loans have been the most important source of external finance in recent years, with an average of about 33 percent of total liabilities from 1991 to 2010. Most of these loans were granted by banks, but this dominance declined from a share of 32 percent in 1991 to 18 percent in 2010. Other loan providers, by contrast, have increased their share to a substantial degree. Other creditors are, for instance, insurers, other financial institutions as well as other or sometimes company-owned enterprises. Especially in phases in which external financing was reduced, non-banks indeed increased their market share.[42]
By the end of 2007, the overall volume of external financing was at a peak, with over 170 billion euro in Germany. After the collapse of Lehman Brothers in the autumn of 2008, short-term loan supply was disrupted completely for the following quarters. This development was a result of stricter credit standards by all banks as a consequence of the impending crisis. This lack of financing opportunity was partly compensated for by long-term loans and more market-based financing.[43] Companies in Germany are used to long-term financing, which reflects their risk aversion. About two-thirds of all loans granted to companies having a duration of over 5 years.[44]
2.2. Impact of the Basel III Regulations on Financing Terms
Basel III has different consequences, and acts differently depending on the consignee. In the following chapter, the key points of Basel III, with relevance to company funding, will be described. Moreover, the expected effect or the conventional wisdom on the impact on financing conditions for enterprises will be summarized.
In 2009, in the time period in which the economies worldwide suffered from the financial crisis, the heads of state and government of the G20 states met in Pittsburgh and decided to improve the resilience of the financial markets by means of new regulations on banking supervision. This task was given to the Basel Committee on Banking Supervision (BCBS), which published in December 2010 the new Basel III Accords.[45] The objective of these new regulations is to improve the banking sector’s ability to absorb shocks arising from financial and economic stress, thus reducing the risk of spillover from the financial sector to the real economy.[46] Following subchapters will outline the essentials of the new regulations and their expected impact on financing terms. The Basel standards generally define requirements applying to financial institutions and to supervisors. Basel I was introduced in 1988 after a long period of instability in the financial system after the breakdown of the Bretton Woods system in 1973. It was the first regulation recommendation for a set of minimum capital requirements. Basel II was later developed to supersede the Basel I Accords and has been in force since 2004.[47]
The Basel III Accords have therefore a novelty status and they an unprecedented, not completely foreseeable impact on the financial markets. Thus, there are no long-term studies or scientific in-depth analyses based on research with long time series available. Following paragraphs are therefore mainly based on the original punishments by the BCBS, comments by the German Central Bank, the Deutsche Bundesbank, some recently published papers and journal contributions and expectations and estimates made by large and well known consulting firms.
2.2.1. Key Contents of the Basel III Accords
Unlike the two previous accords, Basel III addresses not only the risk of bank losses from various classes of loans, other investments and assets, but also and primarily the risks occurring from potential bank runs by requiring different levels of reserves. Among the new regulations, the following key principles can be outlined:[48]
Higher capital requirements through capital buffers and a higher quality of equity capital.
Introduction of the two liquidity ratios LCR and NSFR.
Introduction of a minimum leverage ratio of 3 percent.
The new definition of the elements of core capital, respectively the regulatory capital, is one of the major changes under the Basel III provisions.[49] Total regulatory capital will consist of Tier 1 Capital, the going-concern capital, and Tier 2 Capital, the gone-concern capital.[50] This means, that Tier 1 capital should compensate continuously expected losses while Tier 2 capital is only sustainable in the case of a bankruptcy and the liquidation.[51] Tier 3 capital, responsible for hedging market price risks under Basel II, is cancelled out completely.[52]
Additionally, there are the new definitions of minimum capital requirements in Basel III, which require a higher quantity of equity capital.[53] Under the new requirements and with the arrangements fully phased-in from 1st January 2019 onwards, banks are required to hold a minimum common equity tier 1 (CET 1) capital ratio of 4.5 percent, which means an increase of 2 percent compared to the former Basel II requirements, and 8 percent minimum common equity plus capital conservation buffer of the risk-weighted assets (RWA) of the bank.
Appendix 1 provides a further overview with regard to Basel III and the respective phase-in arrangements until 2019. The capital conservation buffer should be built and sustain periods of stress to absorb potential future losses. Provision for the Minimum Total Capital is a ratio of 10 percent, compared to 8.5 percent under current Basel II requirements. An additional capital buffer, the countercyclical buffer, will be introduced in 2016. It will be between 0 percent and 2.5 percent, and it aims to account for the macro-financial environment and hedge against systemic industry-wide risks.[54] Additionally, the provisions for large exposures will be tightened. The threshold will be oriented and calculated with the core capital instead of the total capital as before. Furthermore, the definition of the borrowing entity will be expanded.[55]
Beyond that, Basel III introduces two liquidity ratios to require a bank to hold sufficient high quality liquid assets to cover its total net cash outflows for 30 days, the Liquidity Coverage Ratio (LCR), and the available amount of stable funding to exceed the required for a horizon of 1 year of extended stress, such as a bank run, the Net Stable Funding Ratio (NSFR). The NSFR, or ‘stable funding requirement’ as it is named in the CRD IV-package,[56] further ensures that illiquid assets, like company loans, are refinanced by stable sources for 12 months. By implication, this means that the term transformation activity will be limited and long-term loans have to be refinanced by banks with more matching maturities.[57]
The liquidity requirements could lead to higher demands for deposits and a stronger competition for deposits. This would drive down margins.[58]
The leverage ratio is simply the calculated difference between CET 1 and the bank's total exposure. This is contrary to the usual understanding of a leverage ratio in a company (debt/equity), and integrates the business volume.[59] The current time schedule puts the implementation of the leverage ratio in the year 2018, even though the observation period already began in 2013. From 2015 onwards, banks will be forced to disclose their leverage ratio.[60]
According to the BCBS, one underlying feature of the recent crisis was the build-up of excessive on and off-balance sheet leverage in the banking systems. Since all off-balance sheet liabilities have to be considered in the exposure measure, the new leverage ratio should avoid a repetition of excessive leverage among banks by innovative means or other dodges.[61]
2.2.2. Effects of Basel III on the Financing Terms for Companies
Several studies have examined the implications of the new capital requirements for banks at a national level,[62] at EU level,[63] and also at a global level.[64] Most studies suggested that larger banks are more affected by Basel III than smaller ones.[65] The overall German banking sector has to increase its core tier 1 capital by around 50 billion euro over the late-2009 level by the year 2018 in order to comply with the required minimum capital ratios, according to the Deutsche Bundesbank.[66] Banks have three basic opportunities to cover this additional capital requirement:[67]
(1) Increase of capital
(2) Deleveraging through downsizing of risk weighted assets
(3) Retention of earnings
Considering that banks will have to maintain more equity capital, which is comparably more expensive, for their loan supply to companies, most experts come to the conclusion:
“Financing cost through bank loans are about to rise under Basel III and the overall loan supply could decline, indeed it could lead to a credit crunch.”[68]
Identifying a credit crunch empirically is difficult, as demand and supply-side factors in lending cannot be clearly differentiated in hindsight.[69] Nonetheless, the traditional relationship in lending would face large-scale changes.[70] This is also reflected by the opinions and expectations among German companies. A survey, conducted in 2012 by the Commerzbank AG, revealed that 80 percent of the companies expect to have more difficulties with loans because of Basel III. And 77 percent of the companies expect higher financing cost.[71] When considering the potential effects of Basel II before its implementation, many experts expected more restrictive bank lending policies already at that time.[72]
While most studies about Basel III do not expect a downward adjustment of loan supplies and therefore credit volumes, Deutsche Bundesbank anticipates a reduction of 3 percent in its long-term forecasts until 2018.[73]
The increased capital requirements under Basel III raise the production costs for loans proportionally to the current capital cost. ‘Proportionally’ means that the effect on poorer ratings and unsecured loans as well as longer maturities is greater. The liquidity ratios provide additional burdens for long-term loans.[74] Since there may occur a gap between current pricing and banks’ cost of equity capital at a higher level of capital and liquidity requirements, banks have several choices to react. As their economic profitability might decline, they could either:[75]
a) Increase pricing for products with comparatively high capital lockup.
b) Reduce supply for products with comparatively high capital lockup.
c) Revise terms for products with comparatively high capital lockup.
d) Absorb part of the cost and reduce their Return on Equity (RoE) targets
In the long run, it also has to be considered that enhanced capital requirements could lead to lower risks or lower betas for investors. This would mean that the cost of equity for banks would be pushed down.[76] Although this seems realistic, there is also evidence that banks may not necessarily achieve lower betas through higher capital ratios. Gual’s paper of December 2011 finds that, for instance, if banks begin to take on higher risks respectively assets with higher risks on their asset side in order to maintain their RoE, they will not be less risky at all.[77]
Regarding the fear of lower loan supply, it can be argued that long transition period allows banks a gradual adjustment to the new provisions. The length of these periods attempts to avoid effects like a credit crunch.[78]
Another fear coming from the increasing capital requirements for banks is the negative influence on economic growth. From an economic point of view, it is questionable whether these additional capital requirements for banks will influence future economic growth negatively. Some argue that higher capital requirements for banks are limiting loan supplies. This in turn would mean that not all economically worthwhile investments would be made due to a lack of funding opportunities.[79]
For a critical discussion of the argument or indeed fear of raising loan costs, it is necessary to consider the composition of loan cost, illustrated in the figure below, which shows the calculation components of loan costs. Short descriptions for measuring and managing credit risk through the two measures expected loss (EL) and unexpected loss (UL) can be found in the appendix 3. Since risk is not the expected, but indeed unexpected write-down cost, the expected cost is covered in the bank Pamp;L. Another illustration covering this issue can be found in the appendix 4.
The pricing formula for the traditional lending business can be divided into four cost components as shown in figure 7: refinancing costs, operational costs, EL, and return on economic capital or UL. Refinancing costs are about to rise under Basel III due to less opportunity for term transformation on the liabilities side and the need for high-quality assets on the asset side because of the LCR and the NSFR. Operational costs could rise because of the need for an alignment of the risk processes with higher complexity also in the long-run. The credit risk is divided into two parts in the calculation: the EL and the UL. The EL is covered by the standard-risk costs whereas the UL has to be covered by equity capital. For this capital, the shareholders require returns which is also called the target RoE. At the moment when more equity capital is required, as is the case with Basel III, this cost component could rise.[80]
illustration not visible in this excerpt
Figure 7: Capital Costs for Banks and Consequent Loan Pricing[81]
To be prepared for the mentioned risks to liquidity supplies, companies are offered different advice and guidance by scientists, bankers, consultants, and other experts.
Measures should be undertaken to enhance ratings, thus facilitate access to loans and cheapen their cost, and enable access to financing alternatives, which should become more important according to present research.[82] These alternatives are manifold and their characteristics play a major role; therefore, they were discussed in the additional chapter 2.3.
Measures to improve the creditworthiness ratings can be distinguished in three categories according to Waschbusch et. al.:[83]
Firstly, there is the generation of a higher transparency in the rating process and improved communication with the bank for an improvement of financial standing in the short term.[84] As bank lending is always a forward-looking decision, it is important to provide documents relating to the current and past situation, like annual reports, as well as valid quantitative and qualitative forecasts.[85]
Secondly, there is the opportunity to optimize the annual report for an improvement of the financial standing in the medium term. This could be the usage of freedom to choose the accounting standards, but also detailed descriptions of the individual positions in the appendix and the management report. For internationally oriented companies, it could be helpful to create an IFRS-compliant report to attract foreign investors.[86]
And thirdly, one can mention the establishment of efficient risk management to improve the financial standing in the long term. Efficient risk management comprises a multi-step process, consisting of a risk analysis in the first step, risk coverage and mitigation in a second step, and the continuous monitoring of risks in a third step.[87]
As of the time of writing this study, there were only a few papers addressing the problem that additional capital requirements for banks would lead to stricter lending standards and higher credit cost.
Admati et al. argue against cut backs on lending and automatically higher cost for loans. They are arguing against a decline in bank lending, as there is no mechanical limit. Banks could therefore maintain all existing assets and reduce leverage through equity issuance, for instance. Regarding the automatically higher funding cost for banks, they mention the fact that the required RoE, which includes a risk-premium, must decline when more equity is used. Any argument that holds the required RoE fixed when evaluating changes in equity capital requirements would be fundamentally flawed.[88]
2.3. Review of Financing Instruments
Even if temporary fears of systematic credit rationing and increased credit costs appear unjustified, the afore described possible impact of recent bank regulations indicate a need to search for alternative financing.[89] Financial instruments are numerous and, as a result of their often different and individual peculiarities, hard to cover exhaustively. This chapter will give an overview and short descriptions as well as pros and cons, where applicable, for common instruments.
To react to possible changes in the financing markets, companies can, on the one hand, strengthen their equity base and, on the other hand, diversify their debt capital structure. As a supplement to bank loans, companies can in particular consider long-term financing instruments.[90] The following introduction to common financial instruments is split into three groups according to their characteristics: equity and mezzanine capital; debt capital and off-balance-sheet instruments.
2.3.1. Equity and Mezzanine Capital
Taking in equity capital can be one way of strengthening the liability side of the balance sheet and diminish leverage.[91] As smaller companies might in some cases be facing a lack of appeal for investors because of low return expectations proportional to their risks, they have the opportunity in Germany to raise capital from state-owned investment companies, the so called ‘Mittelständische Beteiligungsgesellschaften’ (MBGs).[92] As equity holders or investors want to have a say in the company, this financing alternative can be very unpopular with companies and their existing shareholders.[93] Furthermore, the short holding periods of private equity investors are irreconcilable with the long-term financing needs of the Germany companies.[94] Nevertheless, it can also be worthwile to gain knowhow from new investors if they are experienced in a certain sector for instance.[95] To avoid giving the investor a voice, companies can also raise mezzanine capital. This is a mixed form of equity and debt capital. Normally, it has a fixed interest rate, a fixed duration, and other subordinate characteristics. Due to this subordination, it is attributed to equity capital by banks. Transactions are feasible already for sums below one million euro. Preparation can be costly and the interest rate cost are normally in the double-digit range. Mezzanine capital or so-called participation rights can also be securitized to participation papers and traded at organized capital markets.[96] Other mezzanine instruments are silent partnerships and convertible bonds as well as warrant bonds.[97] In the following examination, these instruments will be pooled and referred to as mezzanine capital. For companies with a difficult access to bank loans, it is even harder to raise mezzanine capital due to the higher risk profile.[98]
2.3.2. Debt Capital
Larger companies with access to the capital market have further financing opportunities in addition to common bank loans. One can distinguish between instruments on the private capital markets and instruments on the public capital markets, the so-called organized capital markets. Investors on the private, unorganized capital markets are relationship banks, insurances, or funds. The public capital markets have a more anonymous investor base. This is also the reason for one-way communication with borrowers.[99] Common instruments on the private market are ‘Schuldscheindarlehen’ (SSDs)[100] or Private Placements and Direct-Lending respectively Unitranche structures. Common financing instruments, which are accessible through public markets are ‘Investment-Grade-Bonds’, ‘High-Yield-Bonds’, and ‘Unrated-Bonds’.
SSDs are a mixed form of traditional credit financing and capital market financing, hence they are described as a first step and access to capital market financing for investment grade companies. Borrowers can diversify their investor base and ensure their medium-term financing, especially in times of volatile markets. Typical investors are banks, insurance companies, and specialized funds. SSDs are possible from a volume of 5 million euro upward, depending on the company, since it can be difficult to find investors for small amounts.[101] They normally have durations of 3 to 7 years, while 10 years are also possible.[102] Investors demand a certain degree of transparency, which is considerably lower compared with the requirements when issuing a bond. External rating is not required. The issuance cost are normally also lower compared with bond issuance.[103] Another financing alternative for companies interested in financing in US dollars are US-Private Placements. Investors are primarily US assurance companies specialized on the buy-and-hold-strategy, which means they hold the debt until maturity. Common sums lie between 150 and 350 million US dollars. US-Private Placements are worth considering when there is an opportunity for a natural hedge in USD through the company’s cash flow.[104]
For non-investment-grade companies, more and more direct lending structures with insurance companies and funds are on the ascendent. These are individually negotiable financing structures with only a single or very few investors.[105]
Instruments in the public capital market are typically bonds, which can be distinguished by ratings. High-yield bonds and unrated bonds can have small volumes and are also known as ‘Mittelstandsanleihen’ in Germany. The disadvantage of issuing such bonds are their complex transaction structures, extensive and costly documentation, and extensive obligations for public disclosure. Because of the high fixed offering cost, bonds are normally issued from 100 to 200 million euro upward. Clearly, there are also many advantages, such as the possibility for long terms of up to 10 years, the final maturity, and the diversification of the investor base, implying greater independence from banks. Companies can also use bonds to increase their publicity, which can have positive effects in terms of stock price management for listed companies.[106] For most German SMEs, corporate bond markets will remain foreclosed due to the notional minimum.[107]
[...]
[1] Deutsche Bundesbank (2012), p. 14.
[2] Cf. ib. (2012), p. 14.
[3] Cf. Angelkort Stuwe (2011), p. 6; Deutsche Bundesbank (2010a), p. 20.
[4] Cf. Deutsche Bundesbank (2010a), p. 18.
[5] Cf. Berg Uzik (2011), p. 6.
[6] Cf. Deutsche Bundesbank (2010a), p. 36; Blaes (2011), p. 1.
[7] Commerzbank AG Intranet (2014).
[8] Cf. Schwartz Braun (2013), p. 4.
[9] Cf. Kaserer et al. (2011), p. 11.
[10] Economic and business historians give ‘Mittelstand’ companies many credit for Germany’s economic growth. The ‘German Mittelstand’ is also often referred to as ‘Hidden Champions’.
[11] Author‘s own diagram.
[12] Cf. Hommel Schneider (2003), p. 55.
[13] Cf. Deutsche Bundesbank (2012), p. 14; Deutsche Bundesbank (2001), p. 51 ff.
[14] Cf. Deutsche Bundesbank (2013a), p. 5.
[15] Cf. Hommel Schneider (2003), p. 57.
[16] Engl.: German Central Bank.
[17] Cf. Deutsche Bundesbank (2012), p. 13.
[18] Cf. ib. (2012), p. 14.
[19] Cf. Modigliani Miller (1958).
[20] Cf. Hommel Schneider (2003), p. 57.
[21] Cf. Deutsche Bundesbank (2012), p. 14.
[22] Cf. Bassen et al. (2013), p. 147 f.
[23] Cf. Deutsche Bundesbank (2012), p. 15.
[24] Cf. ib. (2012), p. 21.
[25] Cf. Bassen et al. (2013), p. 146.
[26] Cf. Müller et al. (2006), p. 194 ff.
[27] Cf. Ifo Institute (2014a).
[28] Cf. Ifo Institute (2014b), p. 1.
[29] Ib. (2014b), p. 1.
[30] Cf. Blaes (2011), p. 1.
[31] Cf. ib. (2011), p. 21.
[32] Cf. Deutsche Bundesbank (2010a), p. 37 ff.; European Central Bank (2014a).
[33] Cf. Deutsche Bundesbank (2013a), p. 15.
[34] Cf. Deutsche Bundesbank (2014c), p. 15.
[35] Cf. DSGV (2014), p. 45.
[36] Cf. Deutsche Bundesbank (2013a), p. 15.
[37] Deutsche Bundesbank (2013a), p. 14.
[38] Cf. Deutsche Bundesbank (2014b).
[39] Cf. Trading Economics (2014).
[40] Based on ib. (2014).
[41] Author’s own diagram with data from Deutsche Bundesbank (2014b).
[42] Cf. Deutsche Bundesbank (2012), p. 21.
[43] Cf. ib. (2012), p. 22 ff.
[44] Cf. Barthel et al. (2012), p. 5.
[45] Cf. Angelkort Stuwe (2011), p. 6.
[46] Cf. Basel Committee on Banking Supervision (2011), p. 1.
[47] Cf. BaFin - Federal Financial Supervisory Authority Germany (2014); Basel Committee on Banking Supervision (2013), p. 1 ff.
[48] Cf. Angelkort Stuwe (2011), p. 8; Basel Committee on Banking Supervision (2011), p. 1 ff.
[49] Cf. Waschbusch et al. (2012), p. 192.
[50] Cf. Basel Committee on Banking Supervision (2011), subs. 49.
[51] Cf. Deutsche Bundesbank (2011b), p. 15.
[52] Cf. ib (2011b), p. 10.
[53] Cf. ib. (2011b), p. 17.
[54] Cf. Basel Committee on Banking Supervision (2011), subs. 136 ff.
[55] Cf. Eggers Hortmann (2011), p. 51.
[56] Cf. The European Parliament and the Council of the European Union (2013), p. 12.
[57] Cf. Betghe et al. (2013), p. 11 f.; Kraus et al. (2014), p. 193.
[58] Cf. Dayal et al. (2011), p. 21.
[59] Cf. Commerzbank AG (2012b), p. 10.
[60] Cf. Basel Committee on Banking Supervision (2011), subs. 153.
[61] Cf. Basel Committee on Banking Supervision (2011), p. 2 ff.
[62] Cf. Deutsche Bundesbank (2010b), p. 108 f.
[63] Cf. Grasshoff Neu (2010), p. 14 ff.; Härle et al. (2010), p. 4 ff.; CEBS (2010), p. 3 ff.
[64] Cf. Basel Committee on Banking Supervision (2010).
[65] Cf. f.i. Basel Committee on Banking Supervision (2010), p. 2; CEBS (2010), p. 3.
[66] Cf. Deutsche Bundesbank (2010b), p. 108.
[67] Cf. Nagel (2011), p. 7.
[68] Cf. f.i. Betghe et al. (2013), p. 9 ff.; Waschbusch et al. (2012); Hellmich Siddiqui (2014b); Angelkort Stuwe (2011), p. 15; Kraus et al. (2014), p. 192; Sträter Dubiel (2013), p. 18.
[69] Cf. Deutsche Bundesbank (2010a), p. 36.
[70] Cf. Kraus et al. (2014), p. 192.
[71] Cf. Commerzbank AG (2012a), p. 26.
[72] Cf. Waschbusch et al. (2012), p. 192.
[73] Cf. Deutsche Bundesbank (2010b), p. 8; Waschbusch et al. (2012), p. 193.
[74] Cf. Commerzbank AG (2012b), p. 14.
[75] Cf. Chivukala et al. (2014), p. 1; Dayal et al. (2011), p. 21.
[76] Cf. Chivukala et al. (2014), p. 5.
[77] Cf. Gual (2011), p. 6 ff.
[78] Cf. Nagel (2011), p. 8.
[79] Cf. ib. (2011), p. 8.
[80] Cf. Hellmich Siddiqui (2014a), p. 2.
[81] Hellmich (2013), sl. 63.
[82] Cf. Waschbusch et al. (2012).
[83] Cf. Waschbusch et al. (2012).
[84] Cf. Müller et al. (2011), p. 23.
[85] Cf. Müller et al. (2011), p. 23; Waschbusch et al. (2012).
[86] Cf. Müller et al. (2011), p. 24; Waschbusch et al. (2012).
[87] Cf. Waschbusch et al. (2012).
[88] Cf. Admati et al. (2011) p. i ff.
[89] Cf. Hommel Schneider (2003), p. 69; Fitschen (2013).
[90] Cf. Barthel et al. (2012), p. 5
[91] Cf. Bieg Kussmaul (2009), p. 51.
[92] Cf. Waschbusch et al. (2012).
[93] Cf. Hellmich Siddiqui (2014b).
[94] Cf. Hommel Schneider (2003), p. 70.
[95] Cf. Barthel et al. (2012), p. 12.
[96] Cf. Barthel et al. (2012), p. 10; Hellmich Siddiqui (2014b).
[97] Cf. Grunow Figgener (2006), p. 191 ff.
[98] Cf. Hommel Schneider (2003), p. 71.
[99] Cf. Kraus et al. (2014), p. 194.
[100] Engl.: Bonded loans.
[101] Cf. Höhmann (2011).
[102] Cf. Grunow Figgener (2006), p. 169 f.; Kraus et al. (2014), p. 196; Barthel et al. (2012), p. 7.
[103] Cf. Barthel et al. (2012), p. 7.
[104] Cf. Kraus et al. (2014), p. 197.
[105] Cf. Kraus et al. (2014), p. 196 f.; Grunow Figgener (2006), p. 162.
[106] Cf. Kraus et al. (2014), p. 197 f.; Barthel et al. (2012), p. 8 f.
[107] Cf. Hommel Schneider (2003), p. 69 f.