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Heavily indebted companies: higher capital requirements for banks

Published on June 27, 2023 by Pierre Belhache - 3 mins reading time
Banks Companies European Central Bank HCSF Loans

In a press release published on June 13, the French High Council for Financial Stability (HCSF) confirms its intention to introduce a 3% sectoral cushion for systemic risk on French banks' exposures to large, highly indebted companies, by increasing capital requirements.

The "major risks" measure taken in 2018 updated

In 2018, the HCSF took the decision to prohibit banks from exposing more than 5% of their capital to highly indebted companies. If this threshold was exceeded, the bank concerned was required to notify the Autorité de contrôle prudentiel et de résolution (ACPR) in order to regularize the situation by increasing its capital or reducing the position within a few days.

This rule has been relaxed, as the HCSF explained in a press release dated June 13. Indeed, the French authority sets a capital requirement corresponding to 3% of their exposure for highly-indebted companies and their subsidiaries when the latter exceed 5% of their equity capital. A company is considered highly leveraged when its debt/EBITDA ratio exceeds 6 or is negative.

This measure, announced by the HCSF to prevent overly aggressive debt leverage, is due to come into force in August.

A call for caution

The appearance of this rule is a call for caution on the part of the macroprudential authority. Indeed, even if the scenario is not yet confirmed, in the current context of rising interest rates, the economy could slow down and the number of unpaid loans rise sharply.

The results of the stress tests carried out by banks every 2 years will be published at the end of July. The European Central Bank (ECB) is already anticipating " a cumulative decline in European GDP of 6% between the starting point and a three-year horizon ", compared with a cumulative recession of 3.6% in 2021 and 2.7% in 2018. On the employment front, EBA could see a 6.1-point rise in the unemployment rate, while inflation is falling more slowly than expected. Lastly, on the equity market, the assumption put forward is that prices will fall by 55% in 2023 before rising slightly in 2025. This year's stress tests will cover a wider range of institutions: 70 banks in the European Union, 20 more than previously.

In view of these factors, banking organizations may be forced to increase their provisions to take account of the more delicate economic environment. In particular, this could result in tighter monetary conditions. In this respect, the distribution of corporate loans has already been slowing down for several months.