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LBO loans pit the financial sector against the ECB

Published July 01, 2022 - 3 mins reading time
Banks Credit/Lending European Central Bank

Since late 2021, the European Central Bank has been sounding the alarm about leveraged buyout (LBO) loans. According to the European supervisor, the risk incurred by banks is too high. Banks are challenging the ECB's position, as well as its definition of leveraged finance.

Increase in banks' exposure to LBO loans

Leverage Buy-Out (LBO) loans, which enable companies to be bought out using high levels of debt, are not sitting well with the European Central Bank. Last December, the banking supervisor was already threatening to impose new capital constraints on banks granting too many LBO loans.

For their part, the banks pointed to an error of judgment on the part of the ECB, whose calculations, they claimed, did not take account of companies' cash flow, which would have had the effect of bringing a significant proportion of these loans below the ceiling set by the ECB, set at 6 times Ebitda.

In April, the ECB once again highlighted the risks of leveraged loans, indicating that between the start of 2018 and the end of 2021, systemic banks' exposure to LBO loans had risen considerably, from 40% to almost 60% of their hard capital.

Banks refuse to grant fewer LBO loans

The ECB criticizes banks for granting these leveraged loans without restriction, and for using insufficient control parameters. In March, worldwide LBO loans outstanding exceeded $4,000 billion.

For their part, banks are refusing to let up, arguing that limiting the granting of leveraged loans would deprive many companies of financing opportunities.

They also call into question the European Central Bank's definition of leveraged finance. According to Christian Ossig, one of the heads of the European Banking Federation, interviewed by Les Echos, the ECB's definition is not limited to classic leveraged finance, but includes " a significant part of the European corporate universe ".

However, the ECB's concerns seem legitimate, particularly in the current context of rising rates and inflation, against the backdrop of the Russian-Ukrainian war.

Citigroup, JP Morgan and Bank of America have been ordered by the Fed to increase their capital reserves from October onwards.