BaselII

Basel II - Special Agent 003.65 Investigates

Ron Wells

Claude Pimpernel had been tipped off about the meeting of the secretive GCMG (Global Credit Management Group) by the Traditional Accountants' Society (TAS). Dedicated to backward looking traditional financial management, the TAS found the GCMG an abomination. Now ensconced in a nearby broom-cupboard 003.65 could record every word uttered, utilizing the microphone cannily hidden in the meeting room earlier.

The presenter was just saying; ‘… although it is only due to be introduced from 2006, banks must have three year’s worth of data in order to take advantage of the new rules. Therefore Basel II is already driving up the cost of borrowing for weaker companies.

As you can see from this diagram, the current Basel Committee rules have led to a very flat lending price curve, with double-A rated companies paying a margin above LIBOR that is not much less than the margin paid by triple-B rated companies. Under the present regime banks have to provide the full 8% own capital backing for all corporate lending - regardless of the quality of the debtor. For example it costs a bank just as much to lend to BP as it does to lend to the likes of Parmalat (pre-bankruptcy), so the flat interest rate ‘curve’ is no surprise.

In future however banks that can prove their internal credit rating process meets certain criteria will be able to take advantage of the Basel II rules. That is to say they will be allowed to hold less capital to back lending to strong companies, but will have to provide more capital to cover the weak.

This will lead to a significant increase in the cost of borrowing even for investment grade companies in the triple-B category, as illustrated on the diagram. Many companies - those rated by their banks as below investment grade - may well no longer receive loans at any price. In fact many privately owned companies in Germany are already closing because their bank-lines have been withdrawn.’ (Claude thought; ‘I must obtain a copy of that diagram, my report will be meaningless without it.’)

‘What does this mean for proactive credit managers?’ a member of the audience asked.

‘It means increased pressure to provide unsecured supplier credit, particularly to the companies that banks reject. The credit rating methodology required under Basel II rules has been largely designed by the rating agencies, mainly S&P and Moody’s. Therefore it is highly dependent on statistics. New businesses and small-medium enterprises (SMEs) will be particularly severely disadvantaged. It is in these categories that banks are most likely not to have statistics on file. If you don't have data available to provide so-called predictive statistics you can't create a Basel II acceptable rating.

Our role, as the keepers of the secret power driving commerce and industry, will be to find a way to fill the gap. Suppliers are the most important providers of venture capital; they must be assisted in efforts to develop their markets. GCMG members are the only ones with the power and the foresight to help suppliers succeed, but the Traditional Accountants’ Society will try to frustrate us so be on your guard!’

‘Ha’ thought Claude, little did the speaker know that the TAS would soon receive a full report on this GCMG meeting. No doubt the TAS would continue to hold sway, by once again thwarting the power of credit to generate economic growth.

Later Claude managed to retrieve a copy of the mentioned diagram from a waste bin and made this photographic record for his evidence file.

All characters and organizations mentioned in this article are fictional. Any similarity between such characters and organizations, and non-fictional characters and organizations is entirely intended.

Ron Wells is the author of Global Credit Management - An Executive Summary, published by John Wiley & Sons Limited (http://www.wileyeurope.com), a concise but authoritative work that exposes the power of credit. Credit activities that are well managed have the power to drive business success. However credit management functions are often fragmented across organisations and/or tackled by non-professionals as non-core job functions. The result is the power of credit is shackled and the organisation forfeits the competitive advantages that flow from excellent credit management.