LONDON: The regulatory campaign to make the financial system safer has gone too far and is stifling the flow of credit, threatening to cause more harm than good, argued law firm Allen & Overy in research published on Monday.
The report, titled "The Future of Credit" and commissioned in anticipation of the Financial Stability Board's (FSB) paper on strengthening the oversight and regulation of alternative providers of credit, argues that this latest global initiative will make it difficult for other institutions to fill the funding gap left by banks.
"We are four years down the line and if you ask the man in the street, do we have a much safer system, I'm not sure you would not get a positive reaction," said Allen & Overy's regulatory partner Etay Katz said.
Allen & Overy's research assessed regulatory impact on the provision of credit across 11 separate areas of finance in 13 key jurisdictions across the world and finds little incentive for alternative providers of credit to step into the void.
A&O's research illustrates that aside from deposit-taking and investment banks, some of the worst hit investors under new regulations are European regulated funds (UCITs), Bank and Non-Bank Holding companies in the US, and Chinese Trust Companies.
Even for unregulated funds and insurance companies, there is still a great deal of uncertainty around how they will able to participate in credit markets.
This is especially troubling when the FSB's own statistics show that banks are the only institutions to have increased their share of financial assets in the past five years - up USD26.6 trillion between 2007 and 2011.
Over the same period, alternative credit providers' share of financial assets decreased from 27% to 25%, challenging the FSB's assertion that greater regulation of banks will create incentives for some bank-like activities to migrate to the non-bank financial space.
A&O argues that the FSB's proposed policy framework threatens to throw the financial system into a prolonged period of paralysis which will stifle economic growth.
"You have to allow for some risk in the system rather than just suffocating all possible sources of funding in a way that would prevent businesses from funding themselves at this difficult moment in time," Katz said.
"The alternative providers are focusing on building their infrastructure required to get into the credit markets and do more. But if they start to receive negative sentiment, such as those expressed by the Financial Stability Board, then you have to ask - are we pushing regulation too far?"
Some of the worst hit asset classes under the onslaught of regulation are corporate lending, asset finance, leveraged finance, trade finance and project finance - all of which traditionally relied on bank funding.
Meanwhile, the result of constrained bank lending has led to somewhat of a renaissance in bond markets.
Global bond issuance has increased 6.1% year-on-year to USD2.74trn in the first nine months of 2012, a lot of this driven by corporate borrowers looking for alternative cheap sources of funding in a low interest rate environment.
However, investors in bank bonds have had to deal with the impact of evolving rules on bank resolution and, in particular, bail-in and depositor preference on bank capital structures.
This is making bank issued bonds less attractive, and, therefore, potentially reducing the bond markets as a source of credit for banks.
"We are not saying you shouldn't ratchet up the regulation of financial institutions, but regulators should have an end game in sight and a coherent design," said Katz.