More capital to be raised through bond issuance than banking lending, accountancy firm forecasts

Andy Baldwin, Ernst & Young's head of financial services for Europe, Middle East, India and Africa, said that he expects firms to rely more heavily on investment through corporate bonds than from banking lending this year. He said that the changing dynamic was evidence of the diminishing role banks are playing as intermediaries.

However, in an environment where the accountancy firm said it expects that there will be a 2% decline in overall lending for 2012, Baldwin said that small and medium sized companies will not be able to turn to "bond issuance" to ease their need for capital.

"Perhaps we should not be surprised that the banking sector is unable to act as the catalyst for growth that all would like it to be," Baldwin said in a new report (24-page / 5.57MB PDF) on the financial services outlook forecast for the Eurozone. "In 2012, bank lending will fall twice as fast as in the period that followed the start of the global financial crisis, as banks retrench further behind their national borders. Therefore, we are forecasting a decline of 2% in overall lending this year." 

"Consumers will bear the brunt, as loans to households fall by 6.6%, while loans to non-financial corporates will fall by a more modest 1.9%," he added.

"Banks are lowering their return on equity targets in the face of a deteriorating economic climate. As even previously immune northern European nations drift toward recession, Eurozonewide non-performing loans (NPLs) will rise to their highest ever level next year," Baldwin said. "Bond issuance will rise above bank lending this year, partly as a result of investors dealing directly with corporates. This indicates, perhaps for the first time, that the banking system is being dis-intermediated from the financial system."

Baldwin said that whilst "bond issuance" could "help larger corporates, who have access to the bond markets" he maintained it would "not assist their small-and medium-sized counterparts". Those smaller firms are, he added, "experiencing difficulties in arranging loans and facilities from a number of banks."

Corporate bonds are a form of debt issued by a company and are seen as higher risk than government bonds because of the greater risk that a company will default on repayment. A high quality corporate bond is a bond issued by a company which has a high credit rating.

Baldwin said that banks are facing the triple challenge of trying to restore consumer trust; deal with a "raft of new regulations and legislation" designed to avoid a repeat of the economic crisis; and "reshape and recast their service portfolio and business model to deliver an acceptable rate of return to investors".

He warned policy makers to acknowledge the "rising cost of regulatory compliance" and to be aware of how the regulatory regime 'interplays' with proposed changes to "accounting standards". Uncertainty could, Baldwin said, lead to a reduction in investment in financial services firms.

"In today's global economy, capital is ever more mobile," Baldwin said. "Investors want to see the impact of the current raft of changes to understand what a sustainable and acceptable level of return looks like. More uncertainty will only further reduce the attractiveness of the financial services sector."