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* Basel III, Solvency II to crimp bank funding of SMEs
* Capital rules on securitisation hit company funding
By Paul Taylor
PARIS, Nov 26 (Reuters) - With the ink barely dry on newcapital rules for banks, insurers and pension funds, someEuropean policymakers are already pressing for changes to avoidstrangling investment in credit-starved small business as anunintended consequence.
At the heart of the issue is the treatment of asset-backedsecurities (ABS), through which banks can bundle up loans madeto companies, sell the resulting package and free themselves upto do even more lending.
Forcing financial companies to set aside more capital whenthey buy ABS seemed like common sense after the 2008 financialcrisis, yet it could hinder economic revival in euro zone statesworst hit by the bloc's debt crisis, economists and marketplayers say.
The debate comes at a time when parts of the European Union,struggling to emerge from a long recession, are suffering aninvestment drought, with weak banks reining in lending forsmaller companies and infrastructure projects.
Even healthy small- and medium-sized enterprises (SMEs) inSpain or Italy are having to pay 4 or 5 percentage points moreto borrow, when they can get credit at all, than peers inGermany or Austria.
That reflects financial fragmentation in the euro zone, notjust higher credit risk.
SMEs are the backbone of those economies, providing mostprivate sector jobs, yet most are too small to issue corporatebonds, unlike smaller firms in the United States. In Europe,banks traditionally provide about 80 percent of SME finance.
The European Central Bank (ECB) is leading the chargeagainst the potentially perverse effects of the new Basel IIIbank capital adequacy rules and Solvency 2 EU insuranceregulations.
ECB executive board member Yves Mersch said this month BaselIII's treatment of ABS is "like calibrating the price of floodinsurance on the experience of New Orleans for a city likeMadrid".
High planned capital charges under Solvency II for insurersholding ABS would kill the nascent ABS market for financingsmall business stone dead, Mersch said in a recent speech.
The executive European Commission has also asked insuranceregulators to ease Solvency II provisions on lending to SMEs.
The Basel Committee in charge of setting global bankingcapital standards said in September it would ease capitalrequirements on securitized debt within about two years to helpwean banks off cheap central bank money.
But that may come too late for companies struggling now.
SUB-PRIME COMPARISON
Under the Solvency II framework, insurers would have to setaside capital equivalent to 80 percent of the value of AA-ratedABS they hold and 40 percent of products rated AAA, comparedwith charges for corporate bonds of just 6 and 5 percentrespectively.
A 2012 survey by the Association for Financial Markets inEurope (AFME), whose members include the likes of Barclays, Santander <SAN.MC., Citi and Goldman Sachs which together hold or manage more than 5 trillion euros,found Solvency II was likely to cause a permanent drop insecuritisation funding.
European Internal Market Commissioner Michel Barnier, incharge of drafting EU financial services regulation, toldReuters he shared concerns about the potential impact on SMEfunding and his staff are looking for a solution.
Politicians and regulators devised the tighter rules inresponse to the 2007 sub-prime mortgage crash in the UnitedStates, when a chain default of securitised home loans triggeredthe first wave of the global financial crisis.
Barnier said his first duty in the wake of the financialcrisis had been to tackle an absence of rules that had led to"crazy incentives for risk taking" in the markets.
The ECB's Mersch dismissed comparisons with the sub-primefiasco, saying data showed there was an extremely low defaultrisk among European ABS for small business.
A senior European regulator, speaking on condition ofanonymity, noted Solvency II only comes into force in 2016, andsuggested some ABS rules may be changed before then.
Richard Hopkin, managing director and head of securitizationat the AFME, said he expected both the Basel rules and SolvencyII to be amended favourably. But another potential obstacle iswhat assets banks would be allowed to include in their"cash-like buffers", separate from capital.
NEGATIVE SIGNALLING
If, as current draft proposals suggest, ABS are excluded orranked low in the pecking order, "nobody is going to want totouch them," Hopkin said. "It's negative signalling and won't doanything to encourage investors to come back."
The European Investment Bank reckons investment in fixedcapital, research and development in the EU suffered anunprecedented collapse during the crisis and is now about 17percent below its 2008 peak on average.
In the countries that needed international bailouts -Greece, Ireland, Portugal and Spain - investment has collapsedby almost 50 percent.
The chief cause was political and economic uncertainty,rather than a general lack of finance, but credit is still aserious constraint, particularly for SMEs most dependent on banklending in the hardest-hit countries.
Given the banks' need to deleverage and raise their capitalbuffers to meet new EU and global regulatory requirements, EIBexperts say SMEs and young innovative firms now need to tapsecuritisation and venture capital to expand and prosper.
An EIB report published this month said authorities shouldpromote greater use of loan guarantees, securitisation andventure capital to diversify companies' sources of funding.
Paolo Altichieri, head of global markets at Banca Popolarede Vicenza in Italy, the only European bank to publicly place asecuritisation this year, said official sector backing throughguarantees or first-loss insurance could help revive themoribund market.
"Any type of protection scheme would be welcome and might bean effective catalyst to re-start the lending operations toSMEs," Altichieri said.
The ECB is pushing for unparalleled transparency on ABSthrough its "data warehouse" initiative, that may ultimatelylead to changes in the rules and greater insurer investments.
As Barclays analysts wrote in their European SecuritisationOutlook 2014: "While many of the harsh regulatory initiatives orproposals from recent years are not yet implemented, somesubsectors (those that 'fund the real economy') might ultimatelybenefit from more lenient treatment or could even be promoted bypolitics, regulators and central banks".
