Got a line of credit with your bank? It’s about to get very expensive: Kohler

Businesses are in for a shock when some of the new Basel II international banking rules start to apply on 1 October.

Businesses are in for a shock when some of the new Basel II international banking rules start to apply on 1 October.

Debt funding has already tripled in price and in many cases is simply not available, as banks themselves find their own funding dry up.

But from 1 October there will be a specific and dramatic change to the way lines of credit are arranged and charged. In effect, the old line of credit that is fully available to a chief financial officer will simply no longer exist – it will be too expensive.

Companies routinely arrange lines of credit “just in case”. All documentation is completed and the loan is fully approved, but remains undrawn until the CFO needs it, either for working capital, because of a dip in sales, or an investment opportunity.

Many companies see this as a corporate governance requirement; the board reviews credit lines on a monthly basis to ensure the business has enough liquidity “headroom” to meet contingencies.

A small ongoing fee is typically paid to keep the line of credit available, on top of the setup fee, but the meter does not start running on servicing the loan until it is drawn.

The new Basel II accords drawn up by the Basel Committee on Banking Supervision change the way banks allocate capital for risk.

In the case of lines of credit, the new rules demand that a bank allocate capital to them as if they are fully drawn down from the moment the approvals have been completed.

The effect of this is that borrowers will have to pay full interest on undrawn lines of credit, even though they don’t actually have the money.

There will be ways around the rules that will differ a bit for each bank. Typically this will involve completing the documentation and most of the approval process for the loan up to, but not including, final sign-off.

Essentially, as long as the bank gets to say “no” at the point of drawing down the line of credit, then the money can continue to be priced in the old way.

The problem for boards is deciding whether this still complies with their corporate governance requirements. Most small businesses would be fairly comfortable with having to go back to the bank for approval when looking to draw down a line of credit, but does that qualify as liquidity “headroom”, especially in difficult times when the answer might well suddenly be no?

It will be a cost versus comfort equation. Just a guess, but I’d say most, if not all, companies will go for the lower cost, and lines of credit as they currently exist will disappear.

It will be just another way in which the credit crunch, coupled with Basel II, is making business harder.

This article first appeared on Business Spectator