Nevertheless, akin to efforts in the United States, European banking supervision decided to look closely at these exposures – taking a forward-looking and pre-emptive approach. The growth of the market indeed seems to be driven by a search for yield. And on the face of it, leveraged finance does provide comparatively high yields. In 2014, leveraged-finance products generated more than € billion of net revenues for European banks. In particular, leveraged finance offers an opportunity to increase fee incomes. Accordingly, the volume of underwritten transactions has increased by 35% since 2012, whereas the volume of deals that banks hold in their own books has only increased by 16%. It would appear that banks are doing it for the fees. Still, other factors besides a search for yield are driving the market for leveraged finance: corporate refinancing schedules, for instance. In 2014, about 52% of transactions took place in order to renew or refinance previous deals. Also, greater confidence among investors might play a role. Rating agencies, banks and investment funds have communicated profusely on low default rates and the general attractiveness of the market for leveraged finance. However, the border between confidence and overconfidence is hard to define. Therefore, the question is: should we keep an eye on leveraged finance? My answer as a supervisor is: yes, we should.
Leveraged finance is certainly not a major supervisory concern at the moment, but the recent development of the relevant market exemplifies the need for good risk governance, a welldefined and closely monitored framework for risk appetite and highly assertive risk management. Search for yield has intensified competition in the market for leveraged finance. The result is that the terms for borrowers have become more favourable – ultimately, that increases the risks for the lender. We as supervisors take a close look at the credit quality of borrowers as measured by their level of leverage. Lending to highly leveraged counterparts may entail significant risks. And in the euro area, we observe that the leverage of corporate borrowers has increased. In 2014, 35% of transactions arranged by significant institutions actually refinanced borrowers at an increased level of leverage. Moreover, we as supervisors are not always impressed by the quality of loan contracts. Some loans contain only limited obligations for borrowers, for instance with regard to payment terms. Particularly when refinancing or renewing commitments, banks might be inclined to accept the removal of covenants in order to preserve existing commercial relationships. We as supervisors also care about returns. Banks are taking on risks; but do they gain adequate returns? Well, over the entire credit cycle, they may not necessarily earn more returns because there are other factors at play.