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European Bankruptcies, Held at Bay, May Soon Jump

Friday, 23 Nov 2012 | 4:33 AM ET

New banking regulations may lead to an increased rate of insolvencies, as banks are forced to focus on their capital requirements at the potential cost of keeping "zombie" companies alive.

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The relatively low rate of insolvencies in Europe since the credit crisis began has been credited to central bank monetary easing, which has helped banks put off foreclosing on some loans — a process known as forbearance.

In recent months, concerns have been raised about the number of so-called "zombie companies" this has created, particularly in the U.K. These companies are thought to be kept going because low interest rates mean that they can continue to pay off the interest on their debts, but are not growing. They have been credited with helping to keep employment rates higher than they should be in the current stage of the economic cycle.

(Read More: Is it Time to Kill Off the UK's Zombie Companies?)

As the global banking system prepares for the implementation of more stringent banking regulations, there are worries that rules requiring more capital to be held on their balance sheets could lead to the unwinding of some of these companies.

When banks have to raise their capital requirements, as many will have to ahead of Basel 3 regulations coming into force, their tolerance for underperforming loans on their books may be reduced.

"This issue is clearly attracting some regulatory interest — and some discord — as to what this may mean for capital requirements," Nigel Myer, director of credit strategy at Lloyds, said.

He pointed out that the ESMA, the European Union securities markets regulator, is starting to put more pressure on issuers to improve disclosure of the extent of forbearance on loans on their books.

Banks are increasingly keen to sell off loan books, particularly for commercial real estate, according to data from Deloitte. This could mean that businesses end up with less sympathetic lenders. Western Europe looks to be the most popular place for banks to divest their assets, with 88 percent of banks surveyed by Deloitte planning to shrink assets there. However, most banks believe this process could take up to five years.

(Read More: The Immeasurable Risk Euro Zone Banks May Be Hiding)

In Ireland, where banks have shrunk their balance sheets most aggressively, there has been a steady rise in company insolvencies every year since the credit crisis began. Northern Ireland, where banks often have ties to the rest of the island, has a notably higher insolvency rate than the rest of the U.K.

(Read More: Ireland's Bonds Attract Big Investor)

Yet there are other reasons for banks to hold on to these loans — not least that historically low interest rates allow companies to service repayments even when their revenues have shrunk.

"The fact that banks are required to have stronger balance sheets must add to the pressure to convert bad loans to cash insofar as that is possible but that will be tempered by all sorts of considerations," insolvency body R3 argued.

There are also concerns that valuations are too low at the moment. And with banks' reputations under attack from politicians around the globe, it could be poor public relations to allow big employers to go bust.

"Much as regulators and other officials talk about the risks of forbearance and the benefits of 'properly' valued balance sheets, we suspect that politicians and regulators would be even more concerned about the real economy effects and implications for banks of foreclosing rather than forbearing," Myer said.

—By CNBC's Catherine Boyle; Follow Her on Twitter @cboylecnbc