Bank Funding at Risk From Rules Considered by EU Lawmakers

Sharon Bowles
Chairwoman of the European Parliament’s Economic and Monetary Affairs Committee Sharon Bowles, left, said she’s among legislators pushing for banks to increase disclosure of the assets earmarked for collateral in covered bonds and repurchase agreements. Photographer: Georges Gobet/AFP/Getty Images

European Union lawmakers are considering rules to protect bank depositors that may stymie two of the main funding sources for the region’s lenders.

The proposals risk limiting how much banks can raise from covered bond sales and European Central Bank loans by placing curbs on the assets they can use for security. The aim is to boost protection for account holders and other creditors.

Sharon Bowles, chairwoman of the European Parliament’s Economic and Monetary Affairs Committee, said she’s among legislators pushing for banks to increase disclosure of the assets earmarked for collateral in covered bonds and repurchase agreements. Banks may also have to set aside reserves when secured funding exceeds a set limit.

“I’d like to see a standard definition of covered bonds with clear information to identify if there’s a level of over-collateralization, and the consequences for stakeholders such as depositors,” Bowles, the Liberal Democrat parliament member for the South East England constituency, said in an e-mail.

Tying up assets in collateralized fundraisings is known as encumbrance and pushes unsecured creditors further back in the queue for payment in a default. Any move to limit secured debt issuance risks hurting banks that have relied on record covered bond sales and the 1 trillion euros ($1.3 trillion) of loans that the ECB has pumped into the system since December.

‘Harder for Banks’

“The risk is that banks relying on secured debt could face funding pressures as unsecured funding may be too expensive or not even accessible,” said Bernd Volk, head of covered bond research at Deutsche Bank AG. “It will also make it harder for banks, especially in peripheral countries, to increase new lending.”

Bowles was among EU lawmakers to propose the amendments to the EU’s Capital Requirements Directive last month. The CRD IV adopts bank capital and liquidity rules set out by the Basel Committee on Banking Supervision to prevent future crises.

The amendments are under debate by EU lawmakers before a vote on the text April 25. Finance ministers from the region’s 27 nations will then seek to reach agreement on the draft at a May 2 meeting. The draft law must be approved by parliament and national governments before it can come into effect.

Record Issuance

Issuance of covered bonds, backed by mortgages or public-sector loans and guaranteed by the borrower, soared to an all-time high of 374 billion euros last year as the region’s debt crisis prompted investors to shun banks’ unsecured debt. Sales slowed 25 percent in 2012 from the same period last year as lenders took advantage of the flood of ECB cash, Bloomberg data show.

Lloyds Banking Group Plc of the U.K. and France’s Groupe BPCE are the biggest issuers of the notes this year, raising 11.8 billion euros and 8.1 billion euros respectively, Bloomberg data show. Spanish lenders including Banco Santander SA and Banco Bilbao Vizcaya Argentaria SA have the most covered bonds outstanding.

Covered bonds typically get higher credit ratings than unsecured debt by requiring borrowers to set aside assets that can be sold to pay investors if the issuer defaults. In repurchase agreements, or repos, securities such as government bonds are loaned for a fee.

Central Repository

Under Bowles’s proposal, regulators should know of banks’ repos, securities lending and all forms of transactions where creditors have a claim on assets. She’s suggesting that information be reported to a central trade or securities repository.

In another amendment to CRD IV, Philippe Lamberts and Sven Giegold, European Parliament members from Belgium and Germany, are jointly calling for rules that require deposit-taking banks to put money into a reserve fund when covered bond issuance exceeds 4 percent of total assets.

Vicky Ford, a European lawmaker from the U.K., is meanwhile seeking a European Commission study into whether limits on the level of financial firms’ encumbered assets are needed.

The $3 trillion market for covered bonds is dominated by European banks, for which the securities have been a source of funding since 1769 when King Frederick the Great of Prussia needed to rebuild the country after the Seven Years War.

The European Covered Bond Council lobby group is opposed to new restrictions on sales of the debt.

“We believe that the question of asset encumbrance needs to be addressed through a holistic and gradual approach,” said Luca Bertalot, head of the ECBC in Brussels. “Setting limitations on covered bond issuance without a prior and thorough impact assessment could hamper the funding capacity of mortgage lenders.”

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