Global regulators are set to toughen capital requirements for banks’ holdings of the riskiest types of bundled debt, known as securitizations, while seeking to shield higher-quality paper from overly onerous rules.
The Basel Committee on Banking Supervision will sign off on draft proposals at a meeting in Hong Kong starting Dec. 3, according to two people familiar with the plans who asked not to be named because the process is private.
The boom in the U.S. and European markets for securitizations in the years leading up to 2008 was seen by regulators as one of the main reasons for the collapse of Lehman Brothers Holdings Inc. and the ensuing financial crisis, as lenders struggled with a plunge in the value of previously highly rated instruments backed by residential mortgage debt. The issuance of such securities subsequently plunged.
“It is extremely important” that regulators “use the levers that they have to get a robust market going forward,” said Patricia Jackson, head of prudential advisory at Ernst & Young LLP in London and a former U.K. member of the Basel group. “They realize that it’s very important to get the securitization market going again.”
A lack of robust bank-capital rules may have fueled growth in the run-up to the crisis, according to the International Organization of Securities Commissions. Still, authorities have also called for steps to revive a well-regulated form of the market as a way to make it easier for businesses to get funding.
Securitization includes asset-backed paper as well as instruments based on home loans. An ABS is a financial product whose value derives from a pool of assets such as loans or credit-card debt, rather than mortgages.
Basel requirements force banks to have a minimum amount of capital, such as shareholder equity, or retained earnings, to cover potential losses on their investments, including on securitized debt.
Under Basel rules, banks measure the risk of losses on investments, such as securitized debt, using credit ratings, their own internal models and supervisory guidance. High-quality securitizations have a smaller risk of losses.
“I expect Basel to continue on the same anti-securitization course evident in the capital and liquidity rules,” Karen Shaw Petrou, managing partner of Washington-based research firm Federal Financial Analytics Inc., said in an e-mail, referring to several other initiatives by the committee. “All of this seeks to stamp out structured securitizations and instruments backed by non-traditional assets.”
Regulators at next week’s meeting will also review the details of a planned indebtedness limit for banks, known as a leverage ratio, the people said. The group is seeking to publish the final version of that rule by early next year, Stefan Ingves, the group’s chairman, has said.
The provisional Basel plans for bundled debt published in December 2012 included more widespread use of floors setting a minimum amount of capital banks must hold against structured securities.
The committee said at the time that the proposals would boost capital requirements for low quality securitizations while seeking to reduce them for some “senior securitization exposures” that could be unfairly penalized under the existing framework.
Work on overhauling the capital requirements “needs to be completed,” Uldis Cerps, executive director for banking at the Swedish Financial Supervisory Authority and a member of the Basel committee, said in an interview on Nov. 19. “A new consultation” with the financial industry “is expected quite soon,” he said.
Global regulators will next week also discuss details of a structural liquidity rule, known as a net-stable funding ratio, that would set out minimum requirements for banks to finance long-term investments using sources that are unlikely to dry up in a crisis, Cerps said.
Banks including Credit Suisse Group AG, BNP Paribas SA and Deutsche Bank AG urged the committee to ditch an earlier draft on securitizations, warning that the plans would backfire by tying up capital and starving the economy of credit. They said the proposals would harm lending to businesses by driving up capital requirements even for securitizations backed by the highest quality debt.
The Basel group will next week change some elements of its plans in response to the results of impact studies, the people said, without providing further details. The fundamental approach of the committee hasn’t altered from the earlier draft, one of the people said.
Some 251 billion euros ($341 billion) of securitized products were issued in Europe in 2012, compared with a peak of 711 billion in 2008, according to data from the Association for Financial Markets in Europe.
“While the securitization market is open in the U.S. it is not open in Europe, at least not in any significant way,” Jackson said.