Basel Threatens Market-Making in Securitized Debt, JPMorgan Says

  • Banks may need to hold up to four times as much capital
  • Final guidlines expected in December, may take effect by 2019

New rules proposed by international banking regulators would severely reduce, and possibly eliminate, banks’ profitability in trading bonds that finance everything from home loans and apartment mortgages to auto loans and student debt, according to JPMorgan Chase & Co.

The rules, expected to be finalized in December by the Basel Committee for Banking Supervision, impact nearly all forms of securitized debt, and may force banks to “completely rethink” their market-making activity for asset-backed securities, JPMorgan analysts John Sim, Amy Sze and Meghan Kelleher wrote in a note to clients on Monday.

“There is no sector that escapes unscathed,” the analysts wrote. “Liquidity, which in many of our markets is at best anemic, would become non-existent.”

Banks would have to hold more capital for assets in their trading books, and in some cases, account for potential shocks in credit spreads by up to 34 percent, according to risk weightings outlined in a July 2015 impact study released by the Basel committee.

Strict Rules

The Basel committee is enforcing strict capital rules after the 2008 financial crisis revealed that banks didn’t hold enough capital to absorb losses. The proposal, called the Fundamental Review of the Trading Book, is the latest attempt to toughen treatment given to securitized debt, which regulators say played a significant role in contributing to the last credit crisis. 

The capital charge on standard, investment-grade rated securities bundling auto loans tied to prime credit borrowers could increase up to 10 times, according to JPMorgan. Other forms of securitized debt, such as bonds backed by rental home income, may be required to hold multiple times more capital, according to the report.

European banks have argued plans to stiffen capital rules for asset-backed debt could price them out of the market even as European Central Bank President Mario Draghi pushes to revive sales in Europe. JPMorgan said the regulation could even have the effect of slowing the U.S. housing recovery and stalling any reform of the government-backed housing companies Fannie Mae and Freddie Mac.

Shrinking Volumes

"Regulators seem to be comfortable with the idea that securitization volumes shrink," said Christina Zausner, vice president of policy analysis for the Commercial Real Estate Finance Council, a trade organization. 

The International Swaps and Derivatives Association estimated last month the rule would call for more than four times the total market-risk capital currently held by banks, according to a study it published with other industry groups.

The regulation should be finalized by end of this year, Basel Chairman Stefan Ingves said Oct. 9. It would be then reviewed by the Federal Reserve for possible implementation in the U.S. by 2019.

“The capital treatment is so punitive to securitization relative to other types of debt products, that banks could end up allocating more capital to the latter over time," Zausner said.

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