Banks Warned Not to Hurt Nordic Risk Case With Complex New Swap

  • Danish FSA says synthetic securitizations complicate risk case
  • Nordea’s capital relief note is seen as test case for region

The head of Denmark’s financial watchdog is urging banks to think twice before resorting to capital relief instruments, or risk weakening Nordic efforts to fight global regulators eager to enforce more standardized models for predicting losses.

The instrument in question is a synthetic securitization, in which a bank transfers credit risk in its loan portfolio to investors, who in turn get a cash flow. Nordea Bank AB in August became the Nordic region’s first lender to complete a deal. But efforts to cut capital requirements using such instruments risk sending the wrong signal to global regulators, according to Jesper Berg, director general of the Financial Supervisory Authority in Copenhagen.

Nordic banks and regulators are fighting a proposal by the Basel Committee on Banking Supervision to introduce so-called capital floors, or minimum levels below which capital mustn’t fall. The region argues that such models don’t take into account the strengths of its markets in the same way that the current internal risk-based models do.

The Costs

Denmark’s banks estimate Basel’s approach will add about $20 billion to their capital costs. In Sweden, the industry says the cost will be more than twice that.

“In general, those of us who want to fight for internal models have to be extra careful to do things right,” Berg said in an interview. Securitizations “would justify the arguments of those who believe that some are gaming the system.”

“We all have an interest in not undercutting our position in relation to using internal models,” Berg said. “We need to be credible.”

But the prospect of higher capital requirements is prompting banks across the Nordic region to consider capital relief instruments such as the one Nordea issued last month, according to Tom Johannessen, the bank’s head of group treasury and asset liability management.

Profound Changes

Erik Thedeen, director general of the Stockholm-based FSA, said last week that Basel’s proposed floors could lead to profound structural changes in the banking industry, including securitization of low-risk assets. But securitization -- the repackaging of loans into marketable instruments -- can leave banks with more risk and less capital, he warned.

“This means that the assets that remain on banks’ balance sheets will expose them to bigger risks without this being reflected in higher capital requirements,” Thedeen said.

The European Banking Authority has signaled its tentative support for structures similar to Nordea’s, in which counterparty risk is reduced to zero because investors provide a bank with cash to absorb potential future loan losses in exchange for a coupon payment. The assets remain on the bank’s books.

“We have also been a little skeptical about the synthetic securitizations, because they have been used in the past for less sound purposes,” Lars Overby, the EBA’s head of credit, market and operational risk policy, said in an interview. The challenge is in ensuring banks “are truly removing the risk from the balance sheet.”

Keen to increase funding to small businesses, the European Parliament is considering giving banks an incentive to arrange synthetic securitizations. The market crumbled after the instruments were implicated in the financial crisis. The measure would lower risk weights on the portion of loans banks retain, and would be limited to certain types of deals.

“There are some forms of synthetic securitization that can be desirable for sharing risk,” EU Parliament member Paul Tang said. “The challenge is to differentiate between these forms of securitizations in legal terms.”

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