Covered Bonds Get Second-Class Status in EU Liquidity Review
The European Union’s top banking regulator said that covered bonds shouldn’t be considered a top-tier asset for banks’ emergency liquidity buffers, dealing a blow to Denmark’s $530 billion mortgage-bond market.
Covered bonds, which are debt securities backed by cash flows from other assets such as mortgages, aren’t as stable as European Union sovereign debt for the purpose of building up banks’ liquidity buffers, the London-based European Banking Authority said today. Corporate bonds, equities and some local government debt were also considered to be less liquid than state bonds.
The decision goes against the EBA’s own preliminary study into the liquidity of different assets, published in October, which found covered bonds are more likely to hold their value than corporate bonds and equities over a 30-day period. The EBA submitted its recommendations on liquid assets to the European Commission, the executive arm of the EU, which must approve them next year.
“Despite the excellent liquidity features showed by some covered bonds, doubts remain as to whether these findings are sufficient to justify a deviation from the international standards and their inclusion” in the top category of liquid assets, the EBA, set up in 2011 to harmonize banking rules across the 28-nation bloc, said in a statement.
Banks in Denmark have warned that excluding the securities would leave lenders virtually unable to meet liquidity requirements, and drive up the price of credit.
Denmark’s covered bond market is more than three times the size of the country’s sovereign debt. Danish Prime Minister Helle Thorning-Schmidt said Dec. 3 that her country is “standing by the Danish mortgage system” and will appeal to the Brussels-based commission.
Denmark’s Financial Supervisory Authority said today it won’t tell banks to follow the EBA’s proposal unless the EU commission approves it, an outcome the regulator in Copenhagen doesn’t expect.
“We therefore see no need to change the guidance we have previously given to our institutions on their reporting of the liquidity coverage ratio,” Kristian Vie Madsen, deputy director at the FSA, said in an e-mailed response to questions.
If the commission backs the EBA, Denmark will comply, though the FSA would then seek “exemption-possibilities in place for countries with constraints on liquid assets,” he said.
Sovereign bonds issued by EU countries, including Greece, Spain and the U.K., must be treated as equally liquid because to do otherwise would “reinforce the fragmentation of the single market and the sovereigns-banks loop,” the EBA said.
The liquidity coverage ratio, which requires banks to hold enough easy-to-sell assets to survive a 30-day credit crunch, split opinions of Basel Committee on Banking Supervision members last year.
Some central bankers and regulators warned that an early version of the standard risked causing a credit crunch, while others urged against a wholesale watering down of the measure.
The U.S. Federal Reserve earlier this year proposed tougher liquidity rules than those agreed on by the committee in January, proposing a narrower list of assets that they can use to pad the buffer.
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