A Short History of Basel’s Attempts to Overhaul Rules for ABS

The Basel Committee on Banking Supervision has been working on new requirements for asset-backed securities since the market collapsed after the 2008 bankruptcy of Lehman Brothers Holdings Inc.

Authorities identified the pre-crisis boom in securitizations as one of the prime causes of the turmoil that followed, as banks struggled with a drop in the value of previously highly-rated instruments based on sub-prime residential mortgage debt.

Stefan Ingves, the Basel committee’s chairman, has said that the group’s pre-crisis rules for securitization were “very weak,” and need to be overhauled.

One the the group’s first moves in response to the crisis was to boost capital requirements for parts of the securitization market, including tougher rules for so-called re-securitizations and off-balance sheet conduits.

In 2012, the Basel committee published a first draft of a “fundamental review” of its rules in this area, including an overhaul of the approaches banks can use to measure their risks. A second draft was published in December 2013.

This version “would lead to meaningful reductions in capital requirements vis-a-vis the initial proposals, yet would remain more stringent than under the existing framework,” the committee said.

The draft plans cover banks’ investments in asset-backed debt that they intend to hold to maturity.

Banking Book

The group is working in parallel on an overhaul of its rules for assets banks intend to trade, including ABS.

For the banking book, the draft Basel rules set out a so-called “hierarchy of approaches” that banks should use to measure their risks, and so the capital they need.

Under the plans, banks should use internal models for this risk measurement whenever possible.

The draft sets out rules for how this should be done, in a bid to ensure that banks take account of “the risk of the underlying pool of exposures, including expected losses.”

If it’s not possible to use models, banks would have some scope to use external credit ratings or a “standardized approach” prepared by regulators.

The plans would also set a 15 percent floor limiting how low the measurement of risk can fall, no matter which approach is used.

The rationale behind the overhaul is to “make capital requirements more prudent and risk-sensitive,” to reduce reliance on external credit ratings, and to reduce so called “cliff effects” when banks face a sudden sharp increase or decrease in their requirements, the group has said.

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