Low-Risk ABS Should Get Lower Capital Charge, BOE-ECB Say

European regulators should impose lower capital requirements on less risky securitizations to revitalize the market for asset-backed debt, the Bank of England and European Central Bank said.

Structured debt products that are classed as simple, transparent and standardized, “where the underlying risks can be assessed with more confidence, should have lower capital charges than complex securitizations,” the central banks said in a statement published on Friday on the ECB’s website.

The European Union is considering loosening banks’ capital rules in a drive to boost its 216 billion-euro ($234 billion) market for asset-backed debt. The 28-nation bloc may reduce the capital it requires banks to have for some securitized debt, according to draft policy published on Feb. 18 by the European Commission, the EU’s executive arm.

“Appropriate prudential recognition should be afforded” to simpler securitizations, the BOE and ECB said in response to the commission’s proposal, intended to foster development of the market. “That recognition should reflect the lower risk profile of such transactions.”

The issuance of bonds backed by everything from auto loans to credit-card payments plummeted from the 2008 peak of 819 billion euros to 216 billion euros in 2014, according to Association for Financial Markets in Europe data.

The central banks urged the commission to assess rules for financial products similar to ABS, “in particular covered bonds which should also be subject to appropriate improvements in prudential standards.”

‘Mechanistic Reliance’

The commission’s ABS plans focus on setting criteria for preferential regulatory treatment. Qualifying securities could be exempted from verification requirements for risk-retention rules, and they could be promoted by additional measures such as quality labels.

Existing capital rules for securitization feature “a mechanistic reliance on external credit rating agencies” as well as “inappropriately distributed capital requirements across the different tranches of a transaction,” according to the document.

There are also “loopholes” in defining what counts as an originator of a securitization, the ECB and BOE said, that “can result in the misalignment of the interests” of the underwriter and the final investors.

The European Banking Authority plans to submit its high-quality ABS guidance to the commission by June. Global regulators led by the Basel Committee on Banking Supervision and the International Organization of Securities Commissions are formulating similar standards.

The ECB and BOE said they deferred to the rule-making agencies on criteria to identify securitizations qualifying for lower capital requirements.

The ECB last year embarked on a purchase program that targeted ABS as it tried to encourage banks to lend more to European households and companies. ECB President Mario Draghi has called for regulatory changes to help boost the market.

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