Proposed changes to Basel II banking regulations have not necessarily been getting the attention they deserve.
Hence, we read with interest a fantastic Deutsche Bank note on the impact of the adjustments, and specifically the potential fall-out from proposed increases to the risk weightings of resecuritisations. That’s something which involves (to put it crudely) how much capital banks will have to hold against synthetic or tranched securitisations — things like ABS-backed CDOs.
The thinking here is that resecuritisations should warrant additional capital since they tend to be more highly correlated with systemic risk than ‘traditional’ securitisations. So complex securitisations will need to carry more capital than their plain-vanilla counterparts — in some cases up to 3.5 times more.
Predictably perhaps, the change does not necessarily mean good things for the securitisation market. What’s surprising though, is just how dramatic DB bank analyst Matt Spick views the move. According to the note, he thinks it will do nothing less than kill the market for complex products:
The re-securitisation risk issue is also interesting, in our view, Whilst the securitisation market may come back, the ability of investment banks to carry higher risk tranches (as previously was the case with many banks holding e.g. mezzanine tranches of super-senior CDOs) will be nil, effectively killing the market for complex products, we believe. Below we show in full the proposed re-securitisation capital charges; our view is that they will be prohibitive for the banks to retain any re-securitisation risk in the future, which in turn means all re-securitisation risk will have to be fully distributed. To the extent that this cannot happen (no buyers for lower tranches), the product will simply be unable to exist.
In Deutsche’s view then is the proposed capital charges are so high, banks won’t want to hold on to any of the truly risk tranches of complex securities, and without the banks to take that risk, the market for such securities will effectively perish. No mezzanine-takers = no market.
On a wider note, the proposed changes (additional capital for credit risk, stressed-VaR, etc.) will mean financial institutions will have to hold more capital overall — with the amount of capital held against trading books increased by a factor of two to three times, according to Spick. That, in turn, will knock between 0.5 per cent and 2.1 per cent off of European banks’ Tier 1 capital ratios, or 1.4 per cent on average.
Full note available in the Long Room.
Related links:
This SIV shall come again – FT Alphaville
Banks let off the hook as flawed model is preserved – FT