The UK Treasury waded into the “are covered bonds a good liquidity buffer for banks?” debate on Friday.
EuroWeek’s The Cover reported the ministry’s feelings were that the bonds — largely deemed to be among the safest securities in the world — were not actually an acceptable asset.
The only other state to adopt a similar position is apparently Malta.
As The Cover stated, the UK Treasury feels only government bonds and central bank reserves are actually safe enough:
The damning verdict on the asset class was delivered by Her Majesty’s Treasury in its response to a European Commission consultation paper on possible changes to the Capital Requirements Directive (CRD IV), dated 1 April. CRD IV is being aligned with a new framework for liquidity risk measurement, standards and monitoring that the Basel Committee on Banking Supervision is preparing.
In the UK authorities’ submission to the EC – produced in consultation with the Bank of England and Financial Services Authority – HM Treasury backed up a position outlined by the FSA in October that liquidity buffers should comprise only one tier of liquid assets and that this should be very narrow, comprising only government bonds and central bank reserves. It said that this would ensure simplicity and prevent an erosion of standards over time that might result from a multi-tier approach. The Basel Committee has floated having narrow and broad categories of liquid assets.
Which, of course, differs to the view of the European Covered Bond Council who argue the bonds should be given equal status to government bonds because not only is their structure heavily over-collateralised, but no covered bond has ever suffered a credit loss.
The Treasury, as The Cover reported, rejects this argument:
“Assets such as corporate bonds and covered bonds are far more susceptible than government bonds to illiquidity and price volatility during periods of banking sector stress,” said HM Treasury. “Such periods are typically correlated with periods of stress in the real economy. Therefore, assets originated in the real economy (e.g. corporate debt or mortgage assets) are liable to become illiquid because of credit risk concerns.
“Because of this, investors tend to sell these assets in times of stress, accentuating any price volatility. If an institution attempts to sell these assets at ‘fire sale’ prices, the institution, and other financial institutions holding the same asset, will suffer mark-to-market losses.”
It adds that even the application of haircuts to covered bonds – something the ECBC and others argued against – cannot prevent this from happening. HM Treasury said that the crisis has demonstrated that covered bonds are not resiliently liquid instruments.
Of course, it is worth pointing out that ineligibility of covered bonds in liquidity buffers would go some way to boosting demand for government bonds – including those bonds issued by the UK Treasury.
In the event investors might otherwise be put off your bonds — on account of your state finances — that would prove a handy thing. No?
Related links:
Digesting the Basel reforms – FT Alphaville
Bank capital rules face overhaul – FT
Strengthening the resilience of the banking sector – BIS
The FSA says now is not the time for (bank) bondage - FT Alphaville