Solvency II (insurers) and Basel III (banks).
Both add fresh minimum capital requirements to their respective industries. Similarities generally stop there. The very definition of capital is different, so are risk-weighting and accounting regimes…
At least usually the risk-weighting is different.
From a recent IMF paper comparing the two systems’ possible “unintended consequences” (in fact the first to do both of them together, we think):
More of a concern could be the increased interconnectedness between banks and insurers. Solvency II and Basel III could indeed result in increased demand for sovereign debt by both sectors. In other words, exposure to sovereign risk could increase and the type of interconnectedness between the two sectors could change and could be strengthened through the balance sheet of the sovereign. In principle, this concern could be diffused by the use of insurance internal models (which would capture the heterogeneity in credit risk across EU sovereigns), but their standards are yet to be defined. Clearly, strong collaboration between the regulators of the two sectors would be required to minimize risks of arbitrage between the use of internal models so that for both banks and insurers appropriate risk weighted capital is held and that the risk is properly recognized and accounted for.
This is the zero risk-weighting applied to sovereign bonds under Basel. Although it also concerns the less well-known special treatment for sovereign risk in Solvency II under “spread risk” criteria, which measure credit quality and duration risk (the longer the duration, the more capital insurers need to set by). In actual fact, “borrowings by or demonstrably guaranteed by the national government of an EEA state, issued in the currency of the government” aren’t subject to any spread risk provisions at all.
You could take this as another data point in the AAA bubble…
Although there’s even more interesting stuff in the paper besides. Notably on demand for bank debt. The paper gives Solvency II its due in the story of demand for covered bonds potentially crowding out senior unsecured debt, again because of the way in which rules for spread risk work. The rules make it more attractive for insurers to hold higher-rated but shorter-duration covered bonds, colliding with Basel’s favourable treatment for covered instruments in its liquidity requirements (which provides plenty of bank demand and might make issuance of senior unsecured debt on the supply side).
Solvency II — really not Basel’s boring cousin.
In fact, looking more like its Siamese twin.
(H/T Kiffmeister)
Related links:
How to tinker with bank risk-weightings – FT Alphaville
Covered bonds as the new sovereigns – FT Alphaville