Asset-backed securities may face tougher Basel bank rules

Banks trading asset-backed securities may face tougher capital requirements and stricter oversight from global supervisors amid concerns that regulation is failing to curb excessive-risk taking.

The Basel Committee on Banking Supervision is about to embark on a "fundamental" review of how securitization is regulated, Wayne Byres, the group's secretary general, said in an interview last week.

"Ultimately it's driven at capital treatment, but it's also about reflecting on what have we learned from the crisis about securitization, and the way risks within securitization work," Byres said.

The boom in the U.S. and European markets for securitized debt prior in the years leading up to 2008 has been identified by regulators as one of the main reasons for the collapse of Lehman Brothers Holdings Inc. and the ensuing financial crisis, as lenders struggled with a plunge in the debt's market value.

Securitization has also been the subject of lawsuits, amid accusations that some instruments were flawed or even designed to incur losses.

Eric Schneiderman, attorney general for the state of New York, said this month that a suit against JPMorgan Chase & Co., the biggest U.S. bank, will serve as a template for other legal challenges.

Schneiderman has alleged that the Bear Stearns business that JPMorgan took over in 2008 deceived mortgage-bond investors about the defective loans backing securities they bought, leading to "monumental losses."

"That's become clear is that many aspects of the Basel process need further study and assessment," Richard Reid, research director for the International Centre for Financial Regulation in London, said by e-mail. "My feeling is that the industry will have to deal with regulatory uncertainty for a long time yet."

An asset-backed security is a financial product whose value derives from assets such as loans or credit card debt, rather than mortgages.

New issuance of securitized debt in the U.S. in 2011 totaled $124 billion, down from a peak of $753 billion dollars in 2006, according to data compiled by the Securities Industry and Financial Markets Association.

"That will come out before the end of the year will be more a concept paper than a detailed set of rules," Byres said. "It'll pose some questions."

A lack of robust bank capital rules may have led to the securitization boom before the crisis, according to the International Organization of Securities Commissions.

"Ideally, if the framework can be simplified that would be good," Byres said. "If we could reduce our reliance on credit rating agencies, which is part of a broader theme in lots of the work that we do, then that would be good too."

The push on securitization adds to the Basel group's list of priorities as it seeks to move forward on liquidity rules for lenders.

The committee will seek to complete a review of the so-called liquidity coverage ratio, or LCR, at its next meeting in December, Byres said.

The measure, which is designed to make sure banks hold enough easy-to-sell assets to weather a 30-day credit squeeze, has been the subject of intense discussion over concerns that it might restrict lending to businesses and make it harder for central banks to implement their policies.

"We've had two years of extra time to do analysis, we've had two years to observe what's happening in markets and so it's natural that we will refine the LCR," he said. "It would be naive to think we got it perfect the first time."

The European Central Bank and the Bank of France have called for an expansion of the list of assets that banks can use to meet the LCR, which is scheduled to take effect from 2015. The ECB has said that the list should more closely reflect the range of securities that it accepts from banks as collateral.

"There's an added challenge when you look at central bank eligibility, which is that the list of central bank eligible assets is quite different across countries," Byres said. "You can't have complete reliance on central bank eligibility if you want to have a common standard."

The committee in December will also discuss the preliminary results of a probe into how different banks assess the risk of losses on their assets.

Some U.S. bankers, including Jamie Dimon, chief executive officer of JPMorgan, have called for regulators to assess possible abuses of the current risk-weighting regime, which allows banks to use their own models to assess the safety of assets and so how much capital they need to hold.

"We are committed to publish something on the results as soon as we've got something that we think is robust," Byres said. "It's obvious that there are going to be differences coming out of bank modeling choices. The difficult question is to decide how much is too much."

Byres said the committee was continuing to keep a "watching brief" on whether banks should be allowed to make more use of so-called contingent-convertible bonds, or CoCos, to meet Basel capital requirements.

"Conceptually, they are very simple and easy and attractive, but there are lots of practical, operational issues when you come to try and use them" in an international banking group, Byres said. "For example, which legal entity should issue them, which authority has the authority to pull the trigger -- all sorts of complexities."

CoCos, are a form of fixed income security that would automatically convert into ordinary shares if a bank's capital falls through a pre-determined floor.

The Basel group last year rejected calls for lenders to be allowed to make some use of CoCos to meet capital surcharges imposed on big banks whose collapse may roil the world economy. The committee at the time said that it would keep the matter under review.

"At this stage there's not any work being done to change the rules in that area," he said.

Byres said the committee doesn't intend to get involved in debates in the U.S. and EU on whether to force banks to split their activities or build internal firewalls to curb risk.

Still, he said, such measures may have an impact on the capital rules that lenders' face.

"If those initiatives are implemented, we will have to think about what they mean for the capital regime, because banks will look different, they will have different risks," he said.

European Union lenders would be forced to push much of their trading activity into separately capitalized units and face extra bonus rules under recommendations this month by an EU-mandated group led by European Central Bank Governing Council member Erkki Liikanen.

U.S. and British regulators have also proposed structural changes to banks in a bid to curtail risks.

The committee's priorities for 2013 including reviewing a separate liquidity rule for lenders, known as the net-stable funding ratio, and studying possible changes to the capital rules banks' face on assets they intend to trade, Byres said. (Bloomberg)