15 March 2013

Fitch Ratings: Basel capital proposals conservative vs global SF losses

The Basel Committee on Banking Supervision's revised proposals on the capital treatment of securitisation exposures could limit the appetite for structured notes among banks, Fitch Ratings says. This could restrict the availability of structured finance as a funding source for the wider economy.

The new proposals result in a significantly higher capital requirement for securitised holdings. Senior tranches, which are more likely to be sold to investors than junior positions, are worst affected, and the proposals ignore the improved credit protection in new deal structures since the financial crisis.

Sample capital charges calculated for a stylised prime RMBS transaction with a notional value of $100 show that overall charges for all noteholders increase to between $6.3 and $8.2 under the new proposals, from a maximum of $4.6 under Basel II. In many cases there would be little or no capital relief for holding only a portion of the risk in the underlying portfolio compared with keeping the entire pool of assets on balance sheet.

The proposed revised ratings-based approach seeks to reduce the cliff effect that resulted from multi-notch downgrades of senior tranches during the financial crisis. But it seems to achieve this by increasing the extent of capital that would need to be held against 'AAAsf' rated charges in the first place. This is despite the fact that post-crisis transactions benefit from better-originated, higher-credit-quality assets, and greater credit protection (partly driven by the revision of rating criteria since the crisis).

Fitch knows that regulators face a difficult task in striking the right balance between securing a healthy structured finance market that helps fund the real economy, and maintaining financial stability by ensuring banks and insurers are sufficiently capitalised. But in aiming to more closely align the standardised approach and the internal ratings-based approach, the revised proposals arguably create a more rather than less complex system, with more choices for banks and local regulators under both new systems (hierarchy A and hierarchy B) and resulting potential for regulatory arbitrage.

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