LONDON (Reuters) - Bonds based on high-quality loans should benefit from lower capital requirements to kick-start the market in Europe, the Bank of England and European Central Bank (ECB) said on Friday.
The two central banks were responding to plans from the European Union’s executive, the European Commission, to revive the asset-backed securities (ABS) market to improve funding for companies.
Such securitization involves the pooling of loans such as mortgages, with the interest providing income for the buyer of the bond.
The European Commission has proposed a new category of “simple, transparent and standardized” (STS) bonds to give investors confidence in a sector tarnished by the 2007-09 financial crisis.
The crisis was sparked by ABS based on “sub-prime” U.S. home loans that turned toxic, and though the sector has rebounded in the United States, it remains subdued in Europe.
The Bank of England and ECB’s joint response to the Commission’s plans called for “appropriate prudential recognition”, meaning less than the current level of capital that has to be retained against ABS held by banks or bought by insurers.
“That recognition should reflect the lower risk profile of such transactions relative to non-STS transactions,” their joint statement said.
The global Basel Committee of banking supervisors is considering whether high-quality ABS should benefit from lower capital requirements.
Capital rules for ABS at the global level could take time because some parts of the world are unconvinced of the need for a two-tier approach, but the joint statement did not say whether the EU should take unilateral action.
The two central banks said the “risk sensitivity” of capital charges for high-quality securitization should also be increased under the EU’s insurer Solvency II rules.
“That would help to reinforce the role of insurers as long-term providers of finance to the real economy,” the banks said.
Solvency II is the new set of capital rules for insurers from January next year, which insurers have criticized for being overly tough in relation to ABS.
The ECB and Bank of England also urged the European Commission to assess on a continuing basis the relative capital treatment of similar financial instruments, such as covered bonds.
Under EU rules brought in since the financial crisis, banks have to retain 5 percent of the ABS they originate, as an incentive to maintain high standards, but some fund managers have said the level is too low.
The Bank of England and ECB, however, said that 5 percent is sufficient as an incentive to maintain high standards.
“We do not believe that alternative or additional forms of risk retention should be considered at this time,” they said.
Editing by David Goodman