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Tougher Capital Requirements Under Basel III Could Raise The Costs Of Securitization

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Table Of Contents

  • Credit Risk: Minimum Regulatory Capital Requirements For Securitization Exposures
  • Credit Risk: Supervisory Haircuts On Securitization Collateral
  • Market Risk: Securitization Exposures
  • The Cost Of Securitization Is Likely To Rise
  • Appendix: Summary of Changes

Tougher Capital Requirements Under Basel III Could Raise The Costs Of Securitization

On Sept. 12, 2010, the Bank for International Settlements (BIS) announced new, stricter regulatory capital requirements for banks. The announcement marked the adoption of several revisions to the regulatory capital framework—collectively known as Basel III—that the Basel Committee on Banking Supervision (BCBS) had previously proposed to address some of the main issues that arose during the credit crisis. These revisions built on the existing Basel II framework, published in 2006.

Basel III includes some specific changes to banks' treatment of securitization exposures when calculating their capital requirements. These include:

  • The application of a 1250% risk weight to some lower-rated and unrated securitization exposures;
  • The introduction of more conservative collateral haircuts (discounts) for securitization collateral with respect to counterparty exposure; and
  • The introduction of specific risk haircuts for securitization exposures when calculating the capital requirement related to market risk.

While banks may choose one of Basel III's two broad methodologies for calculating their capital requirements, the standardized approach or the internal ratings-based approach, our discussion focuses on changes in the standardized approach.

We believe the adoption of the Basel III capital requirement platform is likely to raise the cost of securitization and could influence the strategies of banks that originate or invest in structured finance transactions. With the more-conservative capital reserve requirements for certain securitization exposures, banks may look for ways to reduce their existing exposures and will likely also try to reduce the potential capital charges arising from new transactions.

We note that other aspects of Basel III—such as the introduction of leverage and liquidity tests—could also have far-reaching implications for the business models of regulated institutions, including their involvement in securitizations as originators, arrangers, market makers, counterparties, or investors. These broader issues are outside the scope of this article.

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