Considering that the Basel II recommendations for bank capital requirements affects about two dozen banks - at the most, according to banking experts - it sure is causing a stir in the industry. Capital markets observers, however, say the revised set of recommendations, might have, only minor effects on securitization.
Under the Basel II scheme, for which large banks mainly pushed passage, institutions are allowed to choose between two methods for calculating adequate regulatory capital, and apply one of them. The first employs an internal rating based (IRB) approach. Banks can utilize their own internal estimates for default probabilities to determine the risk-weighted capital allocation. The second is more standardized. Risk weights are applied based on the exposure's external rating, according to DBRS. As such, Basel II is more sensitive to credit ratings than the previous model.
Banks might realign their securitization business lines and asset mix in response to Basel II. For asset-backed commercial paper programs in particular, Basel II sets out the risk weights and suggests banks to consider external ratings on the liquidity and credit enhancement facilities, according to Dorothy Poli, a senior vice president in Toronto-based Dominion Bond Rating Service's ABCP group. Banks, therefore, appear to have less flexibility when calculating capital requirements for their asset-backed commercial paper programs.
Some banks could be considered originating banks,' under Basel II, especially if they sponsor ABCP conduits or provide liquidity and credit support. Proposed capital charges could have a significant impact on the types of assets financed through the ABCP conduits and the liabilities that conduits issue to finance their purchases, according to research from Standard & Poor's. Some of Basel II's effects include an increase in the volume of commercial paper issued by CDOs and a decline in the volume of commercial paper issued by securities arbitrage vehicles.
Industry comfort level
Because Basel II essentially allows large U.S. banks to hold less regulatory capital in reserve against their balance sheet assets, bank industry participants become instinctively less comfortable with the outcome.
"We are used to seeing a certain level of capital in banks and judging them to be safe," said Doug Landy, special counsel with the securities and financial institutions department in Cadwalader, Wickersham & Taft's New York City office. "People are saying banks can be just as safe with less capital."
Further, securitization industry participants point out that if banks are allowed to hold back less regulatory capital, the incentive for banks to move assets off of their balance sheets through securitization also drops accordingly, Landy said.
"The impetus to do it for capital relief may not be as strong as it was under Basel I, but there will be other securitization techniques that will become more attractive under Basel II," Landy said.
Another issue: Will the new accord put smaller banks - which will continue to operate under Basel I's restrictions - at a competitive disadvantage once Basel II takes effect? The Federal Reserve Board approved a notice of proposed rulemaking (NPR) on the Basel II capital framework on March 30. These rules are not expected to take effect in the U.S. for several years, because the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp., and the Office of Thrift Supervision have to complete their individual review and approval processes. Then the new accord will be sent out for official comment in the Federal Register.
Basel I, which has already been revised more than 25 times to reflect changes in the banking industry, will come under scrutiny again in consideration of small and midsize banks who will not take advantage of Basel II rules, Susan Schmidt Bies, a Federal Reserve governor, said at the Risk Capital 2006 Forum in Paris earlier this month.
"We expect only one or two dozen banks to move to the U.S. version of Basel II in the near term, meaning that the vast majority of U.S. banks will continue to operate under Basel I," she said. "The agencies have issued an advance notice of proposed rulemaking discussing possible changes to increase the risk sensitivity of U.S. Basel I rules and to mitigate any competitive distortions that might be created by introducing Basel II."
Basel II will be effective for standardized banks at the beginning of 2007, and one year later for IRB banks, according to Poli.
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