In recently submitted comment letters, top U.S. bank representatives and a coalition of congressmen adamantly opposed the banking regulators' proposal reflecting the Basel III capital recommendations, identifying securitizations as an area that will be particularly impacted adversely.
The bipartisan coalition's letter called asset securitization "crucial to our economy, helping to ensure businesses and consumers have access to affordable financing." It says that regulators are proposing the "most cautious approach" recommended by the Basel Committee, doubling the capital surcharge for some securitization exposures to a level above what the banking agencies adopted after the Dodd-Frank Act.
Noting the added weight of the U.S. stress testing process, the Congressmen expressed their concern that "the new capital requirements may lead in some cases to banks having to maintain more capital [against the securitization transaction] than the underlying exposure itself."
Banking regulators issued the proposed rules July 27, 2023, with a deadline of November 30 to submit comments. That timeline was extended to January 16.
In a joint comment letter, the American Bankers Association and Bank Policy Institute expressed similar concerns. They noted the proposal contains no standard by which to determine what an appropriate risk weight should be for credit and operational risk, making it impossible to determine [whether] the costs of higher capital outweigh the benefits.
Banks suggest changes
More specifically, JPMorgan Chase argues that the proposals could use a combination of structural revisions and adjustments to risk weighted-assets (RWA) before finalization. In its 18-page comment, the bank argues that the surcharge placed on Globally Systematic Important Bank should be adjusted for economic growth and the calibration of operational risk for risk-weighted assets, among other proposed revisions.
At the start of its 76-page comment letter, the Structured Financial Association (SFA) stated in bold letters that the proposed rule should not be adopted, and that the SFA opposes it. It argued that U.S. regulators have chosen a much more stringent application of the Basel III recommendations than standards in the EU, U.K, Canada and elsewhere, putting U.S. banks "at a significant disadvantage compared to their international peers."
A key sticking point is the p-factor, which scales up the risk weightings applied to different types of loans in a securitization, and the proposal increases it to 1.0 from 0.5 under current rules.
Scott Frame, chief economist and head of policy at the SFA, said that a pool of loans held by a bank in unsecuritized form and subject to an 8% capital charge would see that charge increase to 12% under the current 0.5 p-factor if the bank instead held every tranche of a securitization backed by the same pool of loans.
"Under the endgame proposal, with p-factor equal to 1.0, the charge would be 16%," Frame said, adding that additional capital required by CCAR stress tests could require banks to maintain more capital against the underlying securitization transaction than the underlying exposure itself.
"Research provided by member firms demonstrated that the additive nature of these requirements can result in changes exceeding the amount for many subordinated exposures," he said.
Charges hit large banks hard
The charges could even hit larger banks hard, Goldman Sachs suggested in its letter.
"If the NPRs [notice of proposed rulemaking] are implemented as proposed, Goldman Sachs' required capital is expected to increase by more than 25%," according to the bank's statement.
The Congressional letter also notes that concern and why it would be problematic.
Banks "could be less likely to act as market makers in the securitization market, reducing market liquidity and driving up borrowing costs for consumers and businesses," the letter says.
The SFA noted that securitizations reduce the cost of credit for consumer and business loans. It said banks are integral to the securitization market by lending to the special purpose entities (SPEs) that issue securities, enabling the SPEs to buy loans; investing in other lenders' asset-backed securities (ABS); making markets in the securities; and sponsoring their own ABS to manage credit risk.
Under the proposed rule, according to the SFA, bank loans made to SPEs will become more expensive and less available; banks will require higher interest rates to invest in ABS; ABS liquidity will lessen as market making becomes less available; and banks' credit-risk management will be hindered.
The SFA recommends numerous changes to the proposal, including reducing the proposed p-factor to 0.5 from 1.0, and setting the p-factor for certain qualifying securitizations at 0.25, and essentially starting over again.
"The agencies should then issue a re-proposed rule that incorporates the recommendations in this letter and contains clear explanations of the changes to the securitization framework as well as the supporting data," the comment letter says.
