Bloomberg News

EU Considers Basel-Rule Changes for Covered Bonds (Update2)

January 20, 2011

Covered bonds and savings banks in the European Union may face less strict capital and liquidity rules than called for by global regulators, as the EU seeks to limit side-effects that may hamper the economic recovery.

The European Commission said it’s considering changes to the way the bonds, backed by pools of mortgages or state loans, and savings banks are treated as part of an “in-depth impact assessment” of rules approved by the Basel Committee on Banking Supervision.

“There are possible areas of maneuver,” Michel Barnier, the EU’s financial services chief, said in an interview in Brussels today. “We have to take into account micro and macro impact assessments which are going on.”

The Group of 20 nations decided to bolster banks’ liquidity and capital to prevent a repeat of the worst financial crisis since the Great Depression. The measures, known as Basel III, were published by regulators in December, and more than double the highest-quality reserves that banks must hold. G-20 leaders pledged in November to “implement fully” the new standards.

The EU study “includes assessing the treatment of covered bonds,” said Chantal Hughes, a spokeswoman for Barnier. They “are an important type of funding for some banks in some parts of Europe and which proved to be a reliable source of liquidity during the financial crisis.”

‘Impeccable’ Record

Covered bonds typically get higher credit ratings and pay less interest because they’re backed by assets, such as mortgages, that stay on the lender’s balance sheet and that can be sold in the event of a default.

“Supervisory authorities are gaining a better appreciation of the covered bond instrument and how it can enhance a safer banking and insurance market,” Ted Lord, head of European covered bonds at Barclays Capital (BARC), said in an e-mail. “Covered bonds have been around since 1769 with an impeccable payment track record.”

Basel III will require banks to hold a buffer of highly liquid assets, but the extent to which it can be filled with covered bonds will generally be capped at 40 percent, with the bonds subject to a cut in value. The minimum liquidity requirement is set to be introduced at the start of 2015.

Danish Concerns

The Danish government has said that Basel III will force banks to dump covered bonds. Danish economy Minister Brian Mikkelsen has raised the matter with the commission.

“It’s a positive step” that the commission is “looking at this issue, this challenge for our financial system,” Ane Arnth Jensen, director of the Copenhagen-based Association of Danish Mortgage Banks, said in a telephone interview. Authorities “should accept these covered bonds are fully liquid,” she said.

The Basel proposals “have the potential to force fundamental changes” to the Danish mortgage market, Monika Mars, a director at PricewaterhouseCoopers AG in Zurich, said in a telephone interview.

The Basel rules won’t be enacted in the EU until governments in the region jointly approve implementing legislation drawn up by the Brussels-based commission.

Lawmakers at the European Parliament also need to endorse the measures before they can take effect.

The commission, the 27-nation EU’s executive branch, plans to present its draft legislation “before the summer,” said Hughes.

‘All Banks’

EU-specific changes may be needed, Hughes said, because the region intends to impose the rules on “all banks” as well as internationally active lenders, “unlike some other major economies.”

The U.S. has still not fully implemented a previous round of rules, known as Basel II, that were published in 2004.

George Osborne, the U.K. Chancellor of the Exchequer, wrote in the Financial Times earlier this month that it’s “vital” that the EU “does not weaken” Basel III as it is implemented in Europe.

“Any talk of ‘European specificities’ in Basel III that are not already accounted for, and any delay to the agreed timetable, will simply reaffirm markets’ suspicion that we are failing to address the difficult issues,” Osborne wrote.

The commission is also examining how the rules “will apply in recognizing the capital” of lenders which are not joint stock companies, including savings banks and co-operatives, Hughes said.

Europe’s savings banks have said that Basel III threatens their business model because they don’t have the same access to capital markets as larger lenders, making it harder for them to meet the new minimum requirements for common equity reserves.

Basel III “may have severe unintended consequences,” the European Savings Bank Group said last month.

To contact the reporters on this story: Jim Brunsden in Brussels at jbrunsden@bloomberg.net.

To contact the editor responsible for this story: Anthony Aarons at aaarons@bloomberg.net.


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