FI’s capital assessment method for securitisation within Pillar 2

Finansinspektionen (FI) believes that securitisation can give rise to risks that are not considered in current regulation. FI is therefore submitting for consultation today the method it intends to use to assess banks’ capital requirement within Pillar 2 for flowback risks during securitisation.

The tightening of capital requirements in recent years, in combination with forthcoming regulations, may strengthen the incentives Swedish banks face to utilise securitisation and contribute to a larger securitisation market. As a whole, FI takes a positive view on the possibility of meeting Swedish demand for credit with a broader base of capital and funding sources, but makes the assessment that stability risks may arise if the market for securitisation closes new issues.

In such situations, banks are left with the choice of either renewing the underlying credit or denying borrowers new or extended credit.

In the former case, flowback risks arise when the credit risk flows back to the banks and they suddenly become subject to a higher capital need. A sudden increase in the capital requirement could mean that banks would experience difficulties meeting their capital requirements, which could have consequences for financial stability since this could have a negative impact on market confidence in the banks. The banks may also need to suddenly reduce other lending or even be forced to wind down parts of their operations in order to comply with the new capital requirements.

In the latter case, financial stability risks may either arise with regard to the total credit supply or be amplified due to the termination of a borrower's financing. This can have serious consequences for borrowers. If a large part of the Swedish credit market is affected by these types of transactions, there may be a sharply elevated risk of a serious contraction to the credit supply in Sweden.

Given this background, FI makes the assessment that it is necessary to ensure that banks are able to manage flowback risk even during periods of economic downturns in order to avoid or reduce risks from a stability perspective.

The method does not entail a ban on securitisation, but removes capital requirement incentives to conduct large, inappropriately structured securitisations. It is therefore being proposed that banks whose transactions meet certain conditions should be exempted from a capital requirement for flowback risk. The method should not currently generate any consequences for the Swedish banks.

FI intends to use this method in its supervisory review and evaluation process starting in 2017. Initially, only firms in supervision categories 1 and 2 will be affected.

The memorandum contains FI's position and proposed exemptions.