Securitisation

Basel II provides a specific treatment for securitisation, a risk management technique that the current Accord does not fully contemplate. The Committee recognises that securitisation by its very nature relates to the transfer of ownership and/or risks associated with the credit exposures of a bank to other parties. In this respect, securitisation is important in helping to provide better risk diversification and to enhance financial stability.

The Committee believes that it is essential for the New Accord to include a robust treatment of securitisation. Otherwise the new framework would remain vulnerable to capital arbitrage, as some securitisations have enabled banks under the current Accord to avoid maintaining capital commensurate with the risks to which they are exposed. To address this concern, Basel II requires banks to look to the economic substance of a securitisation transaction when determining the appropriate capital requirement in both the standardised and IRB treatments.

As elsewhere in the standardised approach to credit risk, banks must assign supervisory risk weights to securitisation exposures based on various criteria. One noteworthy point is the difference in treatment of lower quality and unrated securitisations vis-à-vis comparable corporate exposures. In a securitisation, such positions are generally designed to absorb all losses on the underlying pool of exposures up to a certain level. Accordingly, the Committee believes this concentration of risk warrants higher capital requirements. In particular, for banks using the standardised approach, unrated securitisation positions must be deducted from capital.

For IRB banks that originate securitisations, a key element of the framework is the calculation of the amount of capital that the bank would have been required to hold on the underlying pool had it not securitised the exposures. This amount of capital is referred to as KIRB. If an IRB bank retains a position in a securitisation that obligates it to absorb losses up to or less than KIRB before any other holders bear losses (i.e. a first loss position), then the bank must deduct this position from capital. The Committee believes that this requirement is warranted in order to provide strong incentives for originating banks to shed the risk associated with highly subordinated securitisation positions that inherently contain the greatest risks. For IRB banks that invest in highly rated securitisation exposures, a treatment based on the presence of an external rating, the granularity of the underlying pool, and the thickness of an exposure has been developed.

Because of their importance in ensuring the smooth functioning of commercial paper markets and their importance to corporate banking generally, the Basel II securitisation framework includes an explicit treatment of liquidity facilities provided by banks. In the IRB framework, the capital requirement for a liquidity facility is dependent upon a number of factors including the asset quality of the underlying pool and the degree to which credit enhancements are available to absorb losses prior to use of the facility. Each is a critical input to the supervisory formula designed for use by originating banks to calculate capital requirements for unrated positions, such as liquidity facilities. A treatment of liquidity facilities in the standardised approach is also provided which sets out various criteria for ensuring that more preferential treatment is only provided to those liquidity facilities where the risks are lower.

Many securitisations of revolving retail exposures contain provisions that call for the securitisation to be wound down if the quality of securitised assets begins to deteriorate. The Basel II proposals include a specific treatment of securitisations with these 'early amortisation' features, given that such mechanisms can in effect partly shield investors from fully sharing in the losses of the underlying accounts. The Committee's approach is based on a measure of the quality of the underlying assets in the pool. When this is high, the approach implies a zero capital requirement associated with the securitised exposures. As the quality deteriorates, however, the bank must increasingly hold capital as if future draws on existing credit card lines would remain on its balance sheet.