The European Commission’s desire to boost securitisation is ringing alarm bells among academics and civil society groups. Christophe Nijdam explains why.
Christophe Nijdam is secretary general of Finance Watch.
There are competing opinions among regulatory circles on how to deal with securitisation. On the one hand there is a strong push for its revival including an EU legislative proposal that will make some kinds of securitisation more profitable. On the other, we see caution and a desire to learn the lessons from the financial crisis.
Supporters of the controversial practice claim that, by transforming illiquid assets such as mortgages, auto loans or credit card receivables into tradable securities, securitisation can be an efficient way to allocate capital, supporting economic growth, business development and job creation. The European Commission takes this view and its proposals to boost securitisation are among its top priorities in financial regulation.
But other experts, including more than 80 academics, are rightly urging caution. Finance Watch and other civil society groups also share this view.
The question is how promoting securitisation will affect the lives of citizens: will it create jobs and employment-fuelled growth?
We doubt it will. And like the academics, we fear it could bring new risks that in the end will be borne by citizens.
So what is securitisation?
Securitisation is a financial technique that permits the exchange of relatively illiquid credit claims for tradable securities, packaged to optimise their credit rating. Securitisation changes the function of intermediation and the basic role of the financial intermediary as it seeks to replace interest-based financial intermediaries by fee-based distributors.
Unlike traditional bank lending where all functions are performed by one entity – the bank – in securitisation the different functions (originating, funding, servicing and monitoring) are performed by a chain of separate, specialised entities. This can create serious knock-on effects if one entity in the chain fails to perform.
So as we see there is a lot of money to be made from this proposal, especially by large banks. And while securitisation will increase some kinds of borrowing such as mortgage lending, it is far from clear that the EU’s economy needs more debt of this kind.
Since there is now no shortage of credit supply in Europe (as hinted by interest rates at historical lows), we doubt that reviving securitisation would have a meaningful impact on underlying growth. It also doesn’t really stimulate what Europe needs the most: long-term sustainable investment and employment-fuelled growth.
The European Commission aims to make asset-backed securities more attractive to investors by reducing the capital they must hold against those that can be classified as “simple, transparent and standardised”, or STS. The STS framework can therefore be understood as a quality label that benefits from a more favourable regulatory treatment. As the vast majority of recently issued securitisation would fulfil the STS criteria, some might argue that it is more a rebranding of a tarnished industry than a genuine innovation.
There is a significant risk that lobbying will make the legislative proposal even more industry friendly than it is already, failing to integrate the lessons from the crisis. We should not forget that securitisation greatly amplified the impact of the subprime crisis by facilitating the originate-to-distribute model, increasing the interconnectedness that made it systemic, encouraging conflicts of interest and discouraging proper due diligence because of excessive complexity.
The financial industry fears that a strict STS framework would get in the way of the commercial success of STS securitisation. We argue, to the contrary, that a tight framework would help investors to trust it again. More importantly we must make sure that we get the right approach for citizens, not just the financial industry.