Alternatives to standard securitization practices: the case of covered bonds

Description of impact

The recent financial crisis has a number of causes, but many lay much of the blame on the movement of financing away from traditional bank lending to what is known as the shadow banking system. Securitization – the sale of bonds backed by the payments on a group of loans – plays a major role in the shadow banking system. The ability to easily securitize loans in the pre-crisis period abetted the rapid increase in the issuance of the loans that were used as collateral for securitizations. However, the financial crisis exposed a lot of problems with the securitization process, especially for residential mortgages, the largest asset class used to back securitizations. One alternative to securitization for residential mortgages is covered bonds (CB), which have been used in some European countries for over a century. In this project, we propose to take recent country experiences to compare MBS to CB and to examine why banks issued each of these types of bonds.
The interest on how to improve securitization practices has been a priority in the reform of the so-called international financial architecture [b1 and b2]. The extent to which covered bonds can be considered as a substitute to MBS has influenced recent proposals to change regulation on securitization in Europe. As part of the capital markets union action plan, the European Commission proposed two legislative measures to promote a safe and liquid market for securitization in 2015 that were still under debate in early 2017. The first one is a regulation that applies to all securitization products and includes due diligence, risk retention and transparency rules together with a clear set of criteria to identify simple, transparent and standardized securitizations. The second one is an amendment to the regulation on capital requirements to make the capital treatment of securitizations for banks and investment firms more risk-sensitive and able to properly reflect the specific features of every type of MBS. The latter will likely make it so that MBS have some of the favourable properties of covered bonds.

Description of the underpinning research

Research on securitization has been one of the key issues covered in finance studies over the last few years and the experience on this field is growing [a1]. Empirical studies directly comparing standard forms of securitization to covered bonds are, however, less frequent, although there are some recent exceptions [a2]. The impact of these securitization choices on the real economy is also very relevant (see [a3]).
a1] Carbo-Valverde, S., Marqués Ibáñez, D. and F. Rodríguez-Fernández, (2012), "Securitization, risk transferring and financial stability: the case of Spain" Journal of International Money and Finance, vol. 31, 80-101.
[a2] Carbó Valverde, S., Rosen, R. and Rodríguez Fernández, F.(2017), Are Covered Bonds a Substitute for Mortgage-Backed Securities?, Journal of Economic Policy Reform, forthcoming.
[a3] Carbo-Valverde, S., Degryse, H. and Francisco Rodríguez (2015) “The impact of securitization on credit rationing: empirical evidence”, Journal of Financial Stability, vol. 20, 36-50.

Impact status	Ongoing
Impact date	2010 → 2017