Impact of the SA Output Floor on the European Securitisation Market

This research paper examines the impact on the European securitisation market of the introduction by regulators of the Standardised Approach (SA) Output Floor. This rule change forms one of the final elements of Basel III. It requires that advanced banks, those which calculate regulatory capital based on the Internal Ratings Based Approach (IRBA), hold the greater of (i) IRBA capital and (ii) a percentage of the capital one obtains when the alternative SA is employed.

Our findings are as follows:

  1. For the regulatory wholesale asset class:
    i. Corporate securitisations, both for large corporates and SME portfolios, will be largely      eliminated by the introduction of the Basel SA Output Floor as currently envisaged. This could contribute to a significant reduction in the availability of bank funding to European firms.
    ii. Existing transactions done for risk management purpose, especially corporate ones, are likely to fail the EU Significant Risk Transfer (SRT) test applied by supervisors and, hence, will have to be terminated. Some of the negative effects of the SA Output Floors on existing transactions would be substantially mitigated if IRBA banks were required to evaluate EU SRT tests only under IRBA, at transaction level, even if the aggregate SA Output Floor is binding.
    iii. The impact of Basel and EU rule changes will be felt at a time when securitisation as a capital management tool would likely otherwise be more widely used owing to the rise in capital for corporate lending implied by the SA Output Floor.
  2. For the regulatory retail asset class: the SA Output Floors regime will encourage greater securitisation activity in residential mortgage and other retail loan portfolios because the increase in capital for loans held on balance sheet will exceed, sometimes disproportionately, that of securitised assets.

These findings suggest that implementation of the SA Output Floors will disfavour one asset class substantially while benefiting another asset class with no clear rationale based on policy priorities or risk sensitivity. This is a consequence of adopting regulatory rules that are not soundly rooted in an understanding of the relative riskiness of different asset classes.

While provisional adjustments can moderate some foreseeable effects on securitisation transactions, a more profound reform of the regulatory treatment of securitisation is needed for this financial technique to contribute to the development of the European economy.

The study, commissioned by AFME, is available here.