(Bloomberg) -- UK financial regulators are set to bolster banks’ use of significant risk transfers by making it easier to do “unfunded” deals, where banks use insurance to cover potential loan losses.
The Bank of England will soon bring forward a consultation paper outlining the circumstances under which lenders can create those transfers, according to people with knowledge of the matter. The guidance is part of its wider post-Brexit revamp of the country’s rules on securitization.
Such a move would broaden the universe of investors for UK bank SRTs, something that would reduce their cost overall. In some cases, unfunded SRTs are also cheaper than funded SRTs.
The UK finance industry has long lobbied to be allowed to make broader use of SRTs, a popular tool embraced by European banks to offload risk since the financial crisis that has recently become one of Wall Street’s favorite trades. The transfers boost solvency ratios for traditional lenders, cutting the amount of capital they need to set aside to cover potential losses and allowing them to invest in more lucrative areas.
Unfunded deals are common in the European Union, allowing banks to transfer the risk on a portfolio to a third party investor such as an insurer, while using credit insurance to maintain their interest in potential losses. Some of that protection is provided by the likes of the European Investment Bank and public development funds, which reduces the likelihood of the insurer not honoring its commitment.
The UK has been an exception to that, because banks’ exposure to the loans is typically maintained through collateral like cash, which is posted to cover potential losses on a tranche of the loan. The ‘funded’ nature of those deals makes them safer, but sometimes more expensive to do because it removes the risk of the investor failing to pay out.
The BOE declined to comment. The regulator launched a discussion paper on the future of securitizations last year, which included questions about how banks would mitigate the risks of unfunded SRTs.
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