Equity and Securitization Capital Standards

Based on our analysis of the inter-agency capital proposal’s framework and its credit-risk provisions, FedFin turns now to the proposed approach to equities as well as to that for securitization exposures (i.e., those that are tranched rather than simple secondary-market issuances of packages of loans or other assets backed as needed by a single credit enhancement).  The proposal in some cases liberalizes the current, “general” standardized approach (SA), but more often toughens it to account for elimination of the advanced approach.  This will have particular bearing on significant aspects of category III and IV bank activities (e.g., credit-card securitizations, MMF funding), but all covered banking organizations will see significant capital increases as many activities now permitted within the banking book would need to move to the trading book under the new market-risk rules.  Securitization-related capital standards are generally brought closer to those for underlying assets in simple securitizations, giving banks more balance-sheet flexibility and credit-risk mitigation opportunities if investors accept these structures.  The treatment of equity exposures is generally tightened, sometimes so much as to effectively prohibit certain activities – e.g., non-traditional equity investments in covered funds and BHC subsidiaries.  The new treatment of investment funds will also have significant implications for banks that fund themselves through prime MMFs or sponsor investment funds through equity positions.