PrefBlog

Tireless researchers in Prefblog’s Department of the Completely Obvious have discovered a little known fact, released today (perhaps inadverdently) by the OSFI:

OSFI’s role is to help promote a safe and sound banking sector in Canada, to the benefit of all Canadians, especially depositors. This means that when Canadians deposit money into their bank accounts, they expect that the money will be safe, secure and available when they need access to it.
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OSFI does not oversee the firms that created the non-bank ABCP, so these firms are not subject to OSFI capital guidelines (such as OSFI guideline B-5). OSFI guidelines also do not apply to the offshore banks that negotiated the bulk of the liquidity lines to non-bank ABCP conduits; they are subject to the capital rules of their home countries.

OSFI has also released a backgrounder on its role as related to ABCP:

In 1988 — 20 years ago — the first international capital agreement (Basel I) was reached. As part of that agreement, all lending commitments of a duration of less than one year carried a zero capital charge (i.e. banks did not need to set aside capital for those commitments). The thinking was that short-term obligations are less risky than long-term obligations.

After the Basel I agreement was struck, securitization started to grow rapidly and OSFI became concerned about increasing risk to the banking sector. OSFI was especially concerned about the fact that no capital was being held for some types of liquidity lines, under which banks would lend to conduits with deteriorating asset quality or buy problem assets from the conduit. These liquidity lines, known as “global style lines”, would ensure that if the cash flow to investors was impaired for virtually any reason, the bank would provide cash to the conduit so that investors would be paid. OSFI took the position, as it does for all credit risk, that capital was needed to back the risk. This was at a time when other regulators still had no capital charges for liquidity lines under the 1988 Basel 1 Accord.

OSFI also took the position that it would only continue to support a zero capital charge if the liquidity line was for pure liquidity purposes. Such liquidity lines already existed. A pure liquidity line, subsequently known as a “general market disruption” line, was considered to be a line that could only be drawn if the entire market was subject to an event that caused problems to the normal functioning of all conduits and thus prevented rollovers (i.e. investors could not buy assetbacked commercial paper, even though they might want to do so, signifying that asset quality was not the source of the disruption). It was thought that such a disruption might include a 9/11-type event.

Most of this is a reprise of the Dickson speech from last fall, but Ace Reporters at Canada’s Business Newspaper thought it would be more fun to whip up hysteria than to report facts. A comparison with American practice – not as prudent as OSFI’s approach, for quite some time – is available on PrefBlog.

As for the future:

OSFI and its international counterparts, via the Basel Committee, announced on April 16, 2008, steps being taken to make the banking system even more resilient to financial shocks, including increasing capital requirements for securitization products that are based on complex structured products (called Collateralized Debt Obligations of Asset-Backed Securities), which have produced the majority of losses globally. The Committee also announced it will be enhancing the capital treatment for liquidity facilities to support ABCP. OSFI has recommended, as part of that process, that the zero capital charges for market disruption liquidity lines be removed.
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OSFI has recommended that, in the future, there be a capital charge for any liquidity support provided to ABCP conduits and that more work be undertaken by Basel Committee members, including Canada, to determine the appropriate capital charges. In the meantime, the 10 percent risk weight OSFI established for global lines in 2004 was increased to 20 percent, as of November 1, 2007, as part of the new Basel 2 framework. Since all liquidity lines offered by Canadian banks are now global style lines, they all carry a capital charge.

I wonder what Canada’s National Newspaper and various self-styled Investor Advocates will make of this. As PrefBlog’s Assiduous Readers are aware, an “Investor Advocate” is somebody who knows nothing and cares less.

The press release regarding Basel 2 changes is light on specifics, but provides an indication of direction:

The Committee is introducing a number of measures to help ensure sufficient capital, to capture off-balance sheet exposures more effectively and to improve regulatory capital incentives.

In particular, the Committee will revise the Framework to establish higher capital requirements for certain complex structured credit products, such as so-called “resecuritisations” or CDOs of ABS, which have produced the majority of losses during the recent market turbulence. It will strengthen the capital treatment of liquidity facilities extended to support off-balance sheet vehicles such as ABCP conduits. More detailed proposals will be published later this year.

The Committee will strengthen the capital requirements in the trading book. Global banks’ trading assets have grown at double digit rates in recent years, and in some cases represent the majority of a bank’s assets. The proportion of complex, less liquid credit products held in the trading book has likewise increased rapidly. The current value-at-risk based treatment for assessing capital for trading book risk does not capture extraordinary events that can affect many such exposures. The Committee, in cooperation with the International Organization of Securities Commissions (IOSCO), therefore is extending the scope of its existing proposed guidelines for “incremental default risk” to include other potential event risks in the trading book. Until this event risk charge is in place (planned for 2010), an interim treatment will be applied for complex securitisations held in the trading book. The Committee expects to issue its event risk proposal for public consultation later this year, and it also will conduct a quantitative impact assessment.

Update: Ms. Dickson has addressed remarks to the House of Commons Standing Committee on Finance. Nothing new, really.

This entry was posted on Tuesday, April 22nd, 2008 at 12:51 pm and is filed under Interesting External Papers, Regulation. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.