U.S. regulators ease credit risk rules on guarantees for banks using advanced approach

August 15, 2014

By Bora Yagiz, Compliance Complete

NEW YORK, Aug. 15, 2014 (Thomson Reuters Accelus) – Three major U.S. regulatory agencies have eased requirements under the advanced approach risk-based capital rules by removing a key requirement concerning guarantees provided by counterparties eligible for recognition as credit risk mitigants.

The final rule , agreed by the Office of the Comptroller of the Currency, the Federal Reserve and the Federal Deposit Insurance Corporation, modified the definition of “eligible guarantee” for purposes of the advanced approach risk-based capital rules by removing the requirement that an eligible guarantee be provided by an “eligible guarantor” for all exposures other than securitization exposures.

The change in the definition comes as a response to concerns from the industry. Certain banks using the advanced approach noted that guarantees provided by owners or sponsors of commercial real estate loans fail to meet the definition of eligible guarantor, simply because they have not issued investment grade debt securities. The rule, they argue, ignores valuable credit risk mitigation that should otherwise be recognized under the advanced approach capital requirements.

The definition of eligible guarantor includes a sovereign, international financial organizations (such as the Bank for International Settlements, the IMF, the European Central Bank), a multilateral development bank, a depository institution, a bank holding company, a savings and loan holding company, a credit union, a foreign bank, and a qualifying central counterparty, that at the time the guarantee is issued or anytime thereafter, has issued and has outstanding an unsecured debt security that is investment grade; whose creditworthiness is not positively correlated with the credit risk of the exposures for which it has provided guarantees; and that is not an insurance company engaged predominately in the business of providing credit protection (such as a monoline bond insurer or re-insurer).

By allowing these banks to continue to benefit from such guarantees as they did under the 2007 advanced-approach final rule, however, the final rule may have marked a small yet potentially dangerous regulatory reversal.

“We do not know how much of an increase in credit risk exposure there will be because of this expansion in the definition of eligible guarantee,” said Mayra Rodriguez Valladares, managing principal at MRV Associates, in an interview. “I’m usually more assured to see regulators erring on the conservative side, and keeping the eligible guarantors list short.”

The final rule, however, stopped short of including monoline insurance companies as eligible guarantors, staying in line with the definition of eligible guarantor of the 2013 capital rule. Regulators believe that an insurance company engaged predominately in the business of providing credit protection (such as a monoline bond insurer or re-insurer) can present wrong-way risk (i.e. the risk that occurs when exposure to a counterparty is adversely correlated with the credit quality of that counterparty).

The final rule applies only to banks using the advanced approach under Basel II regulation – and does not revise the definition of eligible guarantee for the standardized approach risk-based capital rules. These institutions generally are banking organization with total consolidated assets of $250 billion or more, and that have total consolidated on-balance sheet foreign exposure of $10 billion or more.

The rule does not entail any additional projected compliance requirements for any small top-tier bank holding company, top-tier savings and loan holding company, or state member bank, since no such institution uses advanced approaches.

(This article was produced by the Compliance Complete service of Thomson Reuters Accelus. Compliance Complete provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Accelus compliance news on Twitter: @GRC_Accelus)
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