Rueful laughter rippled round the City on Tuesday when Michael Roberts, HSBC’s top investment banker, appeared to complain to a House of Lords committee that the capital treatment for securitization was too light.
It must be almost the first time since regulators’ penal clampdown on securitization after the 2008 financial crisis that a banker has made that gripe.
For much of the last 15 years Europe’s financial industry has been bemoaning the illogically harsh treatment of securitization in capital rules for banks and insurance companies. Securitization investments often require higher capital than the very same assets would if held naked. At long last, the market seems to be winning the argument with ABS-phobic politicians. Was Roberts letting the side down?
In fact he made exactly the opposite point to the industry’s usual grudge: HSBC’s direct loans to SMEs were 100% risk-weighted, the head of corporate and institutional banking said, but if HSBC bought a private credit fund’s securitization of similar assets it would only be 20% risk-weighted.
Scoring a point
Examined more closely, the comment was more rhetoric than reneging.
Roberts and Stephen Dainton, head of investment bank management at Barclays, were before the UK upper chamber’s financial services regulation committee and their main goal was to plead for leniency on capital requirements.
Banks’ primacy in financing companies is being eaten away by the rampant crowd of private credit funds, whose firepower is soaring. They are unregulated, free of any obligations to reserve capital and with minimal oversight of their lending standards.
If that wasn’t bad enough, the Trump administration in the US is expected to slash capital requirements for big US banks, already ferocious competitors in European loan and capital markets.
Barclays and HSBC are desperate for UK regulators to cut them some slack in how they implement Basel IV.
Roberts’ comment about securitization was a cunning way to highlight that high capital requirements on corporate loans are driving this bread and butter business out of the banking sector.
To make the point sparkle, he compared apples with pears. The bank capital rules for securitization investments are fiendishly complicated, but any tranche risk-weighted as low as 20% must be investment grade, with substantial overcollateralisation. This ought to be a lower risk position than a portfolio of whole SME loans, which will inevitably suffer some losses — so lower capital is warranted.
Too big to fail
But Roberts’ words should not be dismissed. They point to two important and often overlooked truths about private credit. First, it no longer just frolics in marginal spaces banks have chosen to vacate, but can play with a competitive advantage on their home turf.
Second, its growth is partly being fuelled by leverage from banks. The loans and securitizations used are not public deals but private structures, about which there is little public knowledge. Roberts was highlighting a regulatory arbitrage, which needs to be carefully watched.
The implications are far-reaching. Banks are regulated — and more tightly so since the financial crisis — for two reasons. They keep people’s savings safe and they are the main suppliers of credit.
Private credit does not at the moment need bank-style regulation for the first reason. Investors’ money is held long term, protecting funds from runs — and savers quite rightly invest at their own risk.
However, using bank leverage does weaken private credit’s claim to be a completely separate system from banking. If the vulnerability of banks is that money can be pulled out quickly, then some of that vulnerability rubs off on private credit if it relies on loans from banks, which could suddenly dry up.
The second reason for regulating banks — to protect the provision of credit — will apply every bit as much to private credit funds, if they get big enough to matter.
That moment is coming closer, fast.