This note aims to deep dive on one aspect considered in the recent EC consultation, concerning the liquidity treatment of securitisation in the banking prudential framework. This aspect is often overlooked, compared to the capital treatment and other issues.

One of the main impediments to increase the demand side, as regards banks’ treasuries as potential investors in the European securitisation market, is the unjustifiable liquidity classification and haircuts that are applied to senior tranches of European securitisations in the Liquidity Coverage Ratio (LCR) when owned by European banks.

Over time, the share of ABS in banks’ HQLA buffers (which amount to about 5.6 € trn) has been fluctuating from 0.2% to a maximum of 0.7%. This shows that the high haircuts applied in category 2B (25%/35%) work as a total disincentive for banks to invest (or make market) in securitisation.

This disincentive for banks to invest in ABSs was probably an intended feature, inspired by the losses incurred by some banks having invested in US sub-prime securitisation. However, 15 years after the GFC, and given the highly protective framework developed in the EU, such disincentive is not anymore relevant. LCR eligibility is a crucial aspect, not only for banks, but for the market as a whole. Indeed, LCR eligibility is an important investment criterion for the banks but also for non-bank investors, who take this liquidity aspect into account in their investment decision, because an instrument with a favourable LCR treatment can be more easily sold to a bank when needed, and at a better price.

Banks investing (or market making) in senior tranches of securitisation should not be seen as a source of financial stability risks. Senior tranches carry a small fraction of the risk of the securitised portfolio. Instead, it should be seen as an instrument of cross 2 border private risk sharing, contributing to increased EU financial integration, convergence in funding conditions, and improved resilience.