Calibration of securitized loans
Since several years member states negotiate the critical calibration of the new Solvency II framework for Europe’s insurance sector. During these negotiations over the implementing measures the risk weights for securitized products were lowered several times.
The table shows the deterioration of the risk multiplier in the formula which determines the risk capital (solvency capital requirement) in different draft implementing measures since the first known version of October 2011:
|Type 1||Type 2||Type 1||Type 2||Type 1||Type 2||Type 1||Type 2|
|Oct 2011||7 %||16 %||19 %||20 %|
|Jan 2014||4,3 %||12,5 %||8,5 %||13,4 %||14,8 %||16,6 %||17 %||19,7 %|
|Mar 2014||2,1 %||12,5 %||4,2 %||13,4 %||7,4 %||16,6 %||8,5 %||19,7 %|
|July 2014||2,1 %||12,5 %||3 %||13,4 %||4 %||16,6 %||5 %||19,7 %|
The first lowering of the risk multiplier in January 2014 was based on a thorough exercise of Eiopa based on empirical data. Regulators introduced two types of securities in order to distinguish riskier from less riskier products beyond the assessment of rating agencies. High quality securitisation (Type 1) is defined in a way that it can be demonstrated that it had lower risk of failure until the crisis in 2008. Since January 2014 pressures from member states and DG EcFin have led to two new rounds of lowering of the risk multiplier. Without a solid empirical basis the risk multiplier for BBB products deteriorated to 29,4% of its empirically justified value in October 2011.
Economic policy via financial regulation: ECB and Solvency II hand in hand
The arbitrary lowering of risk weights for securitized products is part of a wider campaign to allow banks to hand out more credit. Recently the ECB announced to buy massively asset-backed securities. While the ECB programmes signals markets that the products will remain liquid, insurance companies are seduced to buy and hold the securities.
Fiddling with risk assessment
The changes to the risk factors for securitised loans shows that law makers believe that they know better than the rating agencies how to assess risk. The criteria for the definition of high quality securitisation are able to define credit securitisations which were less likely to fail before the crisis. But it is doubtful that this would also hold true in the future. In any case even for high quality securitisation this can empirically only justify the lowering of the risk factor to the level of January 2014. All further reductions are not prudent and against the very logic of Solvency II that capital requirements should be proportional to risk.
Regulators already overrule judgment of rating agencies in the field of government bonds. Now a similar regulation-driven manipulation of the market is introduced for a new class of assets. Greens in the European Parliament would support a determined move away from the current use of rating agencies in financial regulation. But we are clearly against arbitrary manipulations inside the existing regime.
Growth by imprudent financial regulation
The imprudent assessment of risk by banks, insurances and markets were at the heart of the financial crisis. Market participants and regulators closed their eyes to the real risks of investments. This triggered an unsustainable growth model built on debt. Now regulators are trying to do the same.’
Putting tax payers and customers at risk
Obviously it is desirable that insurance companies take risk and help finance long-term investments. But this honourable objective of economic policy cannot justify the arbitrary manipulation of solvency capital requirements. There is no free lunch – not even in the insurance market. If a new crisis hits European credit markets insurance companies are put in danger to be undercapitalized at the detriment of customers or even tax payers if bail-out operations would be hard to be resisted.
US products discriminated
The definition of type 1 and type 2 securities is clearly targeted so that credit securities issued in Europe will be usually put in the type 1 category and US credit securities fall into type 2. This seems arbitrary as the risk of major credit crises cannot be limited to the US. Recent history is not a reliable proxy for the future. But it is not in the interest of customers that risks in the portfolio of insurance companies are becoming more concentrated. Therefore, I will speak to regulators and business associations in the US and inform them about the planned changes.
The implementing measures are basically ready to be decided. Some last changes discussed during the recent informal EcoFin in Milan have still to be integrated. The interservices consultation in the European Commission is already completed. The final approval by the college of the European Commission is expected for the end of September. I will meanwhile ask for a meeting of the new negotiation team of the European Parliament in order to discuss the matter. The European Parliament has the right to veto delegated acts such as these implementing measures, which is why the European Commission should have an interest to coordinate important changes with the elected lawmakers.
Eiopa’s basis for the January 2014 calibration:https://eiopa.europa.eu/fileadmin/tx_dam/files/consultations/consultationpapers/EIOPA-13-163/EIOPA_Technical_Report_on_Standard_Formula_Design_and_Calibration_for_certain_Long-Term_Investments__2_.pdf