Banks acting imprudently on collateral requirements for SRTs, says Bank of England
The Bank of England’s Prudential Regulation Authority (PRA) has voiced its concerns over the way that banks are recognising collateral in relation to illiquid and structured financing portfolios.
In a letter to chief financial officers published on 9 April, co-signed by PRA executive directors Charlotte Gerken and Rebecca Jackson, the PRA said that it is “concerned that, in certain areas, not all banks are demonstrating a sufficiently thorough assessment of collateral eligibility”.
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The PRA has identified that “for certain financing portfolios, banks have adopted an imprudent approach associated with the recognition of collateral for regulatory capital purposes, resulting in a potential undercapitalisation of the risks”.
It said that the principal concerns outlined in the letter related to significant risk transfer financing activities, but it expects firms to consider the feedback to all relevant financing portfolios.
“For example, we consider that the repackaging of illiquid assets into a tradeable format, is not, without appropriate supporting evidence, sufficient to justify regulatory capitalisation under trading book rules for accompanying securities financing transactions,” the letter said.
The PRA said that it expected firms assessing market liquidity to assess the relevant secondary market liquidity associated with the specific collateral.
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When assessing their ability to value underlying collateral, firms are expected to have regard to the extent to which a position can be marked-to-market daily “by reference to an active, liquid two-way market”, the letter said.
“For marked-to-model positions that make use of liquid proxies as a key input for valuation purposes, we expect firms to appropriately consider all material risks associated with the collateral and the extent to which these are reliably captured in the model,” the PRA said.
“We expect that for collateral with material unobservable parameters, significant illiquid basis risks or other important factors which cannot be reliably modelled, this eligibility requirement would not be met.”
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