Investment banks, including Goldman Sachs and Barclays Capital, are inventing schemes to reduce the capital cost of risky assets on banks’ balance sheets, in the latest sign that financial market innovation is far from dead.
The schemes, which Goldman insiders refer to as “insurance” and BarCap calls “smart securitisation”, use different mechanisms to achieve the same goal: cutting capital costs by up to half in some cases, at the same time as regulators are threatening to force banks to increase their capital requirements.
BarCap’s structures involve the pooling of assets from several clients into a secured financial product that can be sold on to other investors and rated by a credit rating agency, potentially reducing the capital allocated against the assets by between 10 per cent and 50 per cent.
These new mechanisms are in some respects similar to the discredited structured products, which were widely blamed for fuelling the financial crisis. But the schemes’ backers argue there are two significant differences. First, they involve the securitisation of banks’ existing assets, rather than of new lending. Second, bankers argue that the new products do not disguise the transfer of risk.
“This is the world of smart securitisation,” said Geoff Smailes, managing director of global credit solutions at BarCap. “It’s not securitisation for leverage and arbitrage purposes any more. This is all about restructuring portfolios of assets to achieve risk, capital and funding efficiency in a transparent and less complex way.”
However, some regulators may be wary of the invention of new pooled asset derivatives, especially if they are perceived as a way to avoid regulatory capital requirements.
Some rival bankers also view the schemes with scepticism. “This is a system of capital arbitrage,” said one senior banker at another investment bank. “The need for capital just miraculously disappears.”
BarCap has worked on portfolios worth hundreds of billions of pounds in recent months, including those of the Barclays’ parent company. Investors in the securitised products typically include the original banks, plus third parties, such as hedge funds and private equity firms, as well as BarCap itself.
Separately, Goldman is working on what bankers said was a private-sector version of the UK government’s asset protection scheme. The goal would be similar – to reduce the capital that would need to be held against the assets – although Goldman has yet to find a balance between the risks and rewards that would be attractive to investors.
Investment banks do not believe they can compete with the government-sponsored APS, mainly due to scale. RBS and Lloyds between them are putting £560bn ($914bn) into the scheme. Under Goldman’s idea, it would sell an insurance product to a bank with a toxic portfolio, effectively shifting the risk of the underlying assets off the balance sheet. The insurance would require far less capital to be carried against it than the original assets.
Deutsche Bank engineered a comparable structure to facilitate the dismantling of risk at failed insurer AIG, although bankers close to that transaction said without government involvement the cost of such a structure would be commercially unfeasible.
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