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News on Covered Bonds: Covered Bonds to increase Banks risk-Norway Financial Regulators argue


Covered Bonds to increase Banks risk-Norway Financial Regulators argue

3rd November, 2012

While the world is going gung-ho on promoting Covered Bonds as an alternative to securitisation and regulators are making necessary regulatory amendments to accommodate/ promote covered bonds; Norway's financial regulators have presented the flip side of the coin by proposing to curb covered bond financing arguing that increase in such funds fuels balance sheet risks.

The Financial Supervisory Authority of Norway in the Summary of the report Financial Trends 2012[1] and in its press release on the financial industry outlook[2] stated that after the substantial growth of the instrument, need for putting limits to covered bonds financing was felt. It is felt that extensive use of covered bonds can increase the vulnerability of financing structure of banks. The several reasons posed by the financial regulators are as below:

a.Mortgage loans are used to secure covered bonds, less quality assets remain with banks for availing other types of financing - hence banks' unsecured creditors may perceive an increased credit risk and banks may find it difficult to obtain unsecured funding. With increasing usage of covered bonds banks will experience problems in obtaining funding other than by way of covered bonds which in turn will reduce banks ability to finance loans;

b.The risk associated with investments in covered bonds is lower than the risk associated with investments in bank bonds. Hence, low funding costs of covered bonds are drawing away funding from other areas;

c.The fact that home loans can be funded at significantly lower interest rates through covered bonds than is the case with loans to business and industry may, detrimentally, draw bank lending away from businesses towards households;

d.Relatively favourable funding of home loans has spurred growth in mortgage lending and intensified price pressures in the housing market in various countries.

The financial crisis had exposed the need for robust alternate modes of funding, which was answered by Covered Bonds providing banks with better access to funds in turbulent markets. The Covered Bond market in Norway has seen rapid growth and the instrument makes up 20% of the banks' funding. Covered Bonds have helped banks mitigate liquidity risk and have helped banks through financial crisis but like they say excess of everything may be bad is the message from the financial authority.

[Reported by: Nidhi Bothra]


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