The Pfandbrief 2011 | 2012

Effects of Basel III on the Pfandbrief-based lending business
Liquidity buffer (liquidity coverage ratio)
For the liquidity buffer (liquidity coverage ratio/LCR) proposed under Basel III, in future all
lending institutions must hold highly liquid assets in order to pass a stress scenario lasting 30
days without any available refinancing. In addition to sovereign debt, Pfandbrief (and other
covered bonds) will also be recognised as liquid assets, currently for up to 40% of the buffer
and at a haircut of 15%. The detailed criteria for recognising covered bonds as highly liquid
asset components have not been finalised.
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Still undecided is how the liquidity of the covered bond can be adequately factored in when
measuring the size of the liquidity buffer. The parameters for determining the liquidity
requirement currently stipulate a so-called “run-off factor” of 100% for Pfandbrief. This
assumes that in a crisis situation, covered bonds will not be available as a refinancing
instrument and that follow-up financing for outstanding Pfandbrief will not be possible
upon maturity in such a scenario. The run-off factor would have to be reduced significantly
to adequately reflect the Pfandbrief’s proven record as a source of liquidity to banks during
serious financial crises.
The assets in the liquidity buffer are rightly subjected to rigorous requirements. At the
same time, the criteria for accepting Pfandbrief and other covered bonds into the liquidity
buffer need to be further refined. Precisely which criteria will be selected will be determined
during an observation phase running through the end of 2013. The parameters for
recognition of covered bonds in the liquidity buffer will then be finalised. This means that
there will be an opportunity to rethink the maximum percentage of covered bonds in the
LCR (currently 40%), as well as the prescribed haircut of 15%.
Effects of Basel III on the Pfandbrief-based lending business
With the implementation of the Basel III rules beginning in 2013, the entire banking industry
will regularly face higher regulatory capital requirements due to the increased quality requirements
for equity components, the new capital buffers and the tendency towards higher regulatory
deductions. Banks that are currently not operating significantly above the regulatory minimum
capital requirement will be required to increase capital and/or boost retained earnings or
reduce risk positions on a regular basis over the medium term.
Overall, this will lead to higher absolute equity and total capital costs. Because more – and,
crucially, expensive – equity will have to be held for the same business activities, the investor’s
return on equity will tend to decrease. As margins in the pfandbrief-based lending business –
especially public sector lending – tend to be low, even slight increases in refinancing costs will
place upward pressure on credit terms.
If the leverage ratio is implemented as a Pillar 1 quantitative minimum requirement beginning
in 2018, thereby joining the risk-based regulatory capital requirements public sector
lending will, in all probability, be particularly affected. This is due to the fact that this segment
in general has a low credit risk, which is reflected in correspondingly low regulatory riskweightings,
low regulatory capital and, consequently, a relatively high degree of leverage.