Central banks and supervisory authorities need to monitor asset encumbrance closely, but should focus on the root causes of any excessive encumbrance and avoid “heavy-handed” measures, said a Deutsche Bundesbank official at a vdp seminar today (Tuesday).

Andreas Dombret, member of the executive board of the Deutsche Bundesbank, made the comments in a speech delivered at an Association of German Pfandbrief Banks (vdp) seminar in Tokyo today. He spoke about Germany and the euro area before moving on to address the German Pfandbrief and “the search for safe assets”.

The central bank official noted that the Pfandbrief might benefit from regulation spurred by the financial crisis, such as the introduction of global liquidity standards for banks under Basel III, the status of Pfandbriefe for Liquidity Coverage Ratios (LCRs) and Net Stable Funding Ratios (NSFR), and the demand for collateral in the euro area fuelled by stricter standards for margin requirements on OTC derivative transactions.

As a result, Pfandbriefe, along with other collateral, might be increasingly sought after, a positive for the Pfandbrief market, he said.

But there are possible adverse side-effects of these developments, he noted, in that they may lead to increasing asset encumbrance.

“As a central banker in charge of financial stability … I have to take them with a pinch of salt,” said Dombret.

Increasing asset encumbrance could make refinancing more challenging for banks, and undermine bail-in policies, he said, noting that widespread limits on covered bond issuance have been advocated by some people as a means of addressing the potential effects of higher asset encumbrance.

He acknowledged a need for central banks and supervisory authorities to monitor the matter closely, but called for caution.

“Nevertheless, I would argue that we should not rush to implement heavy-handed measures, lest we throw the baby out with the bathwater,” he said.

There is still sufficient collateral available in the global financial system and any potential scarcity of safe assets may also vary by jurisdiction, he noted, and acceptable levels of asset encumbrance will also depend on the business models of banks.

“In Germany, for example, there are currently no signs of an increase in asset encumbrance that would worry us,” said Dombret. “Against this background, it does not seem advisable to introduce international regulation directly aimed at limiting asset encumbrance at the current juncture.”

Basel III liquidity rules and minimum requirements for bail-inable debt under the Bank Recovery & Resolution Directive (BRRD), meanwhile, also already address the potential problem of asset encumbrance, albeit slightly implicitly, he added.

Improvements in the European banking system and funding markets should also lead to reduced demand for collateral, making shortages a temporary phenomenon.

The focus should be on the underlying root causes of any excessive encumbrance of assets, because “soothing the symptoms alone will not take us forward”, according to Dombret.

In this vein, the pending assessment of banks’ balance sheets – the asset quality review (AQR) – by the European Central Bank and orderly deleveraging of European banks are important steps in addressing any adverse effects from asset encumbrance, he said.