Nout Wellink, chairman of the Basel Committee on Banking Supervision, highlighted how Basel III will boost demand for covered bonds in a speech last Thursday (14 April), and also discussed how the chances of mortgage backed securities being recognised as liquid assets could be improved.

Wellink, president of De Nederlandsche Bank, made the comments while discussing the impact of Basel III on the financial markets at an ING conference in Amsterdam.

“The LCR [Liquidity Coverage Ratio] will change the relative preferences for banks to hold certain asset classes,” he said. “It will make assets that are considered as liquid under the new regulation more popular, and assets that are not considered as liquid assets less so.

“This can shift demand to sovereign bonds, covered bonds and high quality corporate bonds and away from less liquid assets, such as other bank bonds, securitised assets and lower quality corporate bonds. All this can have implications for credit spreads and investors’ returns on particular market segments.”

Wellink said that the prospects for term funding could improve if the liquidity of long term paper improves relative to short term paper.

“This could be stimulated by transparent, collateralised and straightforward asset structures,” he said. “For these reasons covered bonds have become popular recently, although we are not sure on the precise impact on unsecured investors. In the first quarter Eu100bn of covered bonds was issued in Europe and observers expect this asset class to grow further.

“The recognition as liquid assets in the LCR supports the issuance of covered bonds.”

He then raised the prospect of MBS in the future being included in the LCR.

“As you probably know, MBS securities are not recognised in the LCR buffer,” said Wellink. “Increased transparency and market liquidity, for instance through market quotation, would increase the likelihood that MBS securities would be recognised as liquid assets.”

The shortfalls in liquid assets that some countries are facing were also addressed, with Wellink highlighting how “tailor-made” solutions were allowed by the new liquidity regulation.

“For instance, the Reserve Bank of Australia has established a liquidity facility to help local banks meet the LCR requirement,” he said, “while Denmark intends to give special treatment to covered bonds; the possibilities to do so will be fleshed out over the observation period.”

Wellink also discussed how the Net Stable Funding Ratio will under Basel III affect supply of, as well as demand for, covered bonds.

“To limit funding costs, banks will pursue different strategies in their liquidity management. They will try to raise more retail deposits,” he said. “However, the supply of retail savings is limited, in particular in the Netherlands where banks have to compete with insurance companies and pension funds.

“Alternatively, banks could issue more secured funding, for instance covered bonds, or issue more long-term unsecured bonds.”