Are covered bonds the future?
Wednesday 16 March 2011 - by Andrew Hickley
As asset-backed securities took a hammering in the financial crisis, the modest covered bond - the debt security backed by mortgages and public sector loans - has in turn seen its stock rise and rise.
"We call for a more appropriate level of haircuts, such as those used by central banks for repo operations."
Banks, he says, generally seek a balanced liquidity portfolio in terms of the duration of their maturities, and the haircut would discourage banks from using short-term bonds.
He adds that, in the event of a liquidity crisis, the higher interest to be attained from longer-term bonds would present difficulties.
"As experience from the current crisis shows, shorter maturities have always been in better trading conditions in times of stress.
"Hence, it is fair to state that banks tend to have better access to liquidity without having to approach the corresponding central bank if the duration on the assets held for liquidity purposes is on the lower end."
Bertalot points to the European Central Bank's covered bonds haircuts. The ECB classes AAA to A- fixed coupon jumbo-covered bonds as category II instruments for collateral, with haircuts of between 1 and 7.5 per cent, depending on the length of their maturity.
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