Basel II and securitising bank holdings of foreign currency government debt

Abstract

The Basel II Accord on capital standard, which will take effect in 2007 in many countries, requires banks to hold a larger amount of capital than was specified in Basel I against their holdings of certain categories of assets, one of which is foreign currency government debt. The Accord impacts many countries but mostly has major capital implications for around 110 countries with export credit arrangement risk scores of category seven and category four to six, which are the highest risk scores applicable to nations in the Basel agreement. This paper examines one aspect of the balance-sheet implications of the Basel II Accord concerning capital held by commercial banks against their holdings of foreign currency government debt (Eurobonds) issued by their own governments. Basel II attaches 150 per cent risk weight to this asset for countries with classification risk of seven and 100 per cent for countries with classification risk of four to six. Using a simplified numerical model applied on two countries' representatives of the two classification groups, the analysis shows a major necessary increase in capital to meet the requirements specified in Basel II. This necessitates a bank balance sheet reshuffling away from this asset into assets with lower risk weights. Banks, however, have to continuously subscribe to this asset due to the large amounts of dollarised debt in highly dollarised countries, the reduced ability of many countries to market debt internationally and for other relevant reasons. Therefore, we present analysis that relies on the securitisation process to suggest a new proposal that has not been applied or practised yet, in which banks may not have to raise a large amount of additional capital for debt they subscribe to by securitising some of the foreign currency government bonds held on their balance sheets.