EU resurrects banking practice that caused the 2008 financial crisis

BRUSSELS — The European Union wants to breathe new life into a financial practice most commonly associated with causing the 2008 financial crisis as it tries to jump-start banks’ lending to the economy.

On Tuesday, the European Commission will publish a package of legislation aiming to revive the industry of “securitization,” after strict postcrisis laws almost stamped out the use of the practice in the bloc.

Securitization is the practice where banks repackage and resell debt, famously explained by actress Margot Robbie in a bubble bath in the film “The Big Short.” The engineering allows banks to move some assets off their balance sheets, giving them more space to extend new loans.

In the pre-2008 lending boom, American banks sold their dodgiest “subprime” loans to investors around the world. When the U.S. housing bubble burst and borrowers defaulted en masse, a global financial crisis ensued.

Brussels now wants to loosen the rules governing the practice, meaning banks would need to put aside less capital against the loans they trade, as well as easing due diligence and reporting rules around the practice. But the Commission insists enough safeguards will remain to protect against a repeat of 2008.

Pint-sized market

The European market is pint-sized compared with others globally: It shrank from being worth around €2 trillion at its precrisis peak to €1.2 trillion now. The U.S. market has grown from being worth $11.3 trillion (€9.76 trillion) in 2008 to $13.7 trillion (€11.83 trillion) now — leading senior officials at the Commission to call securitization an “underexploited tool in Europe.”

Buzzy political reports from figures like former Italian prime ministers Enrico Letta and Mario Draghi on how to boost the bloc’s ailing economy called for a revival of securitization in the EU to boost bank lending to businesses. The push on securitization forms part of the Commission’s wider plan to stimulate an investment culture in the bloc and turn around its sputtering economic growth.

Buzzy political reports from figures like former Italian prime minister Mario Draghi on how to boost the bloc’s ailing economy called for a revival of securitization in the EU to boost bank lending to businesses. | Paulo Novais/EFE via EPA

Governments including in France and Germany have lobbied heavily to see the rules loosened as this would boost their banking sectors, while finance ministers and heads of government all called on the Commission to revive the market — making it a political priority for Commission President Ursula von der Leyen when she was reelected last year.

Banks will be thrilled to see a revival of the practice in Europe — not least because holding less capital against the risk of securitizations will give them more cash to play with.

Not everyone is convinced

The Commission is hoping that will translate into more available bank lending — but others aren’t convinced.

The NGO Finance Watch said securitizations “won’t channel capital to where it’s needed most” because “they are made of the wrong kind of loans and are used in the wrong kind of way.”

The NGO argued that “banks are under no obligation to use the so-called ‘freed-up capital’ to support loans to the productive parts of the economy,” and that the extra cash will commonly be used to meet regulatory requirements or boost shareholder returns through dividends or buybacks.

Top banking supervisors at the European Central Bank’s supervisory arm warned that lowering bank capital requirements in an attempt to boost the securitization market “would not provide further incentive to transfer risks out of the banking sector and would come at the cost of further deviations from international standards.”

The ECB also called on the Commission to draw on “the lessons of the global financial crisis, when opaque and complex securitisations led to excessive risk-taking,” warning that the EU should “ensure that securitisation does not create excessive leverage in the financial system by fuelling asset bubbles and hiding risks on bank balance sheets.”