Balance sheet management

Simplified by digital assets

European banks face increasing regulatory requirements, perhaps most prominently seen in the upcoming Basel IV standards.

Alternative solutions are necessary

As a result of the Basel IV changes, in the coming years many banks will be required to increase the capital held against their loans. That means lower lending capacities, lower returns on equity and possibly substantial capital injections. That is of course, if we assume banks proceed with a business model that involves building up the number of loans on their balance sheet.

Increased return on equity

CrossLend’s Marketplace and Distribution Service offer a highly efficient alternative. By adopting an originate-to-distribute (OTD) or originate-to-service business model in parallel, banks can increase their lending business without the fear of incurring such punitive capital requirements.

The reason for this is reasonably straightforward. Loan servicing liabilities do not suffer the same capital requirements as loan assets. By mobilising its loan assets and distributing them to an institutional investor, the originating bank can, in a number of scenarios, earn a higher return on equity than under the traditional model.

Flexible syndication

Derecognition of loan assets

The waterfall structures and credit-enhancement features commonplace in traditional ABS transactions often necessitate a continued recognition of the loan assets (or large portion thereof) on the originating bank’s balance sheet. International Financial Reporting Standards (IFRS) impose this restriction since the bank still directly or indirectly participates in the risks or rewards of the loan portfolio.

CrossLend offers a viable solution to this problem. The pass-through notes offered within its Marketplace and as part of its Securitisation-as-a-Service offering, enable many bank originators to derecognise these underlying loan assets from their balance sheets; risks and rewards are distributed to the end investors.

Decreased interest rate risk

When a bank holds loans on its balance sheet, they will naturally look to hedge the risk, however, that hedge can never be 100% accurate. Default rates and recovery rates for example, are based upon assumptions that can change dramatically depending on market conditions. What’s more, central bank rates have in general, not increased interest rates for any extended period since the 1970s, hence any rate increase would be sure to have uncertain effects on the economy at large.

Forward flow agreements such as those offered by CrossLend allow banks to distribute the loans as they are originated. They can continue to write loans according to their usual, robust checks and processes, yet they do not suffer the risk of value impairment arising from interest rate changes. There is no need to build up a qualifying loan book to later securitise. They can simply participate in an agreement to write loans within agreed spread ranges and earn servicing fees uncorrelated to the interest rate environment.

Decreased sector or name risk

The beneficial risk management aspects of an originate-to-distribute model are not just limited to interest rate risk. Sector or single name concentration risks can lead to asymmetrical balance sheets. Rather than undertaking syndication efforts for individual loans or building up portfolios in specific sectors to later securitise them, banks can pre-agree forward flow criteria to distribute these loans to institutional investors if and when they arise.

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