Asset portfolio securitizations and cyclicality of regulatory capital

• Analysis of level and cyclicality of regulatory bank capital for asset portfolio securitizations.
• Asset portfolio securitization increases regulatory capital cyclicality.
• RBA, point-in-time ratings and passive reinvestments further increase cyclicality.
• Asset portfoliio cyclicality is caused by the sensitivity of senior tranches to the macroeconomy.
• Empirical ratings are time-constant and losses exceed capital during crises.

This paper analyzes the level and cyclicality of regulatory bank capital for asset portfolio securitizations in relation to the cyclicality of capital requirements for the underlying loan portfolio as under Basel II/III. We find that the cyclicality of capital requirements is higher for (i) asset portfolio securitizations relative to primary loan portfolios, (ii) Ratings Based Approach (RBA) relative to the Supervisory Formula Approach, (iii) given the RBA for a point-in-time rating methodology relative to a rate-and-forget rating methodology, and (iv) under the passive reinvestment rule relative to alternative rules. Capital requirements of the individual tranches reveal that the volatility of aggregated capital charges for the securitized portfolio is triggered by the most senior tranches. This is due to the fact that senior tranches are more sensitive to the macroeconomy. An empirical analysis provides evidence that current credit ratings are time-constant and that economic losses for securitizations have exceeded the required capital in the recent financial crisis.