I do not understand why securitized loans are treat as off balance sheet. And under Basel II, these are treated on balance sheet to calculate the credit risk requirement. Since the bank has sold off the loan to investors and transferred the credit risk to them, why is this still a concern when calculating credit risk for the bank?
This is a fairly complex area. You are right that as credit risk is transferred, so the capital requirement should go down - indeed this is often given as a reason why a bank may undertake a securitisation. But it is possible that some residual credit risk remains. And the rules for something being off balance sheet from an IFRS accounting point of view can be different from the BIS view of what is off balance sheet. Under older standards, it may have been possible to securitise one asset, buy a similar securitised asset from another party and have a net reduction in capital. Also, in the past, it was possible for 100% of an asset to be moved off balance sheet by transferring a relatively small % to investors. Indeed this was a significant issue in the Enron collapse. Rules have been toughened up since to make such arrangements less attractive (even penal) from a capital perspective.
Under older standards, it may have been possible to securitise one asset, buy a similar securitised asset from another party and have a net reduction in capital. There are 2 transactions here, 1) securitise and sell the asset (eg loan) 2) buy a similar securitised asset from the market Must the second transaction take place? Why is there a need to buy? Is it simply to make use of the cash derived from first transaction?
There is no compulsion to do this - but it is an example of regulatory arbitrage. Say I have to hold a certain amount of capital against an asset. If I can "sell" that asset (through a securitisation) and buy a similar asset (eg someone else's securitisation) and the asset I'm buying is treated more favourably in capital requirements, then I will. And so will lots of others!
