By Huw Jones
LONDON (Reuters) - The European Union's banking watchdog has backed an amendment to a draft law to encourage the use of a more complex version of securitisation for funding companies and freeing up bank balance sheets to lend more.
Securitisation fell out of favour when debt based on poor quality U.S. home loans became untradable during the financial crisis.
The draft EU law has proposed easing capital charges on banks that create and sell high quality "simple, standardised and transparent" or STS pooled debt.
A more complex variety, known as synthetic securitisation, was left out of the draft EU law while the European Banking Authority (EBA) reviews the market sector but some elements may now be included.
With synthetic securitisation, a bank uses credit derivatives or financial guarantees to transfer the credit risk from assets like loans that remain on the bank's balance sheet, unlike with the "true sale" standard form of securitisation.
Investors in synthetic securitisation include insurers, pension funds, asset managers and hedge funds.
The watchdog looked at banks that originate and retain some synthetic securitisations linked to loans for small and medium sized enterprises (SMEs).
In its "opinion" to the European Commission, the watchdog says a lighter capital treatment for synthetic securitisation could also be introduced into the draft EU law but should be limited to senior positions and to SME exposures at this stage.
"While there is wider evidence of zero defaults in relation to highly rated synthetic tranches of SME exposures, data available for other asset classes is less conclusive," EBA said.
EBA, citing data from Bank of America (N:BAC) Merrill Lynch, said European synthetic securitisation peaked during 2004-05 with volume above 180 billion euros.
Issuance almost halved in 2006 and continued falling to almost zero while the market for standard securitisation is still only half of its pre-crisis level.
Richard Hopkin, managing director of securitisation at European banking trade body AFME, said EBA's recommendation was a positive step forward.
It is sometimes difficult to securitise SME loans without the use of synthetic securitisation as well, Hopkin said.
"There is a role for balance sheet synthetic securitisation in reviving the broader securitisation market," he added.