WASHINGTON -- Federal regulators on Thursday proposed lowering capital requirements for banks that retain limited credit risk when they securitize assets.

The new rule is expected to bring down bank costs and encourage more securitization, said James J. McDermott, president of Keefe, Bruyette & Woods Inc., New York.

"Capital clearly has been built up to the highest level in the last 30 years, so I think this is probably an attempt to fine-tune the regulation to fit reality and liquify the market," he said. "It's going to make it [securitization] less expensive for banks."

|A Never-Ending Process'

Changes to the so-called "recourse" regulations have been in the works since June 1990. All the agencies have agreed to put the 99-page document out for comment, but some officials reportedly believe the proposed regulations are too complicated to be practical.

"Is this a never-ending process of complexity?" Federal Reserve Governor Wayne D. Angell asked Thursday.

The part of the plan expected to have the most immediate effect on the industry is the proposal to cut capital requirements for banks that securitize their assets but retain only some of the risk.

"Banks would probably like more capital relief, but it [the proposal] definitely opens up an avenue to do loan sales with partial recourse," said Susan Krause, a senior deputy comptroller at the Comptroller of the Currency's office.

"These rules will simplify the securitization of assets," said Karen Shaw, president of the Institute of Strategic Development. "While many instruments have been designed to minimize the capital cost of the existing risk-based capital regulations, this more straightforward approach will be of great assistance."

Currently, a bank must hold 8% capital against the entire amount of assets sold even if the institution limits its exposure to say, 3% of the deal. Put another way, the capital requirement for a bank selling $100 million in assets is $8 million even if the most the bank could lose is $3 million.

Would Cut Capital Requirement

The proposed regulation would eliminate this anomaly and decrease the bank's capital requirement to 3%.

Another option in the proposed rule would allow banks to set up reserves equal to the amount of possible losses. This option would permit a bank to take the assets off its books altogether, which would lower its asset total and therefore shrink its leverage capital ratio.

"It's like taking the capital hit up front," a Fed official explained.

The proposal also would increase capital requirements for banks that provide credit enhancements to assets securitizations. Under existing regulations, the bank only has to hold capital against the enhancement, even if it covers the first losses on the securities.

The proposal would force that bank to hold capital against the total amount of assets being securitized. Using the numbers from the example above, the bank providing a 10% credit enhancement would see its capital charge jump to $8 million, or 8% of $100 million, from $800,000, which is 8% of $10 million.

Few Banks Provide It

However, regulators said Thursday that the market has evolved to the point where few banks provide this first-loss type of enhancement.

Any regulatory change that requires an increase in capital would apply only to deals done after the rules are finalized by the agencies. On the flip side, any capital decreases would apply to all outstanding transactions.

These proposals, which are out for 60 days of comment, could become regulations by June 1994.

Also on Thursday, the agencies put out their version of a rough draft on a plan to link a bank's capital requirements with its relative loss of risk in a securitization.

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