Statement by John P. LaWare - Statements to the Congress - Board of Governors, Federal Reserve System - securitization of small business loans - Transcript

Federal Reserve Bulletin, August, 1994

Accordingly, section 138 of the House version of H.R.3474 should be either dropped or revised to decouple the agencies' regulatory capital rules from GAAP. Further, we would propose that the Congress also amend section 121 of FDICIA so that the agencies' regulatory reports can follow GAAP to the extent consistent with safety and soundness.

Now I would like to turn to the specifics of section 208 of title II, which deals with the accounting, capital, and reserve requirements for transfers of small business loans. In particular, with respect to capital, section 208 contains two principal provisions. First, small business loans sold with recourse would be reported in accordance with GAAP on the regulatory reports filed by insured depository institutions. Second, the maximum amount of capital and reserves to be maintained by insured depository institutions selling small business loans with recourse would be limited to a specific reserve equal to the selling institution's reasonable estimate of its liability under the recourse arrangement, plus an 8 percent capital requirement against the amount of retained recourse.

As I have noted, one of the most important safety and soundness considerations is the amount of capital that is maintained to protect banking organizations from any risks associated with loan securitization. In our view, the capital provision outlined in section 208 of title II accords quite preferential treatment to the securitization of small business loans. If that treatment were to be extended to small business loan securitizations without imposing limitations, it would raise safety and soundness concerns. The bill incorporates some limitations, however, that help somewhat to mitigate these safety and soundness concerns. First, the preferential capital treatment would be restricted to those institutions that, under the agencies' current risk-based capital standards, are either well capitalized or are adequately capitalized and have the approval of their primary regulator. Second, the aggregate of the maximum contractual recourse obligations on all such loans "sold" may not exceed 15 percent of a bank's total risk-based capital.

Although we do not believe that the approach specified in title II is the best way to manage this activity, we did not object to the approach or believe that it would unduly threaten safety and soundness so long as these limitations were in place and the preferential capital treatment was limited to small business loans. We are concerned, however, that establishing a special capital treatment for small business loans would set a troubling precedent for other types of loans and that the extension of the liberal treatment beyond small business loans could raise safety and soundness concerns.

As I mentioned earlier, the banking agencies have issued specific proposals to revise our capital standards for securitizations and other recourse arrangements. We believe that rather than specifying detailed capital requirements for a select group of assets by statute, it would be preferable for the Congress to revise this legislation to support the agencies' efforts to develop appropriate capital standards for securitizing all types of loans. This would enable the agencies to address small business loan securitization in a manner that would be consistent with the maintenance of a safe and sound banking system. It would also avoid the rigidities that result when technical and complex regulatory requirements are written into law. The agencies need flexibility to be able to adjust the rules to account for changes that occur in the marketplace.