This Selected Issues paper assesses the youth unemployment problem in advanced European economies, especially the euro area. Youth unemployment rates increased sharply in the euro area after the crisis. Much of these increases can be explained by output dynamics and the greater sensitivity of youth unemployment to economic activity compared with adult unemployment. Labor market institutions also play an important role, especially the tax wedge, minimum wages, and spending on active labor market policies. The paper highlights that policies to address youth unemployment should be comprehensive and country specific, focusing on reviving growth and implementing structural reforms.


This Selected Issues paper assesses the youth unemployment problem in advanced European economies, especially the euro area. Youth unemployment rates increased sharply in the euro area after the crisis. Much of these increases can be explained by output dynamics and the greater sensitivity of youth unemployment to economic activity compared with adult unemployment. Labor market institutions also play an important role, especially the tax wedge, minimum wages, and spending on active labor market policies. The paper highlights that policies to address youth unemployment should be comprehensive and country specific, focusing on reviving growth and implementing structural reforms.

Capital Market Development: Sme Financing in the Euro Area2

The corporate sector in Europe is highly dependent on bank financing. This has constrained the recovery of credit supply in the wake of the crisis, particularly to small- and medium-sized enterprises (SMEs). Developing alternative funding sources for SMEs would enhance the resilience of the financial system and help ensure lending to viable smaller firms. An expansion of the SME securitization market would move firmly in this direction, while drawing upon a large existing pool of assets. It would also improve the transmission of monetary policy and the allocation of capital from surplus to deficit economies. Assets from European securitization markets performed relatively well through the crisis, likely reflecting more conservative origination standards. But, further developing these markets requires greater regulatory differentiation of structured finance, cross-country harmonization of asset structures, and official sector support as a catalyst to expand the market, including by underwriting riskier tranches.

A. Background

1. Euro area nonfinancial corporations (NFCs) are more reliant on banks for financing than their U.S. counterparts. About a third of euro area NFC liabilities are bank loans, roughly similar to what is seen in Japan. By contrast, in the United States, they only account for about 7 percent of NFC liabilities; firms are much more reliant on capital markets for their financing (e.g. bonds). Equities also account for a larger share of firm financing in the United States. Focusing only on debt, the picture is similarly stark, with the euro area, Japan, and Europe more broadly, all having about four-fifths of debt finance supplied by banks.

Source: Flow of funds from Bank of Japan, Federal Reserve, and ECB; Federal Reserve, Bank of England, ECB, and Bank of Japan.Note: Total private nonfinancial corporation liabilities were about 2 quadrillion JPY in Japan, 34 trillion USD in the United States, and 27 trillion EUR in the euro area in 2013. Europe is the sum of the euro area and the United Kingdom. Data in right panel are end-2013:Q3, apart from Japan which is end-2012.

2. Only the largest euro area NFCs are able to directly access capital markets. And even though concerns over sovereign risks in the euro area have abated significantly, funding constraints and the high cost of risk for banks in stressed economies have contributed to reduced lending to SMEs. Interest rates charged for small loans in stressed countries are higher than those charged for similar loans in core countries (Al-Eyd and Berkmen, 2013). This is compounded by the fact that low inflation in these countries, and across the euro area, has pushed-up real borrowing rates.

Sources: ECB, Eurostat, Haver Analytics, and IMF staff calculations.1/ MFI lending to corporations under €1 million, for 1-5 years. Real rates are calculated ex post using realized HICP inflation by country.2/ Among those firms that applied within the last six months.

3. SMEs are disproportionately affected by weak credit supply. The ECB’s SAFE survey shows that SMEs applying for loans are experiencing difficulties in obtaining credit from banks. This is particularly the case in Spain and Italy, despite some recent improvement in approval rates.3 In these countries, “finding customers” and “access to finance” are among the largest concerns.

4. Ensuring credit availability to viable SMEs is essential to supporting the recovery in the euro area. In 2012, more than 20 million SMEs in the European Union comprised 99.8 percent of all non-financial enterprises, employed 87 million people (67 percent of total employment), and generated 58 percent of total added value. SMEs account for around 80 percent of employment and 70 percent of value added in Italy, Spain, and Portugal.4 In addition, SME sectors in these economies are dominated by micro-firms with less than 10 employees (about 90-95 percent of total firms).

B. Rationale for Securitization of SME Loans

5. Diversification of funding sources would enhance the resilience of the corporate sector. Broader access to finance would limit the exposure of corporates to banking sector difficulties and help ensure the flow of credit to viable smaller firms, also reducing the vulnerability of the financial system to shocks. In this regard, a number of markets could be further developed, including those in commercial paper (mini-bonds), private equity, and venture capital. On the equity side, European venture capital and growth funding in SMEs amounted to about €5 billion in 2013 (which is about one-half the size of the outstanding stock of actively traded, placed senior tranches of SME securitization transactions) (EVCA, 2014).5 On the debt side, mini-bonds (Italy) and commercial paper markets exist, but these too are relatively small in size. Given the dominance of bank lending, these markets tend to be small or nationally focused.

6. A focus on promoting a more vibrant SME securitization market would have several advantages, including by:

  • Readily drawing upon a large pool of existing bank assets (SME loans) to provide additional funding for SMEs;

  • Boosting bank liquidity and releasing regulatory capital, thus incentivizing banks to cleanse their balance sheets and lend to viable firms;6

  • Helping SMEs to rebalance their financial structure towards longer maturities;

  • Attracting non-bank investors to SMEs, particularly in a low-yield environment.

7. A more developed SME securitization market could also improve the monetary transmission mechanism through the bank lending channel (Jobst and others, 2009). In the context of banks’ reducing their exposure to SMEs and fragmentation across countries, monetary easing has a limited impact on bank credit to SMEs. With SME securitization, SMEs and banks would be able to draw on more funding sources for credit growth, with a smaller charge on capital, thereby making monetary easing through interest rates and standard liquidity facilities more effective. It could also boost the supply of collateral for liquidity provision in a crisis situation.

8. European securitization markets performed comparatively well during the financial crisis, likely reflecting more conservative origination standards. The cumulative default rate on securitization products was relatively low, at around two percent. At the same time, the cumulative default rate for U.S. securitization products was about 18 percent. But, the comparison of U.S. and European securitizations is not straightforward since the underlying assets for these securities differ in their riskiness (Bank of England and ECB, 2014a). About one-third of European securitization products are rated “AAA” (which is the mode), and over half are rated “A” or better. SME securitization shows a slightly lower average rating, with the modal rating of “A”. But almost one-third of SME securitizations are unrated, possibly reflecting their higher likelihood to be retained.

Source: SIFMA and IMF staff calculations.Note: The value of total outstanding European securitization was about 1.5 trillion EUR in 2013. Of this, about 46 percent was placed and 54 percent retained. SME securities accounted for 8 percent of total outstanding European securitization in 2013. Of this, 14 percent were placed, while 86 percent were retained. Europe is a geographic designation here, including both EU and non-EU countries.

9. Given the high reliance on bank lending in the euro area, this note focuses on developing SME loan securitization markets—intermediated through banks as opposed to direct asset securitization—as a readily available source of finance and means to overcome the allocation problem that is reflected in divergent private borrowing costs for similar firms across the euro area.

Overview of the European Securitization Market

The securitization market in the euro area is relatively small and concentrated, making them a limited alternative for firm financing. The outstanding stock of transactions is about €1.5 trillion, which is about the size of the U.S. market if agency-sponsored residential mortgage-backed securities (RMBS) issued by Fannie Mae and Freddie Mac are excluded (Galizia and Gentili, 2014; IMF, 2009 and 2011) (see box figure, upper left panel). The European market is dominated by bank-sponsored RMBS, which amounted to around €860 billion at the end of 2013. SME loan-backed securities (SME) constitute less than one-eighth of the total market (€122 billion), broadly comparable with the share of other securities. Moreover, the euro area securitization market is concentrated, with a handful of countries accounting for the majority of the market. Together, transactions from the Netherlands, Spain, Italy, Belgium, and Germany accounted for about 85 percent of the securitization market in the euro area in 2013 (see box figure, upper right panel).

The securitization market in Europe has contracted by about one-third since the start of the crisis. New placements peaked in 2008 (see box figure, bottom right panel). These have dropped to about one-fourth their earlier size, hovering around €100 billion for 2013. The bulk of the decline in these markets reflects the approximately €500 billion (or about one-third) fall in the RMBS segment between 2009 and 2013. But, in relative terms, the CDO and CMBS markets experienced larger declines, shrinking by almost half, while the SME market similarly fell by about one-third.

As securitization issuance has fallen, the share retained has typically shrunk. But for the SME securitization segment, the share retained has risen throughout the crisis. At the peak, the market was evenly split between retained and placed securitization (see box figure, middle left panel). However, since 2009, placed securitization has fallen by about a half. This mostly reflects the amortization of contracts prior to 2009 that have not been fully offset by new placements (see box panel, bottom left panel). Of new issuances, about two-thirds remain on bank books, while for SME securitizations (securities backed by loans to SMEs), nearly 90 percent are retained. These retained securities can often be used as collateral for short-term funding from the Eurosystem (see box figure, middle right panel). However, although the size of the eligible asset pool for Eurosystem collateral has increased, the pool of eligible securitization has actually dropped, likely reflecting the attrition of these assets (and the net issuance of SME securitization) rather than a tightening of Eurosystem collateral standards (which have been relaxed for some asset classes over the recent past).

Against this background, there is substantial scope to further develop capital market-based funding for SMEs, with a particular focus on securitization. Euro area banks are holding a large stock of relatively illiquid loans that could be transformed into liquid assets through securitization. This could help to spur more lending to SMEs, by releasing regulatory capital and also by bringing new investors to the table.

Figure 1.
Figure 1.

Securitization in Europe

Citation: IMF Staff Country Reports 2014, 199; 10.5089/9781498308007.002.A003

Sources: AFME, RBS estimates, ECB, and IMF staff calculationsNote: ABS = asset-backed securities, CDO = collateralizeddebt obligations, CMBS = commercial mortgage-backed securities, RMBS = residential mortgage-backed securties, SME = ABS backed by small- and medium-sized enterprise (SME) loans, WBS/PFI = whole business securities/project finance initiatives. Europe is a geographic designation, including EU Member States and non-EU countries (top left panel). Other EA is the sum of other euro area members’ outstanding securitization for which separate data are available. It includes Austria, Finland, France, Greece, Ireland, and Portugal (top right panel). Europe includes EU and non-EU countries (bottom panels).

C. Impediments to SME Securitization Markets

10. Several challenges must be addressed to further develop SME securitization in Europe. In particular, structural market factors, including unfavorable economic terms (e.g., high cost of issuance), adverse cyclical factors (e.g., ongoing economic weaknesses) and inefficient and fragmented national insolvency regimes, reduce the incentives for issuance. In addition, regulatory factors, including pending regulatory changes that raise the capital intensity of holding less risky ABS, weaken the investor base.

Structural market factors

11. The economic cost of issuance is high, and a bank must balance this against the potential capital relief from securitization and the cost of alternative sources of funding. High issuance costs reflect lower net interest margins (and thus difficulty in pricing attractive yields), a high cost of structuring SME-backed transactions (e.g., legal cost, due diligence, pooling, ratings, and credit enhancements),7 and the lack of a sufficiently large investor base (e.g., due to regulatory burdens and stringent internal risk guidelines).

12. There can also be high sunk costs in securitizing SME loan portfolios. In particular, setting up IT systems to handle the granular information and variety of collateral related to SME loan portfolios, and operational constraints, such as a lack of uniform reporting standards and credit scoring, make securitization of SME-related claims more costly than, for example, mortgages. The significant heterogeneity of SME portfolios across country loan pools, and differences in national insolvency frameworks all limit the scope for broader securitization markets, both on the supply and demand sides. Also insufficient volumes of long-term loans (which complicate the estimation of the cash flows pattern of SME portfolios) continue to hamper faster market growth.

  • Pooling. Certain conditions must be satisfied to ensure a loan’s suitability for pooling, raising the cost of due diligence. Among these conditions, a few are crucial: a clean credit history, sufficient tenor with a cash stream (i.e., an amortizing loan rather than a bullet loan), clarity on collateral and its availability, and sufficient sectoral diversification. From a bank’s perspective, achieving a critical mass of loans with such characteristics is more difficult in the SME sector than, for example, in the residential mortgage sector where there is more uniformity of loans, longer maturity tenors, and regularity of payment streams due to amortization.

  • Securitizing. Once a pool of loans is identified, legal documentation must be drawn, and ratings must be assigned by a commercial agency. Regarding the latter, SME securitization issuances typically require a compromise on the part of issuers, for example by providing greater credit enhancement than comparable securitization. Overall, these costs provide a degree of transparency (or reduce riskiness), but they must be balanced against the size of the pool to ensure an adequate cost ratio. Typically, the larger the pool, the less costly are such considerations, except perhaps for credit enhancements.

  • High yields. Investors require a favorable risk/return profile. This can be achieved through a sufficiently high-yielding asset (relative to risk), an inherently less risky asset (relative to yield), or a combination of these. However, it can be difficult for a bank to ensure a high-yielding asset with adequate differentiation between tranches from a heterogeneous pool of SME loans since such assets are costly to securitize and command relatively low returns. This contrasts, for example, with the scope for high-yielding securitization from credit card payments given their high relative interest rates. As a result, low returns on SME loans make for low yielding securitized assets.

  • Investor base. More stringent internal risk metrics for institutional investors, reflecting the combination of higher capital charges for securitization transactions (see below) and heightened risk aversion, have narrowed the investor base, which is mostly regulated in Europe (banks, (re)insurance companies, and pension funds). Other types of investors, typically hedge funds, represent only a small portion of the market.

Regulatory hurdles

13. Ongoing reforms tend to set high capital charges on securitization instruments relative to other funding instruments of similar risk.8 Under the proposed regulatory treatment for securitization, senior tranches of transactions compare unfavorably with other funding instruments, such as senior unsecured debt or covered bonds. In particular, the proposed revision to the definition of risk-weighted assets for securitization exposures by banks effectively raises the capital intensity of simpler (or less risky) assets to the level of complex (or more risky) assets, rendering differentiation of these instruments based on actual market performance irrelevant.9 Furthermore, the proposed capital charges under the Solvency II Directive for insurers investing in securitization transaction are higher than those for other assets with comparable risks. Although the capital charge on these assets has recently been lowered,10 it is unlikely to be sufficient to draw institutional investors, particularly given their still-high risk aversion.11 At current market conditions, the proposed regulatory capital charges for highly-rated SME structured finance instruments (securitization and covered bonds) would reduce balance sheet leverage to a point where insurance companies (and to a lesser extent banks) can no longer achieve a sufficient return on equity based on current profitability (Box 2 illustrates how capital charges affect potential returns).

14. Preferential treatment of “high-quality” securitization instruments in the forthcoming European liquidity standards would increase investor appetite for these assets. The Basel definition of the liquidity coverage ratio (LCR) mostly excludes securitization instruments from the measure of liquid assets, apart from some limited types of RMBS, but will allow the inclusion of highly-rated covered bonds up to 70 percent of high quality, liquid asset (HQLA). Failure to broaden the pool of eligible assets to a wider range of securitization structures of sufficient credit quality will reduce investor appetite for such instruments.12 However, the pending LCR under the Capital Requirements Regulation (CRR) is likely to include a wider range of HQS (see Annex 1) in the definition of liquid assets.

15. Recent EU retention rules help ensure that issuers have “skin in the game,” but may also put a burden on investors to fund retained portions once transaction structures for genuine risk transfer replace the current “securitization to repo” issuance. In 2013, more than half of all issuances (and far more than what would be required under the existing “skin in the game” rule of five percent under CRD2) were “retained” by the originators, i.e., the current retention rule is non-binding. Steps are being taken at the EU level to improve access to information to enhance investors’ confidence in the quality of the instrument and the underlying asset. Under the Capital Requirements Regulation (CRR), the EBA has drafted Regulatory Technical Standards that specify requirements for due diligence for institutions becoming exposed to a securitization position as well as for originators, sponsors and lenders to retain economic interest.

Regulatory Hurdles

This Box presents the results of a simple cost-benefit analysis of the proposed capital charges of banks and insurance companies for investments in securitized and non-securitized SME loans under the standardized regulatory approaches (Basel III-Securitization Framework and Solvency II-Capital Charges for Long-term Investment). For these “regulated” investors, the interaction of their desired return on equity (RoE) and the economic cost of capital based on the current yield/net interest margin determines whether the proposed capital charges are binding or not. 1

At current market prices (as of end-May 2014), insurance companies (and to a lesser extent, banks) have an incentive to hold SME loans rather than invest in SME-backed securitization transactions. The blue and red curves depict feasible combinations of the regulatory capital charge and the return on equity (RoE) for any given market rate of return on an asset. Higher capital charges are associated with lower rates of return and vice-versa. The intersection of these curves with the dotted horizontal lines showing the proposed capital charges under Basel III and Solvency II regimes illustrate that investment in highly rated senior bonds (“CLO (SME) AAA”) would result in an RoE of about 11.5 percent for banks and 4.5 percent for insurers. This is well below the RoE that banks and insurers would earn by simply holding the SME loan on their books (14.5 percent and 7.5 percent, respectively). Moreover, in the case of insurers, the RoE from holding the security is well below the current RoE for large insurers. Note that investing in (or not securitizing) SME loans remains profitable for both banks and insurers, with the intersection (or asymptotic convergence) of the blue curves and lines occurring to the right of the current RoE. Thus, the regulatory incentives are stacked against securitization.

Sources: IMF staff calculations, BCBS and EIOPA. Note: Current yields for benchmark deals of “AAA”-rated collateralized loan obligations (CLO) and covered bonds (CB) as well as average net interest margin of SME lending in the euro area after provisioning (20 percent); return on equity after taxes; for the capital charge of insurers, a maturity tenor of three years was assumed for the CLO to derive the solvency capital requirement (EIOPA, 2013); for banks, the calculation of the regulatory capital charge assumes CAR=10% based on given risk weightings according to BCBS (2013). This analysis reflects the standardized approach under the proposed regulatory regimes for banks and insurers. For an assessment of internal model-based approaches in banking, for instance, one would need to apply the so-called “ratings-based approach (RBA)” to rated tranches and the “supervisory formula approach (SFA)” to unrated tranches retained by originators. For investing banks, unrated tranches would need to be fully deducted from capital unless the application of the SFA is granted by the national supervisor.
1 Sophisticated investors are likely to use approved internal models; however, given the overall consistency between internal model-based estimates and standardized approaches, the presented results provide broad guidance regarding the firms’ sensitivity to changes in capital charges.

D. Relative Performance

16. Simple structures and limited, targeted official support have enhanced the relative performance of European securitization markets. Unlike some other jurisdictions, most transactions in Europe showed remarkable resilience during the recent crisis.13 This might be explained by many features of HQS that have developed as a result of both bank-based issuance and established public sector programs—these include traditionally conservative loan origination standards in Europe, with high equity participation of the originator; servicing being retained by the originator (“servicer continuity”) together with issuer due diligence; adequate post-issuance performance monitoring; and treatment of securitization as part of ongoing balance sheet operations (see Annex 2). Moreover, some countries, such as Germany and Spain, have operating successful platforms for bank-sponsored SME securitization.

E. Lessons from Previous SME Support Programs

17. Most SME securitization transactions in Europe have benefitted from public sector-sponsored programs, which have enhanced their relative performance. However, the customized nature of these programs has limited the potential scope for broadening capital market access for SMEs (see Annex 1, Annex 3 and Annex 4). The most significant national programs in Europe are the Asset Securitization Funds for SMEs (“Fondos de Titulización de Activos para Pymes” or FTPYME) in Spain and Kreditanstalt für Wiederaufbau (KfW)’s PROMISE (Programme for Mittelstand-loan Securitisation) platform, which provide cost-efficient funding support to bank-originated loans to SMEs. Such support has generally been motivated by the cost implications of recent structural/regulatory changes for banks’ SME lending, such as the shift towards fee-generating business, the greater risk-sensitivity of capital standards, and a more competitive pricing of SME loans (which in the past was hindered by high public sector presence in many European countries, such as Germany, France, and Spain).

18. In some cases, the European Investment Fund (EIF) has acted as credit guarantor for public sector programs or banks’ own securitization vehicles. These actions help facilitate credit risk transfer and improve market liquidity of SME securitization transactions by widening the investor base. In this regard, the main role of the EIF is to support enhanced debt finance to SMEs. The EIF typically covers tranches rated in the range of “BB” to “A” (mezzanine tranches), for which the secondary market is particularly illiquid.14 Such guarantee schemes are very effective in providing market access to smaller banks with low issuer ratings and mitigating the influence of “sovereign ceilings” in deficit countries, which cap the highest rating issuers can achieve due to the general level of sovereign default risk. During the financial crisis, the EIF also provided “wrappers” for senior tranches issued by banks in stressed economies, making their placement possible with a wider investor base.

19. Schemes also exist at the European level, but their use has been limited to supporting “on-lending” rather than SME securitization. The SME Guarantee Facility was set up under the EU’s 2007-13 Multiannual Financial Framework (MFF) to improve SME’s access to finance, including through co-, counter- and direct guarantees to banks. While the facility was used in 21 countries, generating €15 billion in lending to more than 275,000 SMEs, there was only one agreement under the securitization window.15 The SME Guarantee Facility was closed at the end of the 2007-13 MFF, but its activities, including a securitization instrument, are expected to be continued under the EU’s new COSME program for the 2014—20 MFF.

20. There are also private sector initiatives, such as True Sale International GmbH (TSI). The TSI platform was created in 2004 by a consortium of 13 German commercial banks to promote the German securitization market. It provides issuers of transactions with a cost-efficient, standardized issuance process that is compliant with national competition law and regulatory requirements. The TSI platform allows participating banks to securitize reference loan portfolios through a specially created limited-liability SPV owned by three charitable foundations (Jobst, 2006).16 In 2010, the TSI created the German securitization certification standard (“Deutscher Versicherungsstandard”), which establishes clear rules for transparency, disclosure, lending and loan processing. The platform is heavily used by consumer loan and lease ABS structures; only two SME securitizations have been completed via the TSI so far.

F. Recent Efforts

21. Current initiatives at the European and national levels move in the right direction, but are too small in size or too narrowly focused on bank lending to have a broad impact. These include the joint EC-EIB SME Initiative and the Banque de France (BdF)’s approval of securitized credit claims for collateralized refinancing by originating banks. Both proposals envisage greater official support to bank-sponsored SME lending, but fall short of mechanisms to solicit non-banking funding sources and schemes that would allow direct capital market access:

  • Joint EC-EIB Initiative―This initiative aims to kick-start lending to SMEs by blending EU structural funds, EU funds and EIB resources through guarantees and securitization, thereby offering more generous conditions than existing EU initiatives. However, the take-up among EU countries has been limited, with only a few countries participating so far, partly due to complex procedures governing the use of structural funds as well as funds having already been committed. The option of cross-country pooling of resources and risk, which would significantly leverage resources and reduced the effects of financial fragmentation, is unlikely to be used in the near term, reflecting the limited uptake and, possibly, concerns about an adverse selection bias.

  • Banque de France (BdF) proposal―The BdF developed a scheme for the standardization of securitized credit claims by allowing banks to bundle SME loans rated “BBB-” and higher (through a commonly owned special purpose vehicle (“Euro Secured Notes Issuer”)) as collateral for refinancing via the central bank or interbank repurchase agreements.17 This scheme draws on the experience of the Eurosystem in instituting greater transparency about collateral assets and their performance over time in “retained” securitization transactions via the ECB’s loan-level data initiative. The first transaction was completed in April 2014. However, the current implementation requires detailed supervisory information on loan characteristics, which may limit a broader (pan-European) application.

22. The ECB’s loan-level data initiative will help improve transparency of securitization instruments. The initiative has established requirements for transparency and standardization as necessary preconditions for ABS, including SME ABS, to be considered eligible for Eurosystem collateral. The detailed information on borrower and loan characteristics can be used by current and potential investors to carry out their own credit analysis, and will help address information asymmetries. The benefits are likely to take some time to materialize and will require steadfast implementation of the standards and data requirements.

G. Suggested Measures to Facilitate the Development of SME Securitization

23. Official sector involvement would help promote credit risk transfer via the securitization market. The official sector should support the development of ABS structures that facilitate the transfer of SME lending risks from banks to capital markets, and take steps to align the underlying risks of these instruments with regulatory charges. Low bank funding costs have limited the supply of (more expensive) transactions that involve credit risk transfer and the inclusion of asset types that are generally more costly to securitize, such as SME loans.18 At the same time, higher regulatory capital charges and cumbersome operational requirements for investment have inhibited demand for SME securitization transactions (relative to other forms of investment). Moreover, risk-adjusted returns of senior tranches of such transaction are currently too low for institutional investors (banks, insurance companies, and pension funds) while the non-bank investor base is limited.

24. Measures that would facilitate development of the SME securitization include:19

  • The regulatory regime should appropriately differentiate between high- and low-quality securitization transactions. The proposed revisions to the definition of risk-weighted assets (RWAs) by the Basel Committee and assigned capital charges for long-term investment under the implementation guidance under Solvency II will lead to a significant increase in capital requirements for “regulated” institutional investors in senior tranches of securitization transactions. Reducing the capital intensity of structures that qualify as HQS could encourage the supply of transactions that provide genuine risk transfer (rather being used for funding purposes only).20

    • SME securitization―as an asset class per se―is generally considered HQS in current policy proposals and monetary frameworks, but does not benefit from more favorable regulatory treatment (see Annex 1). HQS would place greater focus on structural characteristics that allow for better risk sharing between originators and investors that can assess the impact of changing economic conditions on the performance of securitization transactions.

    • Demonstrable compliance with these characteristics should result in a regulatory treatment that is commensurate with this proposition in contrast to the currently proposed catch-all regulatory treatment of securitization transactions.

    • Greater disclosure of underlying loan quality and performance monitoring would aid compliance efforts. The operational implementation of HQS would be largely informed by central bank repo eligibility with a focus on transactions with simple structures and transparent underlying asset pools and predictable performance (see Annex 2).

  • Demand for SME securitization is also influenced by proposed regulatory standards for liquidity risk. The definition of the liquidity coverage ratio (LCR) mostly excludes securitization instruments from the measure of liquid assets, apart from some limited types of RMBS. Moreover, the pending liquidity coverage ratio under the Capital Requirements Regulation (CRR) will include only highly-rated RMBS, but will allow the inclusion of highly-rated covered bonds up to 70 percent of the liquidity buffer.21 Broadening the pool of eligible assets to also include HQS in the stock of high quality, liquid asset (HQLA) will increase investor appetite for a wider range of securitization structures of sufficient credit quality.

  • Capital markets for securitized SME loans could be developed further by revising the investment restrictions for institutional investors (e.g., pension funds)—once the supervision and regulatory framework is strengthened—to encourage alternative investments that benefit SME financing, such as venture capital.

  • Structural improvements could further facilitate market development. SME securitization instruments face particular challenges related to the heterogeneity of SME loan portfolios across countries. The complexity of information and different reporting requirements makes it difficult for investors to assess credit risk and creates a home bias.

    • National insolvency frameworks should continue to be strengthened, with a view to cleaning up banks’ balance sheets and boosting the quality and transparency of collateral. This would include policy measures that facilitate out-of-court settlements, reduce impediments to efficient debt restructuring, and introduce guidance on tax incentives and resolution procedures in line with international best practices. Greater harmonization of SME lending standards, loan reporting requirements (through the SSM), and credit registries across countries would facilitate the establishment of a truly single market22 Consideration could be given to broadening the coverage of credit registries through a centralized database. The harmonization of reporting requirements would not only enhance cross-border investor demand but create scope for developing securitization instruments that pool SME loans on an EU-wide basis. The SSM can help in this respect.

    • Direct capital market access for SMEs should be improved via the creation of a mutual issuance platform. This would allow sufficient aggregation for mini-bond and/or structured finance issuance and could build on efforts to achieve greater harmonization of SME funding in line with recent recommendations by European Commission’s High Level Expert Group on SME and Infrastructure Financing (2013b). Also, forms of non-bank intermediated securitization (such as trade receivables) and equity finance should be explored in areas where structural impediments to asset securitization are too high and cannot be overcome in the near term (European Commission, 2014).

  • Official sector involvement would be essential in areas of SME finance where information constraints and insufficient economies limit the effectiveness of market-based solutions. Supply-side impediments to a wider range of non-bank SME funding options are often found in the cost associated with higher standardization of both information disclosure and performance reporting. For SME securitization, existing public sector programs could be augmented and potentially supplemented by additional efforts:

  • The various euro area institutions could initially act as guarantors or strategic investors in cost-efficient funding structures with genuine risk transfer to market investors, while guarding against long-term distortionary effects by making any risk-sharing time-limited. For instance, the EIB/EIF could initially provide guarantees to lower tranches of fully marketable transactions, which would reduce the credit risk of strategic asset purchases of senior tranches by the Eurosystem. Such efforts could be combined with the EC-EIB SME initiative in order to create operational synergies and sufficient critical mass to address the funding needs of SMEs in stressed economies.

  • Incorporating a more nuanced treatment of HQS in the Eurosystem collateral framework could benefit SME securitization by incentivizing issuers to develop transactions irrespective of whether or not parts of it are retained for ECB repo funding.23

H. Conclusion

25. The further development of securitization represents is an important step towards a more integrated capital market in Europe. Given the lack of diversified funding markets, with only the largest firms able to directly access capital markets, credit supply to the corporate sector is heavily influenced by the lending behavior of banks. Securitization of intermediated credit could help overcome the adverse effects of financial fragmentation, improve the allocation of liquidity, and support cross-border investment within the euro area. Restarting securitization can help mitigate structural constraints on credit supply as many banks, especially those in stressed economies, continue facing considerable funding needs while unsecured funding remains impaired, especially at longer maturities―even though concerns over sovereign risks in the euro area have dissipated. An expansion of the SME securitization market would move firmly in this direction, while drawing upon a large existing pool of assets and providing a key non-bank funding channel.

26. However, structural and regulatory conditions are stacked against SME securitization. Unfavorable economic terms and adverse cyclical factors reduce the incentives for issuance. Moreover, pending regulatory changes―Basel III for banks and Solvency II for insurance companies―weaken the investor base by increasing the capital intensity of holding highly-rated securitization transactions and limiting their eligibility for liquidity purposes. Progress towards incubating a larger SME securitization market would require greater regulatory differentiation of HQS, cross-country harmonization of asset structures, and official sector support as a catalyst to greater activity.

Annex 1. Public Sector Support for SME Securitization

1. The most significant programs in Europe are the Asset Securitization Funds for SMEs (Fondos de Titulización de Activos para Pymes or FTPYME) in Spain and Kreditanstalt für Wiederaufbau‘s (KfW) PROMISE (Programme for Mittelstand-loan Securitisation) platform, which provide cost-efficient funding support to bank-originated loans to SMEs. In the KfW program, the issuing bank sells credit protection (supported by third-party guarantees) to create partially funded and leveraged investments in SME exposures (without removing them from its balance sheet). Similarly, in FTPYMEs, banks receive guarantees that support the off-loading of SME loans. While both programs have attracted repeat issuers and involve a considerable cost reduction for issuers, they tend to be very customized and focused on larger banks, with limited or no diversification effects across different SME loan portfolios/banks. Similar products (securitization of lease receivables) have been developed in Italy by arrangers and originators in order to achieve better funding costs. Given the high dependence of SMEs on bank lending, both programs aim at providing capital market access for smaller banks and reducing both the regulatory and economic cost of new lending. By helping financial institutions to achieve regulatory capital relief for securitized SME lending, these programs have created more scope for future SME loan origination.

2. In the United States, SME loan securitization began in 1985 when the Small Business Administration (SBA), a U.S. government agency, launched its loan guarantee program. The SBA does not lend money directly to SMEs but offers government guarantees of up to US$5 million on loans made by commercial lenders to SME borrowers that face challenges obtaining financing. The guarantee covers a portion of an SME loan originated by a local bank, credit union, or a specialized lender, ranging from 50 to 85 percent, depending on the program, limiting the lender’s risk and exposure. The lender then provides the actual loan to the borrower and securitizes the “SBA-backed loan”. During the fiscal year 2012, lending volumes exceeded US$14 billion.

3. In Japan, in addition to the public guarantees, the Bank of Japan (BoJ) introduced measures to support for SME financing and securitization during late 1990s and early 2000s, also aiming at repairing the monetary transmission mechanism. Given the importance of SMEs in Japanese economic activity, improving their access to credit was seen essential to restore the monetary transmission mechanism.

4. In 1999, the BoJ started accepting eligible ABS as collateral for banks’ maintenance requirement. In 2003, the BoJ introduced a program to purchase ABS and ABCP backed by SME loans.1 The objective was to strengthen the transmission mechanism by circumventing around the banking sector, while avoiding market distortions and limiting the risk to the BoJ.2 Accordingly, the BoJ started purchasing ABS with a broad range of underlying assets, including SME loans, receivables, and leases.3 However, other policy measures have distorted a healthy development of the SME sector. Various credit support policies helped shelter existing firms from tighter credit conditions and limited the number of bankruptcies but also kept nonviable SMEs afloat. The measures comprised public credit guarantees, safety net lending by government-affiliated financial institutions (GFIs), and temporary relaxation of provisioning requirements for SME loans (Lam and Shin, 2012).

Annex 2. Defining High-quality Securitization (HQS)

1. There have been five attempts at defining HQS within the broad securitization market: (i) the ECB with its collateral eligibility criteria, (ii) EIOPA with its “Type A” standard for long-term investment of insurers in securitization transactions, (iii) the Bank of England’s eligibility criteria for repo collateral, which closely (but not fully) matches the eligible asset classes and eligibility requirements of the prime collateralized securities (PCS) standard related to sufficient portfolio diversity, no subordinated exposure of loans, risk retention, information about underwriting criteria, and servicer continuity; (iv) the second ECB-BoE joint paper on reviving the European securitization market; and (v) market-led initiatives, such as the prime collateral securities (PCS) certification and the German securitization standard. Together with residential mortgages and consumer loans, leases, and credit card debt, SME loans are commonly found as reference assets for HQS. Complex structures (i.e., re-securitization, synthetic securitization, and single tranche securitization) are unanimously excluded from all lists. Typically, the qualification as HQS should involve additional criteria: (i) restriction to true sale structures (i.e., synthetic transactions are excluded); (ii) minimum rating threshold (least “BBB-” (or equivalent) by two rating agencies at any time since launch1; (iii) exclusion of non-performing loans and loans to self-certifying borrowers or credit-impaired borrowers at the time of loan origination; (iv) underlying portfolio must be homogeneous (i.e., securitization of mixed pools are excluded); and (v) loan-by-loan level data needs to be available at launch and on a regular basis.

2. The identification of HQS would help distinguish simple and prudently structured transactions from transactions with more complex, opaque structures based on transparent characteristics. Some of these characteristics reflect the reasons for the relatively stable performance of European securitization markets during the financial crisis: (i) a strong funding relation to real economic activity, (ii) traditionally conservative loan origination standards, with high equity participation by the originator under the same credit law as non-securitized loans (“skin in the game”), (iii) servicing being retained by the originator (“servicer continuity”) together with issuer due diligence, and (iv) adequate post-issuance performance monitoring. Moreover, the conceptual treatment of securitization as part of ongoing balance sheet operations (with seasoned loans only) further reduces incentive problems (Jobst and Kiff, 2011). In general, the concept of HQS should be applicable to all asset classes that support lending to the real economy (and especially SMEs), and is not limited to investment in senior tranches.2

Annex 3. Selected Official Sector Support for Securitization in Europe

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Sources: HM Treasury, AOFM, KfW, ICO, Italian Ministry of Finance and Economic Affairs, EIF, EIB, European Commission.

Annex 4. Selected Official Sector Support for SME Finance in Europe

article image
Sources: HM Treasury, AOFM, KfW, ICO, Italian Ministry of Finance and Economic Affairs, EIF, EIB, European Commission.


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Prepared by Ali Al-Eyd, Bergljot Barkbu, S. Pelin Berkmen, John Bluedorn, Andreas (Andy) Jobst, and Alexander Tieman (all EUR).


Survey on the access to finance of small and medium-sized enterprises (SAFE) in the euro-area (October 2013-March 2014). The survey covers about 7,520 firms, of which 93 percent are SMEs.


SMEs are defined by the European Commission (2013a) as having fewer than 250 employees. They should also have an annual turnover of up to €50 million, or a balance sheet total of no more than €43 million.


For the purposes of the venture capital and growth funding, SMEs are defined solely by the number of employees in the EVCA dataset. See also Kraemer-Eis and others (2014).


Many large European banks depend on either a large deposit base or rely on wholesale funding for large parts of their balance sheet. Securitization of SME loans would increase secured funding for lending over longer terms, creating high-quality collateral and transferring credit risk to non-bank investors.


Upfront costs related to the due diligence process required to securitize assets can be significant. Credit enhancements (e.g., high subordination levels for senior tranches, overcollateralization, and interest reserve accounts) may also often be required by ratings agencies.


See Bank of England and European Central Bank (2014b) for a comprehensive discussion of regulatory impediments to securitization.


The latest consultation on the treatment of securitization exposures held in the banking book (which closed for comments in late March) proposes higher risk weights for exposures rated “BB+” or above, yet a lower and more risk sensitive approach for securitization tranches rated “BB” or lower. For instance, the risk weighting on “AAA”-rated tranches will increase from 7 percent to 25 percent in the five-year tenor under the standardized approach.


The European Commission has recently proposed to further lower the currently proposed capital charge of 4.3 percent per year of duration to be assigned to the highest quality ABS assets as an attempt by EIOPA to differentiate such assets from lower quality ones.


Note that Solvency II assigns a lower capital charge for covered bonds compared to other non-government and/or unsecured assets. Furthermore, covered bonds will be exempted from “bail-in” that would subject unsecured senior debt of failed banks to forced write-downs or conversion into equity in resolution.


However, it is currently being debated at the European level whether HQS could be included in the EU liquidity coverage ratio under the Capital Requirements Regulation.


Note, however, that some SME loan-backed transactions with non-granular references portfolios, especially those including unsecured (mezzanine) loans, did experience very significant downgrades and defaults during the financial crisis. These transactions represented only a small part of the market and did not exhibit the properties of HQS listed above.


As opposed to credit insurance, an EIF guarantee also implies a substantial leverage effect. In structured transactions, the risk transfer can be achieved with a limited nominal EIF guarantee exposure that covers only a small portion of the loan portfolio, but results in significant “rating uplift” for more senior investors.


Under this agreement, the EIF took the second loss risk and Italian mutual guarantee funds (Confidi) took the first loss tranche, reducing the capital requirement for the originating bank (Unicredit) and facilitating Italian SMEs access to €120 million of new loans.


It is commonplace for charitable foundations to act as SPV shareholders, in order to achieve tax-exempt status, and, thus, eliminating income taxation on funds managed by the SPV. The use of multiple foundations ensures the loans are “bankruptcy remote” from the originating banks. TSI Services GmbH, a limited-liability subsidiary of TSI, organizes and coordinates the establishment of the SPV.


The acceptance of such assets as collateral for Eurosystem credit operations is still under assessment.


Any securitization transaction would require a structure whereby issuers would not be parting with their assets without making some kind of return or gain on sale. This depends on the spread payable to investors as well as the asset yield and the size of the risk retention.


In May 2014, the Bank of England and ECB (2014a,b) published a comprehensive review of existing obstacles to a better functioning of the securitization market in the European Union, which includes some arguments that are also reflected in these recommendations.


HQS can in principle also help meet the increasing demand for high-quality collateral, providing a compliment to government debt.


However, there is discussion about the potential inclusion of a wider (than RMBS) range of highly-rated (AA-” or higher) securitization exposures, namely auto ABS, SME CLO, consumer ABS, as Level 2B (which are capped at 15 percent of HQLA) with a 25 percent valuation haircut.


In particular, the lack of long time series data on the default frequency of SMEs, the heterogeneity of SME portfolios which differ from each other in terms of size, corporate form, business activity, geographic location, and insufficient volumes of long-term loans (which complicate the estimation of the cash flows pattern of SME portfolios) continue to hamper SME securitization.


Throughout the crisis, the ECB has widened the pool of eligible assets. Raw loans are already eligible for repo at the ECB if they are rated “BBB” or above. Assets rated “BB” can be repoed provided the national central bank underwrites the credit. The ECB last reviewed its haircuts on eligible assets in July 2013.


The SMEs accounted 80 total employment (now around 70 percent) and over half of manufacturing value-added in Japan.


The program was ended in March 2006 together with the exit from the QE.


The BOJ set the maximum amount outstanding of purchases at one trillion yen (3/4 percent of the BoJ assets). The total size of outstanding securitized bonds in Japan was 44.5 trillion in 2007 (33 trillion yen in 2013). About half of this amount is trust beneficiary rights. The outstanding ABCP is small and declined from 4.4 trillion in 2007 to 1.8 trillion in 2013. The outstanding ABBs remained broadly the same at around 13 trillion yen.


Note that by limiting eligibility to tranches with a very high rating only would exclude senior most tranches of very high quality by issuers in stressed economies, whose rating is capped by the sovereign ceiling of the respective country, which would contradict the intent of de-linking the regulatory treatment of HQS from sovereign risk.


It is also important to support more junior tranches of safe and robust structures especially via improvement of data and analytics eventually allowing a broad investor base and risk transfer between bank and non-bank sectors.