At the European Securitisation Forum in London yesterday, Paul Sharma, director of wholesale and prudential policy at the FSA, warned the financial crisis had proved the practice of treating securitised products as liquid assets was flawed.
"[Those assets] didn't prove to be very liquid at precisely the time when they needed to be. There isn't sufficient diversification between the true underlying risk in securitisation paper, and the assets that are on balance sheet for other reasons, in terms of liquidity. The reasons why banks buy securitisations... are going to come under significant challenge for business and regulatory reasons," he said.
Nonetheless, Sharma acknowledged the importance of securitisation. "I do believe that securitisation is a significant part of the future development of the financial services industry," he commented.
In a half-hour speech, Sharma drew attention to other well-documented failings in financial markets and regulation that contributed to the financial crisis, such as shortcomings in risk management.
"No profession has more comprehensively failed in the modern era, as far as I know, than the risk management profession within the financial services sector," he said, adding that he counted regulators among those culpable.
Sharma also lamented the pro-cyclicality of capital requirements and highlighted regulators' efforts to combat the problem through loan-loss provisioning. "Even in the absence of securitisation and redistribution of credit risk, there simply was insufficient capital in the financial services sector to absorb the amount of credit risk that was being borne. What we need are capital requirements that are positively anti-cyclical. That is a view that is being held increasingly by regulators across the world."
Lastly, with regard to off-balance-sheet exposures, Sharma insisted upon the importance of ensuring such vehicles are regulated, without expressing a preference for the best method for doing so. "It is important all forms of banking activity are caught within the regulatory net, whether that is by bringing entities such as structured investment vehicles and conduits onto balance sheets, or whether that is by separately regulating them as banks," he said.