WASHINGTON — A proposal by banking regulators that would increase the amount of capital banks must hold against assets could discourage banks from buying municipal bonds, the Securities Industry and Financial Markets Association warned Monday.
In three comment letters filed with federal regulators, SIFMA urged changes to muni-related provisions in proposed international capital requirements, known as BASEL III. The letters were sent by SIFMA to Federal Reserve Board chairman Ben Bernanke, Federal Deposit Insurance Corporation acting chairman Martin Gruenberg, and Comptroller of the Currency Thomas Curry,
SIFMA co-head of municipal securities Michael Decker said the BASEL III proposals would require banks to hold different amounts of capital for revenue bonds and general-obligations bonds. They would require banks to assign a so-called “risk weight” of 20% to GO bonds and 50% to revenue bonds.
SIFMA’s letter argued that the proposal should not differentiate muni bonds by type, but rather by risk category.
Investment grade bonds should be assigned a 20% risk weight and others bonds should be assigned a higher risk weight, such as 50%, SIFMA said.
Decker said the change would align the proposal with the way the market categorizes munis.
“The way people think about bonds is, what is the overall credit risk,” he said.
Another letter from SIFMA urged regulators to exclude muni bonds from a requirement that banks increase or decrease capital requirements based on changes in the market value of their assets.
The financial industry has argued that securities that have market values tied to interest rates should be exempt from the provision, Decker said.
“We argued that if regulators adopt that approach ... municipals be included in [the] category or assets” that will be excepted, Decker said.
He noted that most of the changes in muni market prices are driven by interest rates, not the credit quality of issuers.
“It’s appropriate to think of [municipal bonds] as interest-rate products,” he said.
A third SIFMA letter argued that the proposed capital requirements should not apply to muni-related derivatives contracts with state and local governments.
Decker noted that banks hold a significant and growing portion of outstanding municipal securities, but said the BASEL III proposals could “discourage [banks} from participating in this sector.”
“That would be to the detriment of state and local governments,” he said.
He added that the muni market is “extraordinarily safe” and that new rules should reflect that “minimal credit risk.”