More risk, no reward? The strange revival of securitisation

The European Commission is preparing reforms to revive a niche financial tool: securitisation. This instrument bundles loans like mortgages or consumer credit into financial products (securities), which are then sold to investors. Before 2008, it was promoted as a way to spread risk. In reality, it spread instability. When subprime loans in securitisations defaulted, they triggered losses across entire asset structures, accelerating the global financial meltdown. Since then, tougher rules have helped keep risks in check.

But now, Member States, led by Germany and France, along with parts of the financial industry, are pushing to tear up those rules. They argue that a revived securitisation market would boost European investment, encouraging banks to lend and increase financing to Small and Medium Enterprises (SMEs), as well as facilitating the green and digital transition. But it won’t deliver on these promises. Securitisations won’t channel capital to where it’s needed most. They are made of the wrong kind of loans and are used in the wrong kind of way.

The wrong kind of loans

In Europe, few securitisations actually involve loans to small businesses. That’s because securitisation relies on bundling loans with similar features into a single product. Diverse and bespoke SME loans are difficult to standardise, repackage and sell. As a result, most securitisations are made up of consumer credit or mortgages, types of lending that fuel consumption or property markets, but do little to support SMEs.

When banks securitise loans, they can move them off their balance sheets and reduce the amount of capital they’re required to have. In theory, this frees up room to issue new loans. But there’s no obligation for those new loans to support small businesses. The incentives to finance SMEs simply aren’t there. While in the case of mortgages, the EU already has a proven alternative – covered bonds. They’re cheaper, more resilient and accessible to banks of all sizes. 

A closed loop within the banking system 

Many securitisations aren’t sold to investors at all. Instead, most are kept on banks’ balance sheets, used as collateral to access liquidity from the central bank. That means the associated risk is not dispersed, it stays within the banking sector. 

The central claim behind the push to revive securitisation is that it spreads risk and helps ‘free up’ capital for new lending. But that logic breaks down if these securitised assets don’t leave the banking system. If banks hold on to securitisations or trade them among themselves, the risks don’t go away. 

Worse, the new rules could mean banks have less capital for securitised loans than they would for holding the original loans. That opens the door to regulatory arbitrage, a loophole where financial engineering can be used to lower capital needs without reducing actual risk. In effect, banks would be making balance sheets more complex, and potentially riskier, but with fewer safeguards.

If securitisation is the answer, what is the problem? 

The practice of bundling loans for sale is not inherently flawed. But without proper oversight, it becomes a way to disguise risk, not manage it. And without proportionate capital requirements, banks can’t absorb the losses when things go wrong.

Reducing prudential standards increases systemic risk, and that trade-off must be justified. Currently, it’s not clear what problem securitisation is meant to solve. A leaked draft of the Commission’s proposal contains plans to slash capital requirements, repeating familiar claims: “free up additional lending capital for the Union economy” and “build the Savings and Investments Union”.

But the Commission’s proposals will not deliver on these goals. Even when securitisations are sold, banks are under no obligation to use the so-called ‘freed-up capital’ to support loans to the productive parts of the economy. In practice, this capital is often used to meet regulatory requirements or boost shareholder returns through dividends or buybacks. Unlike equity investors who bring new funding into the economy, banks tend to recycle capital already in the system. As a result, securitisation often helps banks meet their regulatory capital requirements without supporting productive investment.

Recycled bank loans are not the answer 

This points to a deeper flaw in the logic to revive securitisation as a means to foster EU capital markets. Europe already relies far more heavily on banks for private sector financing than other major economies, and securitisation does nothing to change that. In fact, it reinforces a closed loop within the banking system, where banks shift risks around, but little new capital flows into the real economy.

Meanwhile, companies across the EU continue to struggle to access the risk capital they need to grow, as EU capital markets remain largely fragmented. That’s why many of Europe’s most promising firms choose to list abroad or relocate to the US, where deeper capital markets and investors with a higher appetite for risk offer better opportunities to scale.

What capital markets for productive investment look like

Europe’s real problem isn’t too little bank lending or securitisation. It’s too little equity. Firms need real investors who bring new capital into the economy to get long-term, stable funding. They need an integrated EU capital market where they can raise funds by selling equity or bonds to investors. But this requires deeper reform. Member States would have to harmonise insolvency and corporate laws and give the EU stronger supervisory powers to enforce common rules – political steps many governments continue to resist. 

The sad reality is, securitisation is receiving so much attention because it’s one of the very few investment ideas Member States can agree on. But unfortunately, reviving securitisation will do little to finance Europe’s business; it is not a proxy for market depth, and it runs counter to the stated goals of the EU’s ‘Saving and Investment Union’, all while increasing risk. Instead of obsessing over obscure financial instruments, Member States must overcome political differences and make real progress on capital market integration. 

• To learn more about securitisations, read Finance Watch’s “Introduction to Securitisation: Structures, regulation and market for asset-backed securities in the EU”.
• Don’t hesitate to reach out to learn more or to contribute to civil society mobilisation on the watering down of the EU’s securitisation regulation.

Max Kretschmer, Finance Watch