UPDATE 1-EU bank watchdog backs keeping low capital charges on covered bonds

Tue Jul 1, 2014 7:51am EDT

* Watchdog backs low risk weighting if new conditions met

* EBA wants better covered bond information for investors

* Report could help EU justify busting global capital rules (Adds more detail)

By Huw Jones

LONDON, July 1 (Reuters) - EU banking regulators have backed the low capital treatment of top quality covered bonds against the risk of default, a boost for Denmark and other major players in the 2.8 trillion euro ($3.8 trillion) global market.

Covered bonds are debt backed by pools of home or commercial property loans, and 90 percent of the global market is based in Europe, especially in Denmark, Germany, Spain, France and Sweden.

The European Banking Authority (EBA) was asked by the bloc's executive European Commission for advice on how to treat covered bonds in new EU bank capital rules.

"The EBA is of the opinion that the preferential risk-weight treatment that certain covered bonds received across the EU in accordance with the Capital Requirements Regulation is appropriate," the pan-EU banking watchdog said in a statement on Tuesday.

"But it advises strengthening the framework by introducing further qualifying criteria for their preferential treatment."

The European Union executive will now decide whether to put EBA's recommendations into law that would probably take effect by around late 2015.

Currently, covered bonds have a very low risk weighting of 10 percent, meaning the amount of capital that must be held against them in case of default is minimal.

EBA said this risk weighting should be maintained but only if there is also a mandatory requirement to hold more collateral than is needed, though it stops short of giving an actual figure. Such over-collateralisation is currently voluntary.

The issuer of covered bonds should also be required to hold a permanent, readily available pool of assets such as government bonds or cash in case it goes bust.

The banking watchdog also said that another condition for a low risk weighting is "active supervision" of the pool of assets used in covered bonds.

There should also be better information for investors on what assets are used as collateral and the size of the liquidity pool, the watchdog said.

The recommendation to maintain a low risk weighting on covered bonds is likely to be used by the European Commission to justify its separate, anticipated decision to allow the bonds to make up the bulk of liquidity buffers all banks must have in place.

This is contrary to global rules known as Basel III which say only a small part of a bank's liquidity buffer can be made up of covered bonds.

The EBA report said the covered bonds themselves have a positive track record when it comes to defaults, though there have been instances of the bonds' issuers going bust. ($1 = 0.7331 Euros) (Reporting by Huw Jones, editing by Steve Slater/Ruth Pitchford)