When Captain Cook first reached Australia, Prussia had just created the forerunner of today’s covered bonds. This month, Australian banks became the latest to issue the bonds, a safer cousin of the securitisations made infamous in 2007 during the onset of the global financial crisis. US lawmakers may also allow US banks to tap the market.
Don’t all rush at once. What makes covered bonds safer for investors poses risks to other bank creditors. Bondholders get securities backed by loans that stay on banks’ books and carry a bank guarantee, and they are protected even in bankruptcy. But covered bonds encumber bank assets, leaving less for other creditors. The long-term reliance on covered bonds or other secured borrowing threatens to leave all other creditors, including governments extending deposit guarantees, with no security.
Australian regulators have imposed a cap of 8 per cent on the amount of a bank’s domestic assets that can be tied up in cover pools. In Europe, regulators have differing limits; some have none, and all are aware that the banks they supervise are relying on covered bonds because unsecured borrowing is too expensive.