Why Europe's Securitization Market Falls Short - and How to Fix it

Introduction

Securitizations help European banks lend more. They allow banks to move the credit risks of loans off their balance sheets and use the freed-up capital to support new lending. But since the Global Financial Crisis (“GFC”), securitization volumes in Europe have dropped significantly, while in contrast, the U.S. market has grown, even though U.S. defaults peaked during the GFC.

To address this, the EU Commission is reviewing how securitization works in the EU. This is part of its broader plan to build a “Capital and Savings Union” [1].

This article looks at how well the EU securitization market works. It uses a simple numerical example to compare capital requirements for banks and insurers involved in a Significant Risk Transfer (“SRT”). The results highlight problems in the current system, with some elements in the Solvency II capital rules. This article also suggests possible improvements, so that the EU securitisation market can grow again, once these issues are fixed.

Overview of the Example

Banks use SRTs to reduce capital requirements. In an SRT, a bank selects a pool of loans into a portfolio, or reference pool. It sells the junior (riskier) tranche and keeps the senior (safer) part. This way, the bank needs to hold capital for the senior tranche only. The investor who buys the junior tranche holds the capital for that risk. See Figure 1.

Figure 1

In this example, we use a portfolio of commercial real estate loans. First, we calculate capital charges for the full portfolio without any tranching. We do this for both a bank and an insurer.

Next, we split the portfolio into junior and senior tranches. The bank transfers the risk of the junior tranche (e.g., to an insurer) and retains the senior part. We then calculate:

• The capital charge for the senior tranche for the bank, and

• The capital charge for the junior tranche for the insurer.

This helps us assess how effective the securitization structure is.

Assumptions

We use standardized rules for both banks and insurers, not internal models. This makes the example easier to compare and reproduce.

We also assume the following:

• EBA SRT tests are ignored.

• Income from loans and protection fees are not included.

• The SRT is synthetic (not a traditional securitization).

• Counterparty risk is fully removed by cash collateral and no additional capital charges for the bank are required for the counterparty risk

• The minimum capital ratio for banks is set at 8% CET1.

• The SRT is not compliant with the Simple Transparent and Standardized (“STS”) framework¹.

These assumptions simplify the example. While they affect the numbers, the main conclusions remain valid.

Commercial Real Estate Portfolio without Tranches

Banks follow the Capital Requirement Regulations (“CRR”), and insurers follow Solvency II. These frameworks use different methods to calculate capital charges. For a detailed overview and numerical examples of capital charges for a portfolio of Commercial Real Estate loans under both frameworks, please refer to [2].

Figure 2 compares capital charges for banks and insurers using two portfolios:

• Loans with 60% loan-to-value (“LTV”)

• Loans with 80% LTV

Figure 2

The graph illustrates that under Solvency II capital charges depend on duration. For banks using the standardized approach, capital charges depend only on LTV, not duration.

At first glance, the capital charges seem similar, but insurers benefit from inter- and intra-risk diversification rules. These benefits can reduce capital charges by 30% to 40%. Including those benefits, insurers typically have slightly lower capital charges than banks.

Capital Charges for Senior SRT Tranche (Bank)

Banks can calculate capital charges for SRTs using three methods:

• SEC-IRB (Internal Rating-Based Approach)

• SEC-SA (Standardized Approach)

• SEC-ERBA (External Rating-Based Approach)

This article uses method 2: SEC-SA, as defined in the CRR.

When the junior tranche absorbs a set amount of risk, the senior tranche starts at that "attachment point." The higher the attachment point, the lower the capital charge on the retained senior tranche. See also Figure 1.

Figure 3 shows how capital charges for the senior tranche change with different attachment points. Results are shown for both LTV 60% and 80% portfolios.

Figure 3

Key points from this graph:

• There's a minimum capital charge (a "floor"). Going below this offers no benefit.

• Higher-LTV portfolios need a thicker junior tranche to reach this floor.

• Capital charges for senior tranches are much lower than for the full portfolio. This reflects the risk shift to the junior tranche and aligns with expectations.

Capital Charges for Securitizations under Solvency II

Solvency II includes securitization capital charges in the Market Risk module, under the spread risk submodule. Charges depend on:

• Rating

• Duration

• Whether the securitization is STS

Other features (like credit enhancement, tranche thickness, waterfall prioritization) are assumed to be reflected in the rating and duration.

Solvency II recognizes five types of securitizations:

1. Senior STS (rated and unrated)

2. Non-senior STS (rated and unrated)

3. Re-securitizations (rated)

4. Other rated securitizations

5. Unrated, non-STS securitizations

Note that the rating of the securitization tranche should be obtained from an eligible rating agency.

Figure 4 shows the capital charges under Solvency II. Senior STS securitizations clearly receive a favorable treatment (first graph). Also, for junior tranches, STS securitizations receive a considerably lower capital charge (second graph). Note that junior and senior Non-STS securitizations are treated the same, regardless of seniority, and rely only on rating and duration. Hence no distinction between senior and junior tranches is made for non-STS securitizations in Figure 4.

Figure 4

Figure 4 illustrates clearly the issues with the current system:

• The capital for insurers is an order of magnitude higher than the capital relieved by Banks (compare Figurec3), even after including diversification benefits for insurers.

• Non-STS capital charges are a multitude higher than those for STS.

• No distinction is made between senior and junior tranches for non-STS deals.

• Capital charges of non-STS securitizations seem too high given EU default history.

• Insurers face large capital increases if a securitization loses its STS status.

• Unrated, non-STS positions receive a 100% capital charge.

• Private securitizations need costly ratings from an external rating agency to avoid harsh capital treatment.

Capital Charges for Junior Tranche (Insurer)

Finally, Figure 5 compares capital charges for the junior tranche under Solvency II with those for the full loan portfolio.

Results show that a junior tranche rated B/CCC, and even a senior AAA-rated tranche (if non-STS), can have a higher capital charge than the original loan portfolio without credit enhancement. This is not realistic and clearly shows that Solvency II charges for non-STS securitizations are too harsh and need to be revised.

This observation is independent of the inter- and intra-risk² diversification benefits on the capital charges of the insurer.

Figure 5

Conclusion and Recommendations

This article uses a practical example of a Significant Risk Transfer (SRT) involving a commercial real estate loan portfolio to show how capital requirements differ for banks and insurers. It highlights a critical issue: under Solvency II, insurers face higher capital charges for holding securitized assets than they would for holding the original loans. This is particularly severe for non-STS transactions and creates a disincentive to invest in securitizations, limiting the development of the EU securitization market.

The following recommendations would be beneficial for the European Securitization Market:

• Recalibrate Solvency II Capital Charges;

  Adjust capital requirements for non-STS securitizations to better reflect actual risk and historical default rates in the EU market.

• Differentiate in Solvency II Between Tranches;

  Introduce separate capital treatments for senior and junior tranches of non-STS securitizations, as their risk profiles are significantly different.

• Introduce a Capital Charge Cap in Solvency II;

  Ensure that capital charges for securitized tranches do not exceed the charges for the underlying loan portfolio.

References

[1] Targeted consultation of the functioning of the EU securitization framework, European Commission, 9 October 2024

[2] How Smart Structuring Helps Banks and Insurers Maximize Regulatory Benefits, D.Dieleman, Substack, 17 April 2025

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1. The Simple Transparent and Standardized (“STS”) framework for securitizations was introduced by the EU in 2017. Today, only 1/3 of the European securitizations is an STS securitization.

2. Intra-risk diversification rules relate to diversification within a single risk type (i.e. equity risk and credit spread risk in the market risk module), while inter-risk diversification rules relate to diversification between different risk modules, (i.e. market risk and longevity risk)

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About the Author

Danny Dieleman

is a seasoned financial professional with over two decades of experience in risk management, balance sheet optimization, and financial strategy. Drawing on a PhD in Physics and a background as a lecturer at the University of Amsterdam, he combines analytical depth with practical execution—turning complex financial and capital challenges into clear, strategic solutions. Currently serving as Senior Treasury Executive at a Leading European Bank , he’s passionate about innovation, collaboration, and building smarter ways to understand and deploy risk and capital.

Follow Danny Dieleman on his blog at https://substack.com/@dannydieleman

The views expressed are his own and do not represent the views of his current or former organisations.