SRTs: The Future of Capital Relief – But Who is Absorbing the Risk?

Significant Risk Transfers (SRTs) have become an essential tool for banks seeking to manage regulatory capital efficiently. By transferring the credit risk of specific loan portfolios to external investors, banks can reduce their risk-weighted assets (RWA) and optimise capital allocation. Over the last couple of years, the European SRT market has grown significantly, driven by regulatory developments and increasing investor interest. The introduction of the simple, transparent and standardised (STS) framework for on-balance-sheet securitisations has further reinforced the product’s attractiveness among market participants.

The European Banking Authority (EBA) has played a critical role in shaping the market. Its guidelines provide a harmonised interpretation of STS criteria, ensuring consistency and boosting market confidence. These regulatory efforts, combined with the increasing capital pressures on banks, have made SRT transactions a permanent feature in capital management strategies. SRT issuance volumes have increased, new investors have entered the market and transactions are becoming more mainstream – in 2024 alone over 70 banks issued SRTs.

How SRT Transactions Work

SRT transactions are a form of synthetic securitisation, meaning the underlying assets remain on the bank’s balance sheet, but their associated credit risk is transferred. The structure typically consists of three tranches:

• Senior tranche – retained by the bank, benefiting from lower capital requirements
• Mezzanine tranche –  held by investors, transferring risk and achieving capital relief
• First-loss tranche – retained by the bank to demonstrate alignment of interest

Investors, such as asset managers, pension funds and insurance companies provide credit protection via financial guarantees or credit-linked notes. These transactions allow banks to optimise their capital ratios while continuing to lend.

Let us briefly take a look at the cash flow mechanisms (see illustration).  The proceeds from the CLN (credit-linked note) issued to investors are held in a collateral account. If losses occur on the reference portfolio, these funds compensate the bank – ensuring the risk transfer is effective. Over time (as losses materialise) payments flow from the collateral account to the bank, reducing the protection available to investors.

Regulatory Developments Driving Growth

The growth of the SRT market is closely tied to regulatory changes. The Capital Requirements Regulation (CRR) has raised capital requirements, making SRT an attractive alternative to raising new equity. The introduction of output floors will most likely further increase RWAs, reinforcing the need for capital-efficient solutions.

The EBA’s guidelines on STS criteria for on-balance-sheet securitisations, outlined in its final report EBA/GL/2024/05, provide key clarifications for the market. They require specific credit events, credit protection payments and debt workout terms to be defined.

The EBA emphasizes robust credit risk mitigation standards such as the use of acceptable high-quality collateral and clear requirements for synthetic excess spread to enhance credit protection. The guidelines highlight the relevance of third-party verification agents to ensure STS compliance without conflicts of interest. They also introduce a rigorous approval process for capital relief that requires banks to demonstrate a genuine transfer of risk in synthetic securitisation transactions.

Investor Interest in SRT Transactions

SRT transactions offer attractive risk-adjusted returns, drawing interest from institutional investors. Compared to traditional asset-backed securities (ABS), SRTs typically provide higher yields due to their illiquidity and bespoke nature. Since they are unrated they allow investors to gain exposure to high-quality loan portfolios from well-capitalised banks and “national champions” such as Barclays and Santander, i.e. banks whose lending history spans decades and has been tested through various economic crises and market cycles.

The investor base has expanded in recent years, with credit funds and supranational institutions becoming active participants. This growing demand has facilitated an increase in issuance with banks across Europe incorporating SRT transactions into their capital planning.

Historically, corporate and SME loans have dominated SRT portfolios due to their high RWA burdens. However, the range of securitised assets has expanded significantly. Now deals may include residential mortgages, auto loans, project finance and infrastructure debt, green assets and ESG-linked portfolios, shipping and agriculture loans.

The appeal of SRTs lies primarily in their yield pickup over more traditional credit instruments like CLOs (collateralized loan obligations) or conventional ABS. Because SRTs are private deals and may require more work, they tend to offer a significant spread premium. Of course, this yield comes with trade-offs as credit risk is most likely higher and selling an SRT portfolio would require significant due diligence efforts. Savvy investors, however, are willing to perform the necessary work and benefit from higher yields.

Leverage and Risk Containment

While synthetic securitisation has brought significant benefits to banks, there has been a growing narrative of caution around SRT transactions. Economists draw parallels to previous financial instruments that contributed to the 2008 financial crisis. This caution stems from concerns about the risks associated with transfers of credit risk.

Although the current market is designed with safeguards in mind, it still carries some of the same elements seen in products that contributed to the global financial crisis. Critics argue that while these transactions may relieve banks from regulatory pressures, the risks are being shifted outside the regulated banking system and are now concentrated in less-capitalised institutions.

This shift could expose the financial system to systemic risks, particularly if the institutions absorbing the risks are less capable of weathering losses than the banks that originated them. A potential use of leverage by institutional investors backing these transactions can amplify positive returns, however, it could also increase exposure to losses in volatile market conditions – making SRT transactions potentially vulnerable to market downturns.

Conclusion

As capital requirements continue to tighten, the role of SRT transactions in optimising balance sheets will only grow, providing banks with a flexible and efficient tool for managing risk and capital. With an increasingly diverse range of asset classes being securitised – from corporate and SME loans to residential mortgages and infrastructure finance – SRT transactions are poised to remain a key feature of European banking for years to come. However, as concerns over leverage and systemic risk continue to emerge, it is evident that while the risks may have been transferred, they haven’t disappeared entirely.