Regulators See Danger in New Risk-Retention Rules

New risk retention standards could restrict the availability of credit and hurt the economy if not carefully written, according to a report released on Tuesday by a new council of US regulators.

The council also said the new standards could reduce the kind of volatility in the asset-backed securities market that occurred during the 2007 to 2009 financial crisis when the housing market collapsed.

The Financial Stability Oversight Council, which is led by the Treasury Department and includes representatives from all the major financial regulators, was required to issue the report by the new Dodd-Frank financial reform law.

The study said asking lenders to retain some risk from the loans they originate may help lead to better lending decisions and mitigate some of the "pro-cyclical" effects from securitization that can lead to market bubbles.

"However, if overly restrictive, risk retention could constrain the formation of credit, which could adversely impact economic growth," the study said. "The challenge is to design a risk retention framework that maximizes benefits while minimizing its costs,"

Regulators are currently wrestling with how to best implement a new risk retention regulation that will force loan originators and securitizers to retain in their portfolios at least 5 percent of the value of loans, rather than shifting all of the risk to investors as the debt gets resold. Certain mortgages could escape this requirement.