The prudential regulator says it may penalise issuers of covered bonds with higher capital ratios if they allocate too many high-quality assets to their cover pools.The Australian Prudential Regulation Authority yesterday released a discussion paper on the planned prudential treatment of covered bonds, a funding instrument made possible only in recent weeks following changes to the Banking Act.Investors in covered bonds will have first claim over home-loan assets in the cover pools, leaving depositors (who were formerly the priority claimants in the event of a bank liquidation) in a secondary position.APRA noted in the discussion paper that allocating high-quality assets to a cover pool could lead to a deterioration in the average quality of remaining assets."If this were to result in a situation where the overall level and/or concentration of risks remaining in the ADI were to become excessive relative to its capital, APRA may consider adjusting an ADI's prudential capital ratio," the regulator wrote.Banks also face a deduction from core capital if the ratio of covered bonds exceeds the policy cap of eight per cent of domestic assets.To help check on banks' use of covered bonds, APRA will require them to produce lists of all assets included in cover pools on demand.A covered bond "monitor", or external auditor, will also check on the activities of each issuer.Deloitte partner Graham Mott said of the APRA paper: "It puts the emphasis on risk management. It puts the responsibility on the board and senior management to demonstrate that appropriate due diligence has been undertaken."And they need to produce a continuous, clear record of the assets, and be able to provide to APRA at any time a list of those assets."