Basel III Redux: The New International Capital Standards for Banks Known as Basel III Need to Be Rethought When It Comes to Mortgage Servicing Rights. Otherwise, There Will Be a Dramatic Migration of Servicing Assets to Non-Depository Institutions

By Healy, Thomas J. | Mortgage Banking, September 2013 | Go to article overview

Basel III Redux: The New International Capital Standards for Banks Known as Basel III Need to Be Rethought When It Comes to Mortgage Servicing Rights. Otherwise, There Will Be a Dramatic Migration of Servicing Assets to Non-Depository Institutions


Healy, Thomas J., Mortgage Banking


Mortgage lending today operates in an artificial environment. More than 90 percent of all mortgages originated are Fannie Mae, Freddie Mac and Ginnie Mae product--and a large share of the resultant securities are purchased by the Federal Reserve. There is essentially no private mortgage market. [paragraph] This situation cannot go on indefinitely. At some point we need to reintroduce private capital into the equation. [paragraph] Additionally, because bureaucrats are not necessarily skilled at identifying consumer needs and ways to profitably satisfy them, entrepreneurs need to be incented to re-enter the market and create products that economically satisfy these evolving needs. [paragraph] Current regulations will either impede this transition or drive it into the hands of non-regulated enterprises. [paragraph] The Dodd-Frank Wall Street Reform and Consumer Protection Act, the Consumer Financial Protection Bureau (CFPB), National Mortgage Settlement, artificially low interest rates, Home Affordable Modification Program (HAMP), Home Affordable Refinance Program (HARP) and other government programs are all distorting the market. They are layering on often-conflicting requirements, impeding the growth of the private sector and creating regulation arbitrage opportunities.

Most of these programs just mentioned directly affect the operational side of the mortgage industry with a strong secondary impact on mortgage banking financial returns. Basel III, on the other hand, has little operational impact but directly affects the financial returns of this industry.

Background

Basel is an international committee that was established in 1974 with the goal of improving, and making more consistent, the supervisory guidelines that each country imposes on their banks. The Basel Committee on Banking Supervision has no enforcement capabilities but is well respected and, thus, is a strong force in defining banking regulations worldwide.

The 1988 Basel Accord (Basel I) was the first attempt at defining uniform capital requirements across country lines. It was based on five classes of assets grouped by credit risk.

While overall capital required was defined as 8 percent, each of the five classes carried risk weightings that were a percentage of that 8 percent, ranging from zero percent (e.g., U.S. Treasuries) up to 100 percent (e.g., commercial loans) for bank assets of good credit quality.

Basel II, introduced in 2004, added a three-pillar concept. These pillars included:

* Establishing minimum capital required based on not only Basel I's five credit risk levels, but also a bank's operational and market risks;

* Requiring bank supervisors to perform reviews of their banks to assess the efficacy of each bank's own Pillar 1 conclusions; and

* Adding additional disclosures in banks' regulatory filings that address each bank's capital position and risks. This was intended to allow for better market understanding and, thus, enforce market discipline.

Implementation of Basel II was slow due to the political and economic environment during those boom days. The economic bust of 2007, however, resulted in a recognition by the Basel Committee that further work needed to be done to further strengthen global capital requirements.

What is Basel III?

Basel III was first introduced in 2010/2011, modified in January 2013 and finalized in July 2013. It has not yet been implemented.

Basel III calls for banks to hold additional minimum capital and addresses liquidity concerns as well. There are myriad changes within Basel III that affect most aspects of banks' balance sheets.

From the perspective of bank-owned mortgage bankers, however, the final outcome was a partial "win" for mortgage lenders and a "lose" for mortgage servicers.

Mortgage lenders were initially faced with the prospect of holding increasing capital on existing mortgages based on each loan's mortgage category as well as the borrower's loan-to-value ratio (LTV). …

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