ABA calls for changes to Basel III mortgage provisions

The Basel III endgame capital proposal would impose significant costs on the U.S. economy, ranging from small business loans to the pricing of derivatives that allow businesses to hedge their risks, the American Bankers Association and the Bank Policy Institute said in a joint letter to federal regulators.

ABA and BPI argued that the banking agencies dramatically underestimated the consequences of their proposal and failed to weigh the costs and benefits of their changes. Among its problems, the proposal includes an operational risk charge that would impose a tax on all banking activities at a level that massively overstates banks’ actual operational risk and fails to acknowledge that U.S. banks are already required to capitalize for operational risk through the stress tests, the associations said.

The comments advance that the proposal imposes unnecessarily high credit risk weights on mortgage loans, detailing that risk weights for mortgages would range from 40% to 90%, even before accounting for the impact of the separate operational risk charge and the Federal Reserve’s stress test. For loans intended to be sold to government-sponsored enterprises, the effective risk weight could be as high as 140%, when historical experience suggests an average risk weight of 25% is more appropriate. Overall, the risk weights in the proposal would “unjustifiably increase the cost and decrease the availability of mortgage credit to consumers, and particularly LMI (low- and middle-income) and minority borrowers, who face the largest charges.”

The comments address other anomalous results, such as mandating equal treatment for first-lien and second-lien residential exposures held by the same bank on the same property (with no intervening liens). This proposed approach results in punitive increases in the risk weight on the first-lien exposure if the same bank provided a second-lien exposure (e.g., a home equity loan or line of credit) on the property, rather than reducing the risk weight on the second-lien exposure.

Via appendix, the joint trades offer finding that finding that operational risk capital charges would add five percentage points to the risk weight of a mortgage loan retained on a bank’s balance sheet, on average, and estimating that operational risk capital charges would double the risk weight for a mortgage loan sold to a GSE. Overall, the comments urge the agencies to fundamentally reconsider this proposal and conduct a rigorous and comprehensive assessment of the first- and second-order consequences that changes to the capital framework could cause.