Seven Reasons Why the Entire Mortgage Market Should Care About the Basel Bank Capital Rule Proposal
In late July, the Federal Reserve, Federal Deposit Insurance Corporation (FDIC), and Office of the Comptroller of the Currency (OCC) issued interagency
proposed changes to capital requirements for banks with assets of $100 billion or more. The
so-called Basel “end game” proposal would complete U.S. regulators’ implementation of the Basel III standards and make changes in response to the recent large bank failures. The new rules will impact more than three dozen large U.S. banks, including more than two dozen regional banks that support the mortgage market and are not currently subject to the heightened capital standards on U.S. GSIBs (Globally Systemically Important Banks – i.e., the 8 largest banks).
These large banks play a critical role in the mortgage market as lenders, mortgage holders, servicers, aggregators and providers of warehouse and MSR financing – functions that could be impaired if this rule is not changed. This is not just “big bank stuff” – this is a major capital proposal with potentially far-reaching implications for the economy, for housing and for the mortgage market, issued with virtually no economic impact analysis and few justifications for the mortgage-related changes.
Here are seven reasons why the rest of the mortgage market should care about the Basel Capital rule:
- The proposed changes would increase overall minimum capital requirements at larger banks by about 15-20 percent. Higher capital standards – particularly of that magnitude – will mean less lending overall in the economy with a potential to stunt overall economic growth. How much? We don’t know because the agencies barely analyzed it.
- Capital rules drive business decisions – comprehensive changes to credit, operational, and market risk capital requirements will also impact what lines business the banks will focus on…or pull back from. Which sectors could get hurt? We don’t know because the agencies provided only a cursory assessment.
- The large increase in overall capital levels for regional banks will have second-order effects on consumer and business borrowers. What are they? We don’t know because the agencies hardly mentioned them.
- The
proposed rule changes the capital treatment of single-family mortgages, which could have significant negative implications for the broader mortgage market. The rule increases risk weights for single-family mortgages well above the level in the Basel Accords themselves, and for 80%+ LTV loans, higher than the current 50% risk weight. This could impact larger banks’ participation in the jumbo correspondent business, as aggregators of conforming mortgages, and as buyers of CRA-eligible mortgages from IMBs. Mortgage market performance in the post-Global Financial Crisis world has been strong and resilient, and delinquencies are near record lows. Why are the regulators proposing higher risk weights now? How does this affect home affordability? We don’t know because they don’t explain it.
- The proposed rule also makes the already-punitive capital treatment of mortgage servicing rights even harsher by reimposing a 10% cap on MSRs as a percentage of these banks’ Tier 1 capital – a cap the regulators raised only five years ago in response to concerns about banks leaving the mortgage market. MBA believes this provision, if implemented, could further reduce MSR demand and impair MSR liquidity and valuations, to the detriment of IMBs and others that originate and sell. How will this further the goal of a diverse and robust market for mortgage servicing?
- Because mortgage banking produces an MSR asset with every loan that’s made, these changes will impact IMBs, community banks, credit unions, and their customers. Reduced servicing premiums will mean higher interest rates for borrowers. A further bank pull-back from the mortgage market will also put more pressure – both market and regulatory – on IMBs. MBA is concerned that the Federal Housing Finance Agency (FHFA) and Ginnie Mae – under pressure from the bank regulators on FSOC – could seek to extend these poorly conceived capital standards to IMBs. How does this make the mortgage market more resilient?
- The large overall capital increase could also impact larger banks’ interest in supporting their warehouse lending and MSR financing businesses. These lines of business already have high risk weightings relative to the underlying credit risk, and banks could quickly begin reducing or eliminating their exposure in order to get into compliance with the rules once they are finalized. Again, how does this strengthen our housing finance system?
A few weeks ago just before the Board and FDIC voted on this proposal, based on media reports about the contents of the rule (that we were able to confirm as true), MBA sent a letter to
the leadership of the banking agencies urging them to vote against the rules and highlighting the adverse impact on both the macro economy and the housing finance system.
MBA’s early opposition appears to have helped put “drag” on these rules as several Fed and FDIC Board members, in voting against the proposal, specifically highlighted concerns with the mortgage market implications. The rule passed the FDIC and Fed boards on a combined 7-4 vote, including a very tepid “yes” from Fed Chair Jerome Powell. By way of context, prior Basel II and Basel III proposed rules received unanimous votes from the Fed and FDIC.
Comments on this proposal are due by November 30, 2023. The rule proposes a three-year transition period for compliance beginning July 1, 2025, but market participants should not take comfort that this will soften the impact – we expect banks will begin managing to the rule as soon as it is final. It’s an 1100-page rule and we have only begun to analyze it, but based on a review of the mortgage-related provisions, MBA will express strong opposition to the portions of rule that undermine the housing finance ecosystem.
For more information or questions, please contact me, Pete Mills at (202) 557-2878.
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