Basel capital rules may be revised to boost bank mortgage lending

"Regulators, she said, must examine whether prudential standards contributed to the contraction and whether the standards reflect the actual risks involved. In part, this results from over calibration of the capital treatment for these activities, resulting in requirements that are both disproportionate to risk and that make mortgage activities too costly for banks to engage, Bowman said. I see a path forward that incorporates both renewed bank participation in the mortgage market and a safe and sound banking system."

"MSR valuations can be challenging to calculate because they are not based on transaction prices in liquid markets. Instead, they are derived from models that depend on subjective assumptions about mortgage prepayment and the likelihood of default. This makes the valuations volatile, especially during interest rate swings, and we have observed that during periods of high defaults, some MSR markets can experience stress or seize up."

Regulators must examine whether prudential standards contributed to the mortgage market contraction and whether those standards reflect actual risks. Over-calibration of capital treatment has produced requirements disproportionate to risk and made mortgage activities too costly for banks, reducing bank participation. The 2013 changes to capital treatment of mortgage servicing rights increased risk weights and imposed a deduction threshold that penalized large MSR holdings. MSR valuations rely on models with subjective assumptions about prepayment and default, causing valuation volatility during interest-rate swings. During periods of high defaults some MSR markets can experience stress or seize up. Managing MSR volatility requires sophisticated hedging or borrower retention strategies.

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