Bcbs Risk-Weights

[Bland Unsight]

Interesting piece in the FT on Wednesday, google for "UK’s financial regulators move to boost challenger banks", and it minded me to start a thread where all the Basel Committee on Banking Supervision Revisions to the Standardised Approach for credit risk stuff can live.

A quotation from Andrew Bailey where he makes the argument that the current risk-weights are pushing the challengers into the "racier" end of the market and an allusion to the fact that in the past that has ended badly.

It's interesting how the challenger banks got so balls deep in BTL so quickly, so now you have the ridiculous situation that Basel risk-weights which are, at least in part, supposed reduce the systemic threat from pro-cyclical lending into real estate are shaping up to form a systemic threat to our challenger banks (because they've bet the ranch on BTL).

I think that reading between the lines is called for, but on balance the remarks attributed to Bailey in the piece are consistent with the Bank of England taking a pretty dim view of BTL and having their face set against it. In my reading Bailey seems to be suggesting that the challengers need to be allowed to compete with the big banks on prime lending, not that they need to be allowed to lend like idiots to anything with a 25% deposit and a heartfelt desire to be a landlord.

Both in the immediate wake of the release of the consultation paper in December and to this day there has been no explicit statement from the Bank of England indicating that they are against fairly punitive risk-weights landing on BTL mortgage books. The refrain has always been that there need be no increase in capital requirements in the system as a whole, (but that is consistent with a trimming of capital requirements against some lending whilst making them more stringent for other classes of lending). At this stage there remain grounds for optimism that in due course BCBS risk-weights may put pressure on BTL mortgage rates.

[Bland Unsight]

Every time I think I've got a decent feel for what the automatic capitalisation will do to a topic title I slip up and create something ridiculous

[Neverwhere]

It could be worse, you could have called it 'Basel Iii'

[Neverwhere]

If we're pulling it all together on one thread then here are the BTL relevant sections of the Second consultative document (hopefully I haven't missed anything):

Basel Committee on Banking Supervision
Second consultative document
Standards: Revisions to the Standardised Approach for credit risk
Issued for comment by 11 March 2016
December 2015
Bank for International Settlements

[. . .]

Introduction

This is the Committee’s second consultation on Revisions to the Standardised Approach for credit risk. The Committee wishes to thank all respondents for their extensive feedback on its first consultative document, which was published in December 2014.¹ The revised proposals in this second consultative document aim to address the issues raised by respondents with respect to the initial proposals. These revised proposals also seek to achieve the objectives set out in the first consultative document to balance simplicity and risk sensitivity, to promote comparability by reducing variability in risk-weighted assets across banks and jurisdictions, and to ensure that the standardised approach (SA) constitutes a suitable alternative and complement to the Internal Ratings-Based (IRB) approach.

[. . .]

For other exposure classes the Committee has built on the first consultative proposals as well as on feedback received and evidence from the first Quantitative Impact Study (QIS) to improve the current approach. For exposures secured by real estate, the Committee proposes to use the loan-to-valuation (LTV) ratio as the main risk driver for risk weighting purposes, and to use a three-category classification (from less to more risky) as follows:

• General treatment for exposures secured by real estate where repayment is not materially dependent on rent/sale of the property;
• A more conservative treatment for exposures secured by real estate where repayment is materially dependent on cash flows (ie rent/sale) generated by the property. Specialised lending (corporate) exposures assigned to “income-producing real estate” under the IRB approach would be classified under this category;
• A conservative, flat risk weight for specialised lending real estate exposures defined as “land acquisition, development and construction” (ie loans to companies or SPVs, unfinished property meeting the definition of specialised lending).

[. . .]

The Committee notes that the SA is a global minimum standard and that it is not possible to take into account all national characteristics in a simple approach. As such, national supervisors should require a more conservative treatment if they consider it necessary to reflect jurisdictional specificities. Furthermore, the SA is a methodology for calculating minimum risk-based capital requirements and should in no way be seen as a substitute for prudent risk management by banks.

[. . .]

Next steps

The Committee welcomes comments on all aspects of the revised proposals, particularly in relation to specific questions included in this consultative document. Comments should be uploaded at www.bis.org/bcbs/commentupload.htm by Friday 11 March 2016. All comments will be published on the website of the Bank for International Settlements unless a respondent requests confidential treatment.

The Committee will conduct a comprehensive QIS as part of the Basel III monitoring exercise collecting data as of end-December 2015. All calibrations in the consultative document are preliminary, and will be subject to revisions post-consultation and based on evidence from the second QIS. The Committee will assess the proposals and will adjust calibrations where necessary, to ensure overall consistency within the capital framework. Increasing overall capital requirements under the SA for credit risk is not an objective of the Committee; rather, capital requirements should be commensurate with the underlying risk.

The Committee encourages market participants to contact their national supervisors if they wish to participate in the QIS on a best-efforts basis. Extensive and good quality data will be crucial in supporting an appropriate calibration of the revised standardised approach.

Prior to finalising the revised SA, the Committee will evaluate appropriate implementation arrangements, including transitional or grandfathering provisions where necessary, and will provide sufficient time for implementation taking into account the range of other reforms that have been, or are due to be, agreed by the Committee.

Section 1: Proposed revisions to the standardised approach for credit risk

[. . .]

1.2 Specialised lending exposures to corporates

In the 2014 consultative document, the Committee proposed to increase the risk sensitivity of the SA and align the SA with the IRB approach by introducing the IRB’s five subcategories of specialised lending exposures. The rationale is that these exposures generally exhibit higher risks and losses than other types of corporate exposures. For simplicity, the proposed risk weights were:

• For project finance, object finance, commodities finance and income-producing real estate finance: A bank would assign the higher of a 120% risk weight and the risk weight of the counterparty; and
• For land acquisition, development and construction finance: A bank would assign the higher of a 150% risk weight and the risk weight of the counterparty.

[. . .]

Finally, the Committee proposes to revise the taxonomy of real estate exposures to clarify respondents’ queries on the classification of specialised lending exposures related to real estate. In particular, the Committee proposes to categorise income-producing real estate exposures and land acquisition, development and construction exposures as real estate exposures. The treatments for these exposures are described in Section 1.5.

[. . .]

1.5 Real estate exposure classification

Under the current SA, exposures secured by residential or commercial real estate are the only exposure categories that are risk-weighted based on the collateral securing the relevant exposure,¹¹ as opposed to the counterparty. Currently, residential real estate exposures receive a risk weight of 35% where the loans are granted in accordance with strict prudential criteria, such as the existence of substantial margin of additional security over the amount of the loan based on strict valuation rules. Commercial real estate exposures receive a 100% risk weight, with national discretion to allow a preferential risk weight under certain strict conditions.

Revised taxonomy

The 2014 consultative document maintained the distinction between residential and commercial real estate exposures within the real estate exposure class and introduced two specialised lending subcategories related to real estate (alongside other specialised lending sub-categories, under the corporate exposure class): income-producing real estate (IPRE) and land acquisition, development and construction (ADC). Some respondents were of the view that there could be potential gaps in the assignment of exposures to IPRE and ADC, and sought clarification on the distinction between these sub-categories and the real estate exposure class. In this consultative document the Committee proposes to categorise all exposures related to real estate under the same exposure class, including IPRE and ADC (ie IPRE and ADC exposures would be defined and categorised in the real estate exposure class, rather than under the specialised lending category within the corporate exposure class).

Under this new taxonomy, exposures secured by either residential or commercial real estate would receive differing risk-weight treatments depending on whether repayment of the loan is materially dependent on the cash flows generated by the property. This is the main characteristic used to define specialised lending. Risk weights applied to exposures where there is material dependence would be relatively higher than risk weights applied when there is no material dependence. This is to account for the higher risk due to the stronger positive correlation between the prospects for repayment of the exposure and the prospects for recovery in the event of a default. Specialised lending (corporate) exposures assigned to IPRE under the IRB approach would be classified under this category and be risk-weighted according to LTV ratios.¹² In addition, this category might include some exposures to individuals secured by rental property.

The financing of ADC loans, relating to both residential and commercial real estate, would receive a 150% risk weight in line with the treatment in the 2014 consultative document.

The following chart summarises the revised proposals for the real estate exposure class:



1.5.1 Residential real estate exposures

Background: current treatment and previous consultative proposal

The current SA applies a 35% risk weight to all exposures secured by mortgages on residential property, provided that there is a substantial margin of additional security over the amount of the loan based on strict valuation rules. Such an approach lacks risk sensitivity and comparability across jurisdictions, as it does not specify the margin of additional security required to achieve the 35% risk weight.

In order to increase risk sensitivity and harmonise global standards in this exposure category, the Committee proposed, in its 2014 consultative document, to assign risk weights (ranging from 25% to 100%) based on the following risk drivers: (1) the loan-to-value (LTV) ratio; and (2) the debt servicing coverage (DSC) ratio, as a proxy of the borrower’s ability to service the mortgage. The exposure would have to meet specific requirements to apply the risk weight table, and risk weights would have to be applied to the full exposure amount (ie without splitting the exposure across different LTV buckets). The value of the property (denominator of the LTV ratio) and the DSC ratio would be measured at origination and be kept constant throughout the life of the loan.

Feedback received

While respondents welcomed the Committee’s efforts to enhance the risk sensitivity of this exposure class, they claimed that a one-size-fits-all approach has its limitations. Respondents generally supported the use of the LTV ratio as a risk driver, but raised significant concerns on the DSC ratio using a standardised definition and a fixed threshold, given the material differences in underwriting practices, regulations, tax regimes and average incomes across jurisdictions.

Revised proposal

QIS data show that the loss incurred in the event of a default and the likelihood of a borrower’s default are lower when the outstanding loan amount relative to the value of the residential real estate collateral is lower. The Committee has therefore decided to retain the LTV ratio as the principal risk driver for this exposure class. When calculating capital requirements, the property should be valued prudently (see revised language in Annex 1, paragraph 50). While the value of the property (ie the denominator of the LTV ratio) would be kept constant at origination, supervisors may require banks to revise the value downwards in case of a general decline in residential market prices.

Given the challenges of defining and calibrating a DSC ratio that can be equitably applied across jurisdictions, the Committee has decided not to use this ratio as a risk driver. However, since evidence (within jurisdictions) still supports a metric such as the DSC ratio as a meaningful predictor of loan performance, the Committee proposes to require the assessment of the borrower’s ability to pay (for example, through the DSC ratio) as a key underwriting criterion.

In order to apply the preferential risk weight based on the LTV ratio, banks would need to satisfy other requirements in addition to the assessment of the borrower’s ability to pay. These additional requirements would focus on the quality of the collateral (eg adequate valuation, finished property), the collateral’s effectiveness (eg legal enforceability, seniority of lien¹³), and other procedural aspects (eg required documentation). A bank would assign a higher risk weight to the exposure, irrespective of the LTV ratio, if the above requirements are not met.

Moreover, the Committee proposes to differentiate risk weights based on whether loan repayment is materially dependent on cash flows generated by the real estate collateral. While risk weights would still vary based on the exposure’s LTV ratio, a bank would assign a higher risk weight to the exposure if repayment of the loan is materially dependent on the cash flows generated by the real estate collateral.

Annex 1, paragraphs 49 to 56 of this consultative document present the Committee’s proposals for differentiating the risk weight for exposures secured by residential real estate.

[. . .]

1.5.3 Land acquisition, development and construction (ADC) exposures

ADC exposures would be risk-weighted at 150%, consistent with the 2014 consultative document. This category would include loans to companies or SPVs financing any of the land acquisition, development and construction of any residential or commercial properties where the source of repayment at origination of the exposure is either the future uncertain sale of the property or cash flows whose source of repayment is substantially uncertain. ADC exposures would also include loans to companies or individuals to finance the acquisition of finished properties where the repayment of the loan depends on the future uncertain sale of the property.

[. . .]

1.8 Defaulted exposures

Background

While the current SA includes a separate asset category for past due loans, the Committee is of the view that the past due concept should apply to all assets and not just loans. Therefore, this section refers to past due (or defaulted, as explained below) exposures.

The 2014 consultative document did not include any specific proposal on the treatment of past due loans, although it was noted that the current treatment might be reviewed.

The current SA treatment of past due loans relies on the accounting concept of “specific provisions”. For example, past due loans receive a risk weight of 100% if specific provisions are no less than 20% of the outstanding amount of the loan.¹⁶

Proposed revisions

Aligning with IRB: From “past due” to “defaulted” exposures

One of the weaknesses identified in the current SA is the insufficient alignment with the IRB approach. Under the current treatment, the concept of “past due” is based on the simple trigger of a loan being past due more than 90 days. On the contrary, the IRB approach uses a concept of exposures “in default” which, in addition to the 90 days past due trigger, includes loans where banks are of the view that the obligor is unlikely to pay its credit obligation to the banking group in full (Basel II, paragraph 452).¹⁷

The Committee proposes that the definition of past due should be as far as possible aligned with the IRB’s “defaulted exposure” definition. Annex 1, paragraph 75 includes a proposed definition for defaulted exposures in SA.

Risk weight treatment

In the current SA the amount of specific provisions lowers both the exposure amount as well as the risk weight, ie leading to a double benefit. Moreover, while provisions are meant to reflect expected losses, capital requirements (risk weights) provide protection against unexpected losses. For these reasons, the Committee proposes that specific provisions and partial write-offs should factor only into the calculation of the exposure amount and should have no bearing on the risk-weighting of past due exposures.

The Committee proposes that the unsecured portion of any defaulted exposure (other than residential real estate), net of specific provisions and partial write-offs, receive a risk weight of 150%. As an exception, defaulted residential real estate exposures where the repayment does not materially depend on the cash flows generated by the property securing the loan would receive a risk weight of 100%.

The secured portions of defaulted exposures can be risk-weighted in accordance with the CRM framework provided that collateral and guarantees meet the eligibility requirements of the CRM framework.

The current treatment allows a lower risk weight of 100% where a past due loan is fully secured by forms of collateral that are not eligible under the CRM framework, provided that provisions reach 15% of the outstanding amount of the loan. Given that the proposed revisions delink the risk weight with the amount of provisions, maintaining this treatment would be inconsistent. The Committee welcomes evidence on the materiality of removing this possibility.

[. . .]

Section 3: Objectives of the SA review in light of current proposals

[. . .]

One of the key weaknesses of the current SA is the lack of granularity and risk sensitivity in a number of exposure classes. Taking into account the characteristics of each exposure class, the Committee proposes to increase the risk sensitivity of the SA in areas where revisions in the risk-weighting methodologies would not result in unwarranted increased complexity and comparability issues. For example:

• enhanced risk sensitivity for bank exposures where ratings are not available or cannot be used for regulatory purposes;
• enhanced granularity to differentiate the riskiness of certain exposures (eg specialised lending and corporate SMEs, subordinated debt and equity holdings);
• enhanced risk sensitivity for real estate exposures by introducing specific treatments depending on whether the repayment of the loan materially depends on the cash flows generated by the property, and by introducing the LTV ratio as a risk driver; and
• enhanced risk sensitivity for exposures with currency mismatches between the lending currency and the currency of the borrower’s main source of income.

Another weakness of the current SA is the lack of clarity in the risk-weight treatment of certain exposures, such as retail exposures. The Committee has sought to provide more clarity on the application of the regulatory retail criteria for retail exposures, and the treatment where the criteria have not been met.

To further reduce complexity in the SA, the Committee proposes to revise the credit risk mitigation framework, by removing internal modelling approaches in the calculation of capital charges for certain exposures backed by financial collateral.

To address the variability in the risk-weighted assets across banks using the IRB approach, the Committee intends to impose a standardised approach floor on modelled credit risk capital requirements.²² In line with this objective, some of the proposals set out in this consultative document (such as the introduction of equity and specialised lending categories, and the replacement of the 90-days past-due concept by the IRB definition of default) also aim to align, to the extent possible, the definitions and scope of exposure classes for the SA and IRB approach.

[. . .]

Annex 1

Proposals on risk weighting for exposure classes and credit risk mitigation

The text below would replace current paragraphs 50 to 210 from the Basel II framework available at: www.bis.org/publ/bcbs128.pdf.

This Annex details the proposals for exposure classes where a specific treatment is being considered. For completeness, it also includes the treatment of exposure classes which are out of scope of this review (ie sovereigns, central banks and public sector entities), even though the Committee might review such treatment in the future as part of a holistic review of sovereign-related risks.

NB: References to paragraphs in this consultative paper are shown [in brackets]. References to other parts of the Basel framework are shown without brackets. Risk weights are included for indicative purposes and to help estimate the impact of the proposals under consideration during the QIS.

Introduction

1. The Committee permits banks to choose between two broad methodologies for calculating their risk-based capital requirements for credit risk. One alternative, the standardised approach, assigns standardised measures of credit risk as described in paragraphs [4 to 82]. To determine the risk weights in the standardised approach for certain exposure classes, in jurisdictions that allow the use of external ratings for regulatory purposes, banks may, as a starting point, use assessments by external credit assessment institutions that are recognised as eligible for capital purposes by national supervisors, in accordance with paragraphs [83 to 101].²³ Under the standardised approach, exposures should be risk-weighted net of specific provisions.

2. The other risk-based capital alternative for measuring credit risk, the Internal Ratings-Based (IRB) approach, allows banks to use their internal rating systems for credit risk, subject to the explicit approval of the bank’s supervisor.

3. Securitisation exposures are addressed in Section IV.²⁴ Credit equivalent amounts of OTC derivatives that expose a bank to counterparty credit risk²⁵ are to be calculated under the rules set forth in Annex 4.²⁶ Equity investments in funds and exposures to central counterparties must be treated according to their own specific frameworks.²⁷

A. Individual exposures

[. . .]

9. Real estate exposure class

49. The risk weights described in paragraphs [54 and 58] will apply to jurisdictions where structural factors result in sustainably low credit losses associated with the exposures to the real estate market. National supervisory authorities should evaluate whether the risk weights in the corresponding risk weight tables are considered too low for these types of exposures in their jurisdictions based on default experience and other factors such as market price stability. Supervisors, therefore, may require banks in their jurisdictions to increase these risk weights as appropriate.

50. To apply the risk-weights in tables [9, 10, 11 and 12], the loan must meet the following requirements:

• Finished property: the property securing the exposure must be fully completed. Subject to national discretion, supervisors may apply the risk-weight treatment described in paragraph [54] for loans to individuals that are secured by residential property under construction, provided that: (i) the property under construction is a one-to-four family residential housing unit that will be the residence of the borrower (this does not include apartments within a larger construction project); or (ii) where the sovereign or PSEs have the legal powers and ability to ensure that the property under construction will be finished.
• Legal enforceability: any claim on the property taken must be legally enforceable in all relevant jurisdictions. The collateral agreement and the legal process underpinning it must be such that they provide for the bank to realise the value of the property within a reasonable time frame.
• Claims over the property: Claims over the property are restricted to situations where the lender bank holds a first lien over the property, or a single bank holds the first lien and any sequentially lower ranking lien(s) (ie there is no intermediate lien from another bank) over the same property. However, in jurisdictions where there is no doubt that junior liens provide the holder with a claim for collateral that is legally enforceable and constitutes an effective credit risk mitigant, junior liens held by a different bank than the one holding the senior lien may also be recognised.⁴¹ In order to meet the above requirements, the national frameworks governing liens should ensure the following: (i) each bank holding a lien on a property can initiate the sale of the property independently from other entities holding a lien on the property and (ii) where the sale of the property is not carried out by means of a public auction, entities holding a senior lien take reasonable steps to obtain a fair market value or the best price that may be obtained in the circumstances when exercising any power of sale on their own (ie it is not possible for the entity holding the senior lien to sell the property on its own at a discounted value in detriment of the junior lien).
• Ability of the borrower to repay: the borrower must meet the requirements set according to paragraph [51].
• Prudent value of property: the property must be valued according to the criteria in paragraph [52] for determining the value in the loan to value (LTV) ratio. Moreover the value of the property must not depend materially on the performance of the borrower.
• Required documentation: all the information required at loan origination and for monitoring purposes should be properly documented, including information on the ability of the borrower to repay and on the valuation of the property.

51. National supervisors should ensure that banks put in place underwriting policies with respect to the granting of mortgage loans that include the assessment of the ability of the borrower to repay. Underwriting policies must define (a) metric(s) (such as the loan’s debt service coverage ratio) and specify its (their) corresponding relevant level(s) to conduct such assessment.⁴² Underwriting policies must also be appropriate when the repayment of the mortgage loan depends materially on the cash flows generated by the property, including relevant metrics (such as an occupancy rate of the property). National supervisors may provide guidance on appropriate definitions and levels for these metrics in their jurisdictions.

52. The LTV ratio is the amount of the loan divided by the value of the property. The value of the property will be maintained at the value measured at origination unless national supervisors elect to require banks to revise the property value downward.⁴³ The value must be adjusted if an extraordinary, idiosyncratic event occurs resulting in a permanent reduction of the property value. Modifications made to the property that unequivocally increase its value could also be considered in the LTV. When calculating the LTV ratio, the loan amount will be reduced as the loan amortises.

The LTV ratio must be prudently calculated in accordance with the following requirements:

• Amount of the loan: includes the outstanding loan amount and any undrawn committed amount of the mortgage loan.⁴⁴ The loan amount must be calculated gross of any provisions and other risk mitigants.⁴⁵
• Value of the property: the valuation must be appraised independently⁴⁶ using prudently conservative valuation criteria. To ensure that the value of the property is appraised in a prudently conservative manner, this value must exclude expectations on price increases and must be adjusted to take into account the potential for the current market price to be significantly above the value that would be sustainable over the life of the loan. National authorities should provide guidance setting out prudent valuation criteria where such guidance does not already exist under national law. If a market value can be determined, the valuation should not be higher than the market value.⁴⁷

Where guarantees or financial collateral which are eligible according to the SA’s credit risk mitigation framework are provided, banks may recognise these risk mitigants in their calculation of the real estate exposure amount. Notwithstanding, such eligible guarantees and financial collateral must not be factored into the LTV ratio calculation that will determine the applicable risk weight.

9.1 Residential real estate exposures

53. A residential real estate exposure is an exposure secured by an immovable property that has the nature of a dwelling and satisfies all applicable laws and regulations enabling the property to be occupied for housing purposes (ie residential property).

54. Where the requirements in paragraph [50] are met and provided that paragraphs [56] and [61] are not applicable, the risk weight to be assigned to the total exposure amount will be determined based on the exposure’s LTV ratio.



55. Where the requirements in paragraph [50] are not met, the risk weight will be the higher of 100% or the risk weight of the counterparty, provided that paragraphs [56] and [61] are not applicable.

56. When the prospects for repayment and recovery on the exposure materially depend on the cash flows generated by the property securing the loan rather than on the underlying capacity of the borrower to repay the debt from other sources, and provided that paragraph [61] is not applicable, the exposure will be risk-weighted as follows:^{49, 50}

• if the requirements in paragraph [50] are met, according to the LTV ratio as set out in the risk-weight table [10] below; and
• if the requirements of paragraph [50] are not met, at 150%.

The primary source of these cash flows would generally be lease or rental payments, or the sale, of the residential property. The distinguishing characteristic of these exposures versus other residential real estate exposures is the strong positive correlation between the prospects for repayment of the obligation and the prospects for recovery in the event of default, with both depending materially on the cash flows generated by the property securing the exposure.



[. . .]

9.3 Land acquisition, development and construction exposures

61. Land acquisition, development and construction (ADC) lending will be risk-weighted at 150%. ADC includes loans to companies or SPVs financing any of the land acquisition, development and construction of any residential or commercial properties where the source of repayment at origination of the exposure is either the future uncertain sale of the property or cash flows whose source of repayment is substantially uncertain. ADC exposures will also include loans to companies or individuals to finance the acquisition of finished property where the repayment of the loan depends on the future uncertain sale of the property.

[. . .]

78. Defaulted residential real estate exposures where repayments do not materially depend on cash flows generated by the property securing the loan shall be risk-weighted net of specific provisions and partial write-offs at 100%. Other real estate exposures shall be risk-weighted net of specific provisions and partial write-offs at 150%. Guarantees or financial collateral which are eligible according to the credit risk mitigation framework might be taken into account in the calculation of the exposure in accordance with paragraph [52].

[. . .]

Annex 2

Summary of results from first QIS on 2014 consultative document

The Basel Committee undertook a QIS on the 2014 consultative proposals to revise the SA (“SA QIS”) as part of its Basel III Monitoring QIS. Some 241 banks from 27 countries participated in the SA QIS, of which 92 were Group 1 banks (including 30 global systemically important banks) and 119 were Group 2 banks. Of the 300 QIS templates that were submitted for the 2015 Basel data collection exercise, 242 provided at least some data for the analysis and 153 were from Europe. This suggests that the data collected might be weighted towards European jurisdictions. Most reporting banks also reported data as of the reporting date of 31 December 2014.

According to the 2014 QIS results, capital requirements under the indicative risk weights presented in the consultation paper would increase substantially relative to the current SA and IRB. Although the proposed revisions were directionally consistent with today’s capital frameworks (ie applying higher risk weights to the same exposures), average risk weights increased for many exposure classes. Increases in average risk weights were mostly concentrated in certain exposure classes. The classes that showed the highest increases in terms of average risk weights were “specialised lending”, “sub-debt, equity and other capital instruments”, “banks” and “corporate”; while “commercial real estate” and “residential real estate” showed modest increases. Average risk weights for “retail”, “sovereigns” and “MDBs” were largely unchanged, as the Basel II SA treatment for these exposure classes was largely maintained.

One of the key objectives of this first QIS was to assess the appropriateness of the proposed risk drivers in the 2014 consultative document. The main observations included:

• [. . .]
• For the residential real estate category, the QIS evaluated the performance of LTV and debt-service coverage (DSC) ratios as risk drivers. Except for the lowest and highest LTV bands, the PD and LGD tended to correlate closely to the LTV ratio. The DSC ratio was found to be a relatively good discriminator of risk for the exposures, but there were concerns about the consistency of its definition and the appropriateness of the proposed threshold across jurisdictions. Overall, the results demonstrated that, on average, residential real estate received a higher average risk weight, driven by large concentrations of mortgages recorded in the 60-80% LTV bucket.

¹ Available at www.bis.org/bcbs/publ/d307.pdf.

¹¹ Some respondents asked if additional guarantees or collateral eligible under the CRM could be also taken into account when calculating capital requirements for real estate exposures. Paragraph 52 in Annex 1 has been added to clarify how the calculation of capital requirements should be done.

¹² This is in line with feedback received on the 2014 consultative document; in particular, some respondents pointed out that, in the case of IPRE, the LTV ratio would be more appropriate than a 120% flat risk weight, and a more meaningful risk indicator than the risk weight of the counterparty.

¹³ Junior liens could be recognised by national supervisors under certain conditions, as described in paragraph 50. They would be treated according to footnote of paragraph 52.

¹⁶ The current treatment cannot be applied uniformly across jurisdictions given differing accounting rules on provisioning. The concept of specific provisions is not used in all accounting regimes, and there are initiatives at an international level that may lead to a change of the relevant accounting concepts.

¹⁷ The IRB approach also contains additional rules to further specify this assessment and rules for the treatment of overdrafts and re-ageing of loans. In addition, the IRB approach contains a national discretion to extend the 90 days threshold to up to 180 days or retail and PSE obligations.

²² See the Committee’s consultative document Capital floors: the design of a framework based on standardised approaches, December 2014, www.bis.org/bcbs/publ/d306.pdf.

²³ Where ratings are referenced, the notations follow the methodology used by one institution, Standard & Poor’s. The use of Standard & Poor’s credit ratings is an example only; those of some other external credit assessment institutions could equally well be used. The ratings used throughout this document, therefore, do not express any preferences or determinations by the Committee on external assessment institutions.

²⁴ Revised standards are available at www.bis.org/bcbs/publ/d303.pdf.

²⁵ The counterparty credit risk is defined as the risk that the counterparty to a transaction could default before the final settlement of the transaction’s cash flows. An economic loss would occur if the transactions or portfolio of transactions with the counterparty has a positive economic value at the time of default. Unlike a firm’s exposure to credit risk through a loan, where the exposure to credit risk is unilateral and only the lending bank faces the risk of loss, the counterparty credit risk creates a bilateral risk of loss: the market value of the transaction can be positive or negative to either counterparty to the transaction. The market value is uncertain and can vary over time with the movement of underlying market factors.

²⁶ Revised standards are available at www.bis.org/publ/bcbs279.pdf.

²⁷ Final standards on capital requirements for banks’ equity investments in funds are available at www.bis.org/publ/bcbs266.pdf; and for capital requirements for bank exposures to central counterparties are available at www.bis.org/publ/bcbs282.pdf.

⁴¹ Likewise, this would apply to junior liens held by the same bank that holds the senior lien in case there is an intermediate lien from another bank (ie the senior and junior liens held by the bank are not in sequential ranking order).

⁴² Metrics and levels for measuring the ability to repay should mirror the FSB Principles for sound residential mortgage underwriting (available at www.financialstabilityboard.org/wp-content/uploads/r_120418.pdf?page_moved=1).

⁴³ If the value has been adjusted downwards, a subsequent upwards adjustment can be made but not to a higher value than the value at origination.

⁴⁴ If a bank grants different loans secured by the same property and they are sequential in ranking order (ie there is no intermediate lien from another bank), the different loans should be considered as a single exposure for risk-weighting purposes, and the amount of the loans should be added to calculate the LTV ratio.

⁴⁵ In jurisdictions where junior liens held by a different bank than that holding the senior lien are recognised (in accordance with paragraph [50] or where footnote [41] applies), the loan amount of the junior liens must include all other loans secured with liens of equal or higher ranking than the bank’s lien securing the loan. If there is insufficient information for ascertaining the ranking of the other liens, the bank should assume that these liens rank pari passu with the junior lien held by the bank. The bank will first determine the “base” risk weight based on tables [9], [10], [11] or [12], as applicable and adjust the “base” risk weight by a multiplier of 1.25, for application to the loan amount of the junior lien.

⁴⁶ The valuation must be done independently from the bank’s mortgage acquisition, loan processing and loan decision process.

⁴⁷ In the case where the mortgage loan is financing the purchase of the property, the value of the property for LTV purposes will not be higher than the effective purchase price.

⁴⁸ For residential real estate exposures to individuals with an LTV ratio higher than 100% the risk weight applied will be 75%. For residential real estate exposures to SMEs (as defined in paragraph [45]) with an LTV ratio higher than 100% the risk weight applied will be 85%.

⁴⁹ Exposures secured by properties where the borrower lives in one unit and rents other unit(s) within the same property will be automatically excluded from this penalised treatment as long as the number of units is not higher than 4.

⁵⁰ Also excluded from this treatment are loans to associations or cooperatives of individuals that are regulated under national law and exist with the only purpose of granting its members the use of a first residence in the property securing the loan.

[Bland Unsight]

Good shout, Neverwhere.

In no particular order, 'this is where we left the story' just before Christmas, with a Mortgage Strategy piece, Regulator reassures challenger banks over Basel buy-to-let capital hikes, (16/12/2015) being fairly typical of how the matter was being reported;

But the letter, sent to many banking institutions, said: “…we do not expect forthcoming adjustments to risk-weighted assets at Basel to add to system-wide capital requirements.”

If approved, buy-to-let lenders, specifically smaller banks and building societies, will be forced to hold more capital in reserve for mortgages advanced to landlords which could act as further restrictive measure on the buy-to-let market.

Source: Mortgage Strategy (link above)

The other key document for me to give context on why this may turn out to be a very big deal is the Council of Mortgage Lenders response to the first round of the BCBS consultation (issued 27 March 2015). From that source:

If the proposed changes did occur, we estimate that a number of lenders would withdraw from the BTL market and interest rates on BTL mortgages would have to rise.

[Neverwhere]

Worth emphasising this quote from Bailey in the Financial Times article you mention above to provide some further context to those reassurances, I think:

“The risk weights could be an issue here — if the reason that’s happening [concentrations of lending or lenders at the racier end of the market] is because the small banks are effectively locked out of the prime market due to the effect of risk weights . . . then they will tend to concentrate on the other end.”

Might the challenger banks intend to have the PRA lobby on behalf of BTL, only to have them push for substantially lower risk weights for owner occupier mortgages instead?

[Bland Unsight]

BCBS risk-weights getting a bit more mainstream.

We are all aware of the headwinds in the market in the form of: the Basel Committee on Banking Supervision consultation paper on the standardised approach for credit risk; changes to taxation for landlords; and the Financial Policy Committee’s powers of direction. Allow me to tackle them one by one.

Lender capital

The BCBS consultation paper potentially increases the amount of capital some lenders are required to hold for buy-to-let loans, therefore making them less profitable for the lender and less attractive as an asset class, despite the sector’s outstanding performance during the financial crisis. This could force prices up for consumers or see some lenders move away from buy-to-let.

The likelihood of this proposal coming in as it stands, however, is in question. It will need a lot of consultation before being finalised. In any event, it will not come into force until 2019 at the earliest and most likely only in stages over several years. Some lenders may consider moving to the internal ratings-based approach, which will mitigate the risks entirely.

Source: Alan Cleary: Headwinds, not death, for buy-to-let, Mortgage Strategy, 10/02/2016

[spyguy]

'In any event, it will not come into force until 2019 at the earliest and most likely only in stages over several years.'

Well, he's wrong on that.

It comes in force in 2019.

Banks will have to move to comply a couple of years before i.e. now-ish.

Ah, just checked - a real towering intellect of banking.

A quick google of 'Precise Mortgages' shows someone hovering around the loan shark level, operating in the adverse credit mortgage market.

What could go wrong?

http://www.ftadviser.com/2016/01/15/ifa-industry/companies-and-people/precise-mortgages-parent-in-sale-talks-dNiAfspnHH5coNZKlUhRLK/article.html

'Charter Court Financial Services - including Charter Savings Bank, Precise Mortgages and Exact Mortgage Experts - is sounding out the market for a new backer, FTAdviser understands.'

[BorrowToLeech]

...despite the sectors outstanding performance during the financial crisis...

What he really means of course is outstanding performance during the bailouts. The financial crisis saw real estate collapse worldwide.

This is exactly the moral hazard the bailouts made inevitable. He's calling for banks to treat real estate as a less risky investment precisely because it was back-stopped by the state the last time.

Edited February 10, 2016 by BuyToLeech

[Bland Unsight]

A quick google of 'Precise Mortgages' shows someone hovering around the loan shark level, operating in the adverse credit mortgage market.

What could go wrong?

Exactly. If you're in the BTL mortgage game and HPC has never heard of you, you're not really in the BTL mortgage game.

Appears to be a rounding error in the accounts of some US behemoth.

Seems they missed the CML memo on Basel 3, "I mentioned it once, but I think I got away with it..."

[Neverwhere]

The Silence of the Landlords .

I love it!

[Neverwhere]

Basel III - The Revenge! - coming to Estate Agents nationwide very soon.

Basel III - Return of the Rate High

[Democorruptcy]

What he really means of course is outstanding performance during the bailouts. The financial crisis saw real estate collapse worldwide.

This is exactly the moral hazard the bailouts made inevitable. He's calling for banks to treat real estate as a less risky investment precisely because it was back-stopped by the state the last time.

He could be calling for it because we know it's partly back stopped by the state again - Help to Buy Bail Banks.

[Bland Unsight]

The Silence of the Landlords .

And according to Mortgage Strategy, The Silence of the Landlords' Lenders also continues

A number of lenders have tightened affordability standards on buy-to-let lending, with Santander and TSB the latest players to increase the interest rate in their rental assessment.

Some lenders have cited these changes as a reaction to the reduction in mortgage interest relief available to landlords from 2017, combined with a 3% Stamp Duty premium payable on second properties.

However, McCoy said that most lenders are currently hiding from the Basel Committee’s plans and failing to discuss the potential impact on the market.

“Some of the changes to rental calculations could be a reflection of the Stamp Duty and tax relief changes, but at the back of lenders’ minds they might be thinking at least they’ve watered down the shock of further potential changes brought about by the Basel Committee’.

“If these rules come in, what might happen is that the gap between buy-to-let and residential rates will widen because lenders will have to price accordingly for the risk,” McCoy added.

Source: Lenders already tightening BTL criteria to pre-empt Basel – Sesame, Mortgage Strategy, 11 February 2016, (emphasis added).

Edited February 15, 2016 by Idlewild

[Bland Unsight]

Notice the comment from Mark whatshisface at the bottom.

Looking at this individuals Disqus posting he's presenting himself as a surveyor.

This is pretty good stuff...

When I first bought my flat, not only was I surveying in the day, I worked in a pub in the evening, plus I didn't go on holiday for 15 years ! That was the norm, and everyone expected to make sacrifices to own their own property. I have also read the other discussions below. Yes, there is pent up demand, but people in their twenties today, want to live in the "Trendy" areas and are prepared to get on the "Ladder" in what they consider an uncool area.You can still buy flats under £200,000 in greater London, but they will have to live in suburbia. They have to accept that this is the way that it has always been done and then you move up the ladder and eventually into the area you want..Although this changes as you get older But society today, young people expect to go on holiday, go to clubs and have meals out, plus going down the pub, and in a lot of cases want a new car. Whilst I don't really blame them for wanting this, but unfortunately they will have to have a reality check.

Source

Yeah, right. We'll see who gets the reality check.

Edited February 15, 2016 by Idlewild

[The12YearWait]

The kind of young people he talks about do need a reality check ... unfortunately they are out there,in the jacuzzi at my gym (43GBP a month) i heard some 25 year old bloke suggesting it was the norm for his generation to get a new car on lease to 60 year old bloke. Little to55er was one of those people with a London haircut.

My ex partner has only ever known living as an adult in the financial fantasy of the last 16 years due to leaving university in 2001, she is the coffee drinking, lease car driving, spendaholic they talk of ... it is these dumfux as well as parasitic landlords who need a reality check.

[Bland Unsight]

“The proposals are likely to impact the profitability of buy-to-let lending because returns achieved on these portfolios may be insufficient to compensate for the additional capital requirements. Some Fitch-rated lenders might need to adjust their strategies,” Fitch said.

Source: Basel may prompt lenders to rethink buy-to-let strategies – Fitch, Mortgage Strategy, 29 February 2016

[spyguy]

Source: Basel may prompt lenders to rethink buy-to-let strategies – Fitch, Mortgage Strategy, 29 February 2016

Commercial loans - higher IRs.

IO loan ... what in fcksake is a regulated bank doing IO lending for!! Leave it to Dodge Dave and his loan sharks!

[Bland Unsight]

IO loan ... what in fcksake is a regulated bank doing IO lending for!! Leave it to Dodge Dave and his loan sharks!

Hold up the asset values of the assets on which 70% of their loan book is secured? The safety valve that the Bank of England seem to have changed their mind about in mid-2014?

[Bland Unsight]

As referenced in post #5 at the end of last year we had the beginning of the second round of consultation on revisions to the Standardised Approach and at the point the challenger banks who had piled into buy-to-let (e.g. Kent Reliance, Paragon) were looking for reassurance and don't seem to have been offered any that was fit to publish, (so reading between the lines, perhaps they were not offered any).

As mentioned on other threads the Bank of England's Deputy Governor (Financial Stability), Sir John Cunliffe gave evidence to the House of Lords Economic Affairs Committee on Wednesday, (video stream of the session at the link).

One of the Lords on the Committee declared an interest as a board member of a challenger bank (possibly Secure Trust Bank if his register of interests is up to date) and asked a question about Basel 3, (the question is at about 15:01).

Cunliffe made the following points in his answer

• the current Standardised approach (SA) risk-weights are "out of date" and "risk insensitive"
• there is a big difference between the risk-weights that challenger banks using SA risk-weights have to use compared to the risk-weights employed by big lenders using Advanced Internal Ratings Based (IRB) approach risk-weights, (35% vs 20%)
• the assurance given by the Bank of England that they did not expect an overall increase in the level of capital backing the system as a whole still held good
• that assurance did not hold for at the level of an "individual lender" or "sector of the market"
• the Bank did anticipate some changes in "distribution" as a result

Hence the surmise that the BCBS revision of SA risk-weights (and harmonising of Advanced IRB risk-weights and SA risk-weights) will provide commercial incentives for lenders to shed BTL lending and replace it with owner-occupiers still holds up.

The best way to shed lending is to make your offer less competitive in the market, and you do that by raising rates. You can lend to owner-occupiers if you can solve the affordability crisis, and you can do that if house prices fall. Also, once house prices do fall, you can shed more BTL by using margin calls to call in the loans where the LTV has fallen. Hence plenty of potential for commercial incentives pushing BTL lenders to (financially) screw their customers, (i.e. the savvy BTLers who understand property - but not, perhaps, lending).

Edited March 5, 2016 by Idlewild

[Bland Unsight]

Oh just get on with it already !

Amen to that!

[Neverwhere]

Having just posted this on the BTL Finance thread it seems like it's also worth having here for reference:

BCBS Consultative Document, Capital floors: The design of a framework based on standardised approaches

Capital floors and leverage ratios

13. The Committee views the role of a capital floor as complementing the leverage ratio introduced as part of Basel III. Each measure addresses different issues and offsets shortcomings of the other. A risk-weighted capital floor addresses the following:

• RWA inconsistency and dispersion. Excessive variation in RWAs for the same exposures raises level playing field concerns across internationally active banks and detracts from market confidence in the capital framework. Risk-weighted capital floors enforce greater consistency by narrowing the range of outcomes. In contrast, the leverage ratio does not directly address the inconsistent assignment of risk weights.
• Low level of models-based RWAs. Extremely low levels of internally modelled RWAs have been observed for some exposure categories. Even with a leverage ratio in place, there is still the risk that banks could face incentives to grow rapidly in businesses where the calibration of internally modelled capital requirements is low. After the models-based approaches of Basel II were introduced, significant reductions in bank-wide RWAs occurred in a number of jurisdictions. Risk-weighted capital floors are responsive to these issues.
• Horizontal inequity in risk-weighted capital requirements. Capital floors make for a more level playing field between standardised banks and banks using internal models for regulatory capital purposes.

14. The leverage ratio addresses the following issues:

• Use of low RWAs to boost financial leverage. In any risk-weighted capital framework, whether standardised or models-based, some exposures will receive lower risk weights than others. Banks can boost their financial leverage by increasing their exposures to low risk-weighted assets, increasing the fragility of their financing structures and the potential for subsequent problems if risk weights are mis-specified or risks are otherwise not captured. The leverage ratio aims to directly guard against the risk of unsustainable growth of leverage in a way that risk-weighted capital floors do not.
• Unexpectedly large losses in low-RWA portfolios. When unexpectedly large losses materialise in low-RWA portfolios, the leverage ratio is likely to deliver more capital to cushion such losses than a capital floor that would have been applied to a perceived low risk exposure. A risk-weighted capital floor may not be an effective safeguard for banks or portfolios with low average risk weights. In contrast, the leverage ratio is less effective for banks or portfolios with relatively high average risk weights.
• Lack of market confidence in RWAs. During the recent crisis, market participants placed greater importance on banks’ leverage ratios, as RWA ratios were seen to be less transparent, less reliable and less objective.

15. Together, capital floors and the leverage ratio aim to reinforce the risk-weighted capital framework and promote confidence in the regulatory capital framework. Table 1 outlines the complementary roles of a capital floor and a leverage ratio.

[. . .]

26. The Committee is of the view that the standardised approach used by a bank when calculating the capital floor should be the one implemented by the jurisdiction in which it operates and in which it is subject to its regulatory framework. The Committee recognises that this may produce some variability due to national variations in the implementation of the standardised approaches. But the alternative – applying a prescriptive and uniform set of standardised approaches for the floor – may create variations between national implementations of the standardised approaches and the proposed standardised floor.

[Digsby]

Notice the comment from Mark whatshisface at the bottom.

What a bizarre comment. People can't afford to buy, and so what they need is more money - lower prices won't work. A completely inflexible mind at work, there.

[Bland Unsight]

What a bizarre comment. People can't afford to buy, and so what they need is more money - lower prices won't work. A completely inflexible mind at work, there.

If you take the credit and changes in lending practices out of your model for demand, that is where your 'thinking' takes you.

Worth noting in passing that the average BTLer thinks they understand housing demand because they see prices rising, (even though most know full well that rents are not so 'accommodating'). Hence they read rising prices incorrectly and infer masses of demand that is never giving up and renting a box room in a shared house (hence wrong) and they further assume that rents will be able to spike upwards (hence wrong because the demand that does spike is driven by credit, and rents are paid with earnings and LHA not credit).

[Bland Unsight]

The CML have their response to the December 2015 BCBS consultation up on their website. Not the most interesting five pages produced since 2008.

The CML appear to be idiotically missing the point that a natural reading of the conduct of the G10 central bankers is to address concerns about the private banks lending too much money against real estate and hence foisting levels of debt on households which mean that the economies are vulnerable to shocks. The whole line of defence appears to be "but look, these loans haven't blown up". It is almost as if the instigation of worldwide ZIRP, and its impact on the ability of the BTL brigade to service their mortgages, was just a happy part of business as normal.

Good to see that they clocked the 150% RW ADC category, and the fact that this applies to "individuals". If that category is intended to catch interest-only buy-to-let then we could be seeing prime lending to owner-occupiers at RWs of 20%-25% under both SA and IRB and the PropertyLater clowns remortgaging in 2018 at rates which are planned to make money with a risk-weight that is more than seven times higher, and that will be f**king interesting, to say the least, should it come to pass.

Edited March 12, 2016 by Idlewild