EBA欧洲银行-Slides-Session-2-Nicola-Gabarino_40页_1mb

Summary of "Specialisation in mortgage risk under Basel II"

Core Content

This paper examines the impact of Basel II regulatory frameworks on the specialization of UK banks in mortgage risk, focusing on how different methodologies for calculating risk weights influence market outcomes. The study uses micro-data on 7 million UK mortgages from 2005 to 2015 to analyze the effects of Basel II on interest rates and portfolio shares.

Main Viewpoints

• Residential mortgage market as a financial crisis epicenter: The residential mortgage market is highlighted as a key factor in the financial crisis, with a significant share of total bank lending.
• Methodology-driven heterogeneity in capital requirements: The Basel II framework introduced different methodologies (Internal Rating-Based (IRB) and Standardised Approach (SA)) for calculating risk weights, leading to varying capital requirements across institutions.
• Specialization and risk distribution: The paper argues that the differences in methodologies can lead to specialization, with implications for how risk is distributed across the market.
• Identification challenge: The study addresses the challenge of isolating the effect of regulatory methodologies on market outcomes by using quasi-experimental variation from the switch to Basel II and new LTV-level risk weight data.

Key Information

Methodology

• Triple difference model (2005-15): This model is used to isolate the effect of Basel II on interest rates and portfolio shares, considering the interaction between Basel II adoption, IRB status, and LTV levels.
• Risk weights 'pass-through' model (2009-15): This model assesses how changes in risk weights affect interest rates, incorporating capital requirements and fixed effects.

Hypotheses

• Interest rates: The hypothesis is that the differential impact of Basel II on IRB firms at low LTV leads to a decrease in interest rates.
• Portfolio shares: The hypothesis is that the differential impact leads to an increase in portfolio shares for low LTV mortgages.

Results

• Triple difference model:
  • Interest rates: IRB firms saw an additional 32 basis points (bp) price advantage at low LTV compared to high LTV.
  • Portfolio shares: IRB firms increased their portfolio share of low LTV mortgages by 12 percentage points (pp).
• Risk weights model:
  • A 1 percentage point (pp) increase in risk weight leads to a 1 bp increase in interest rates.
  • At low LTV (≤50%), a 30 pp increase in risk weight results in a 30 bp increase in interest rates.
  • The pass-through effect is more pronounced for lenders with low capital buffers.

Policy Implications

• Systemic importance: Basel II led to smaller firms specializing in high LTV mortgages, which may reduce systemic importance.
• Risk management: However, this specialization may also result in less sophisticated risk management practices.
• Options for reform: The paper suggests two options for reforming the Basel II framework:
  • More risk-sensitive SA: To better align with IRB methodologies.
  • Floors on IRB: To prevent excessive risk-taking by IRB firms.

Additional Insights

• Alternative channels: The study also explores other channels, such as exposure to the crisis and funding shocks, which may influence interest rates.
• Data sources: The research uses a product sales database with information on rates, product characteristics, property and loan values, and borrower characteristics.
• Survey data: CMA/PRA survey data is used to understand risk weights by loan-to-value (LTV) bands, with 17 'solo' entities using IRB from 2008 to 2015.

Conclusion

The paper demonstrates that the Basel II framework's methodology-driven approach to risk weights significantly affects market specialization and outcomes. The findings suggest that the switch to Basel II has led to a more risk-sensitive market, with implications for both systemic importance and risk management practices. The results highlight the need for further reforms to ensure a balanced and effective regulatory framework.