Regulators Plan to Take Mortgage Rules Into Account on Basel III

WASHINGTON — Regulators sought to assure lawmakers and financial institutions on Thursday that they would weigh potential conflicts from a slew of proposed mortgage regulations due out shortly as they finalize Basel III capital and liquidity rules.

"We recognize the close linkage and the potential interactions have to be taken into account," said George French, deputy director of risk management supervision for the Federal Deposit Insurance Corp., at a joint hearing of two House Financial Services subcommittees. "We certainly looked at the proposed 'qualified mortgage' standards as we were developing those mortgage proposals in these rules."

Though the rules are not directly related, they are interconnected. The Basel III proposal issued by regulators in June would assign a higher risk-weighting for mortgages, based partly on the experiences of the financial crisis. That would effectively force banks to raise capital against mortgages they hold. At the same time, however, regulators are working on rules that would require lenders to ensure borrowers have the ability to repay mortgages, including creating a safe-class of loans that will be dubbed "qualified mortgages."

Bankers are concerned that taken together the rules will impair their ability to make mortgages.

"People are very concerned about how these two rules will interact," French said. "Those are very significant observations that we have to look at as we develop how to proceed with these rules."

Making things more complicated are the sheer number of regulators involved. The Federal Reserve Board, FDIC and Office of the Comptroller of the Currency are developing the Basel III rules while the Consumer Financial Protection Bureau is in charge of the qualified mortgage plan. The banking regulators must also still finalize a rule that requires lenders to retain 5% of a mortgage unless it meets separate criteria of a "qualified residential mortgage."

Bank regulators stressed to lawmakers at the hearing that they are considering a range of issues, including how provisions could impact residential mortgages.

"We are sensitive to the comments of community banks," said Michael Gibson, director of the division of banking supervision and regulation for the Fed. "There are many aspects of the proposal where we've learned a lot from the comments about the details of where there might be some impacts that we need to look at. But stronger quality and quantity of capital for all banks is an important reform."

Lawmakers on both sides of the aisle acknowledged the necessity for improved capital requirements at banks of all sizes, but expressed concern on differentiating how to apply such complex rules to smaller-sized and regional banks.

"A case can be made that we need higher-quality capital," said Rep. Jeb Hensarling, R-Texas, the incoming chairman of the House Financial Services Committee. "It is a very poor case for more complex capital standards that do not recognize the difference between large money center banks and our community financial institutions."

It was the second hearing this month on the U.S.' adoption of Basel III, which is designed to improve the quality and quantity of capital that banks of all sizes must hold to prevent a repeat of the financial crisis. The U.S., along with other member nations, had pledged to begin implementing Basel III by Jan. 1, but opted earlier this month to indefinitely delay the rules given the more than 2,500 comments the agencies received.

Topping the list of concerns held by policymakers are proposed changes to how banks will have to measure risk on certain assets in order to be more risk-sensitive. Under the proposal, U.S. government securities, for example, would retain a risk weighting of 0%, while residential mortgage exposure, which is currently assigned a 50% risk weight for high-quality mortgages, could be assigned a risk weight of up to 200% based on the mortgages' loan-to-value ratio and other criteria.

Stakeholders argue such changes could have a devastating impact on the kinds of products that community banks will be able to continue to offer to customers.

Greg Gonzales, commissioner of the Tennessee Department of Financial Institutions, testified that 5- and 7-year adjustable rate mortgages, for example, are "bread and butter products for community banks," which they "have been making for a long time, and they've done it well for many years."

"I've had some of these institutions tell me … 'What am I going to tell some of my customers when I have to pull back in this area because the risk weighting is basically telling community banks, we don't want you in this area?'" said Gonzales, who testified on behalf of the Conference of State Bank Supervisors.

On several occasions, lawmakers urged regulators to use "great caution" on how they proceed with the rulemaking process, especially given the fact that a definition of a qualified mortgage would not be finalized until January.

"One of the things we've all heard about from our bankers, large and small, is if the QM is written too narrowly or not to the satisfaction of compliance officers and regulators, the caution that will be exercised by financial institutions could really hurt the housing market and hurt those who may be on the bubble a little bit in terms of whether they can secure a mortgage," said Rep. Shelley Moore Capito, R-W.Va., chairwoman of the Financial Institutions and Consumer Credit Subcommittee. "This is an exceedingly important topic."

Lawmakers are concerned that regulators could inadvertently assign the wrong cost of risk of mortgages and home equity lines of credit under the Basel III rules, causing the cost of credit to go up and limit credit availability.

"We are hearing that as proposed the risk weights may not accurately reflect true riskiness of lending exposures in particular mortgages," said Rep. Scott Garrett, R-N.J., chairman of the Capital Markets and Government-Sponsored Enterprise Subcommittee. "If that's the case, then failure to accurately calibrate the capital with risk results in the banks reducing the overall lending going forward."

Regulators stressed they would take a second look at the issue based on the numerous comments they received before making a decision on how to proceed.

As in the Senate Banking Committee hearing two weeks ago, regulators also stressed a willingness to make adjustments to their proposal to respond to comments by banks, especially with regards to changes to risk weights on residential mortgages.

"We do intend to make changes to the rule in response to comments and this is certainly one of the areas of that is of great importance," said French.

Regulators have not set a new deadline on when they expect to adopt the rules, but have provided assurances that they will provide a lengthy transition period.