Can Banks Circumvent Minimum Capital Requirements? The Case of Mortgage Portfolios Under Basel II
39 Pages Posted: 18 May 2010 Last revised: 21 May 2010
Date Written: May 19, 2010
Abstract
The recent mortgage crisis has resulted in several bank failures as the number of mortgage defaults increased. The current Basel I capital framework does not require banks to hold sufficient amounts of capital to support their mortgage lending activities. The new Basel II capital rules are intended to correct this problem. However, Basel II models could become too complex and too costly to implement, often resulting in a trade-off between complexity and model accuracy. In addition, the variation of the model, particularly how mortgage portfolios are segmented, could have a significant impact on the default and loss estimated and, thus, could affect the amount of capital that banks are required to hold. This paper finds that the calculated Basel II capital varies considerably across the default prediction model and segmentation schemes, thus providing banks with an incentive to choose an approach that results in the least required capital for them. We also find that a more granular segmentation model produces smaller required capital, regardless of the economic environment. In addition, while borrowers’ credit risk factors are consistently superior, economic factors have also played a role in mortgage default during the financial crisis.
Keywords: Basel II, Bank Capital, Bank Regulation, Mortgage Default, Retail Credit Risk
JEL Classification: G28, G21, G38, L51
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Securitization and Distressed Loan Renegotiation: Evidence from the Subprime Mortgage Crisis
By Tomasz Piskorski, Amit Seru, ...
-
Why Don't Lenders Renegotiate More Home Mortgages? Redefaults, Self-Cures and Securitization
By Manuel Adelino, Kristopher Gerardi, ...
-
Recourse and Residential Mortgage Default: Evidence from U.S. States
By Andra C. Ghent and Marianna Kudlyak
-
Why Don't Lenders Renegotiate More Home Mortgages? Redefaults, Self-Cures, and Securitization
By Manuel Adelino, Kristopher Gerardi, ...
-
Moral and Social Constraints to Strategic Default on Mortgages
By Luigi Guiso, Paola Sapienza, ...
-
Moral and Social Constraints to Strategic Default on Mortgages
By Luigi Guiso, Paola Sapienza, ...
-
Reducing Foreclosures: No Easy Answers
By Christopher L. Foote, Kristopher Gerardi, ...
-
Reducing Foreclosures: No Easy Answers
By Christopher L. Foote, Kristopher Gerardi, ...
-
An Empirical Model of Subprime Mortgage Default from 2000 to 2007
By Patrick Bajari, Chenghuan Sean Chu, ...