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

See all articles by Julapa Jagtiani

Julapa Jagtiani

Federal Reserve Banks - Federal Reserve Bank of Philadelphia

Christopher Henderson

Federal Reserve Banks - Federal Reserve Bank of Philadelphia

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

Jagtiani, Julapa A. and Henderson, Christopher, Can Banks Circumvent Minimum Capital Requirements? The Case of Mortgage Portfolios Under Basel II (May 19, 2010). FRB of Philadelphia Working Paper No. 10-17, Available at SSRN: https://ssrn.com/abstract=1609904 or http://dx.doi.org/10.2139/ssrn.1609904

Julapa A. Jagtiani (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

Christopher Henderson

Federal Reserve Banks - Federal Reserve Bank of Philadelphia

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
148
Abstract Views
1,366
Rank
356,899
PlumX Metrics