In the latest of a series of articles, experts from Titlesolv, a leading provider of title insurance and indemnity solutions, explore one of the key elements of risk: Basel III.
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div>In the latest of a series of articles, experts from Titlesolv, a leading provider of title insurance and indemnity solutions, explore one of the key elements of risk: Basel III.
With the implementation of the Mortgage Market Review Rules on 26th April 2014 now behind lenders, greater focus is anticipated on the implementation of the Capital Requirements Directive IV which is intended to give effect to the Basel III in EU Member States.
According to the Bank for International Settlements the Basel III reforms intend “to strengthen global capital and liquidity rules with the goal of promoting a more resilient banking sector. The objective of the reforms is to improve the banking sector’s ability to absorb shocks arising from financial and economic stress, whatever the source, thus reducing the risk of spill over from the financial sector to the real economy.”
As well conceived and as necessary as these intentions are, they introduce unique challenges in the mortgage lending sphere which lenders with a strong portfolio weighting in this sector must address.
Pillar I of Basel III introduces new rules relating to Capital Adequacy Ratios, Leverage Ratios, Liquidity Coverage Ratios and Net Stable Funding Ratios. Of these the alterations, Tier one Capital Adequacy Ratios and Liquidity Ratios present the greatest challenges to mortgage lenders.
In the case of the former, there are higher capital adequacy requirements to be held over property as an asset class, with residential mortgages carrying a risk weighting of 35 per cent and speculative property financing carrying a recommended risk weighting of 150 per cent.
This is due to the alterations in the definitions of Risk Weighted Assets and Regulatory Capital which strip out some hybrid financial instruments, intangibles and deferred tax assets and mortgage servicing rights from the calculation of capital based on tier one capital ratio and common equity ratio.
Moreover, under Pillar I, for all risk exposures being trading and banking book exposures, adequate capital must be held against operational risks. These include risks relating to fraud and legal documentation. In the case of Liquidity Ratios, the Liquidity Coverage Ratio prescribes that high quality highly liquid assets available must exceed net cash outflows for the next 30 days.
This could potentially signify a lower future weighting on property assets in a bank’s portfolio. The Net Stable Funding Ratio prescribes that long term financial resources must exceed long term commitments, and in this context, a minimum ratio of 65 per cent is currently recommended for residential mortgages with residual maturity beyond one year.
The foregoing changes collectively suggest that mortgage lending institutions must review and revise their risk management practices to ensure that they maintain their return on investment.
The appetite for mortgage lending is threatened by Basel III due to increased capital adequacy requirements and increased diligence required for compliance with operational risk management criteria.
The standard response by mortgage lenders would be to pass on the increased costs of capital and increased operational costs resulting from Basel III to the borrower. However, this may prove to be unpopular given that the intention of Basel III is to redress the perceived exposures to systemic failures which were precipitated during the financial crisis and for which the banks were solely held to be responsible.
Title Insurance can be used to transfer risk from a lender’s balance sheet to that of an insurer and therefore free up capital which would otherwise be committed to meeting capital adequacy requirements.
The product which has traditionally been employed as a mechanism for reducing risk weightings on mortgage books and for delivering significant title and legal documentation diligence savings, may prove to be an invaluable vehicle for assisting lenders in their navigation of the Basel III implementation trajectory.
Attributed to Christopher Taylor, Chief Executive Officer, Titlesolv
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