According to her, regulators should investigate whether prudential standards have contributed to the contraction and whether the standards reflect the actual risks.
“In part, this is due to an overcalibration of capital treatment for these activities, resulting in requirements that are disproportionate to the risk and making mortgage activities too expensive for banks to participate in,” Bowman said. “I see a path forward that includes both renewed bank participation in the mortgage market and a safe and sound banking system.”
Capital rules, market consequences
Bowman’s speech focused heavily on the 2013 changes to the capital treatment of mortgage servicing rights (MSRs).
These revisions increased risk weights for many institutions and imposed a deduction threshold that imposed additional penalties once MSRs exceeded a certain percentage of capital. She acknowledged the original rationale behind the rules.
“At the time, regulators tightened the capital treatment of MSRs for valid reasons,” Bowman said. “MSR valuations can be challenging to calculate because they are not based on transaction prices in liquid markets. Instead, they are derived from models that rely on subjective assumptions about mortgage prepayment and the probability of default.
“This makes valuations volatile, especially during interest rate movements, and we have noticed that some MSR markets can experience stress or freeze during periods of high defaults.”
Still, she warned that the pendulum may have swung too far.
“These are legitimate concerns, and I want to be clear that holding MSRs is not the right choice for every bank,” Bowman added. “Successfully managing volatility in MSR valuations as interest rates change requires advanced hedging capabilities or an effective borrower retention strategy during refinancing waves.”
Over time, Bowman says, regulators have gained a better understanding of how capital treatment influences pricing and participation decisions.
Because banks securitize a large portion of loans to low- and middle-income borrowers, she suggested the MSR framework could impact the availability and affordability of mortgages.
She also expressed concern that uniform risk weights for mortgages – regardless of Loan-to-Value (LTV) ratios – fail to capture differences in the probability of default and severity of losses.
“In light of these considerations, I am open to revisiting whether the capital treatment of MSRs and mortgages is appropriately tailored and proportionate to the risks,” Bowman said.
Basel is changing on the horizon
Bowman outlined two upcoming proposals within the Basel capital framework.
The first would eliminate the requirement to deduct mortgage investment assets from regulatory capital while maintaining a 250% risk weight, with regulators seeking comment on whether that level is appropriate.
The second would lead to greater risk sensitivity for residential mortgage exposures – potentially linking capital requirements to LTV ratios rather than applying a uniform standard.
“These potential changes would address legitimate concerns about the structure of the mortgage market, while maintaining appropriate prudential safeguards,” Bowman said. “I look forward to receiving feedback from industry and other stakeholders as we consider these changes.”
She concluded the speech by emphasizing that stronger banking participation and a secure system are not mutually exclusive.
“By creating a resilient mortgage market with robust participation from all types of financial institutions, we can deliver affordable credit and high-quality services to borrowers regardless of economic conditions,” Bowman said. “Strengthening banks’ participation in these activities does not threaten the safety and soundness of the banking system. These objectives are consistent.”
MBA endorses proposals
In a statement released after the speech, the Association of Mortgage Bankers (MBA) endorsed Bowman’s approach.
President and CEO Bob Broeksmit said the MBA has long sought changes to better align capital standards with the actual risk profiles of mortgage loans and services.
“We welcome Vice Chairman Bowman’s comments today, which outline a path to reinvigorating bank participation in mortgage lending,” Broeksmit said. “Her recognition that aspects of the current capital framework have discouraged banks from competing in mortgage production and servicing is an important step forward.
“A better calibrated approach, especially with regard to mortgage servicing rights and mortgage lending, will strengthen banks’ ability to serve creditworthy borrowers while maintaining safety and soundness.”
Broeksmit added that MBA plans to actively participate once the proposals are released.
“MBA is eager to review the upcoming proposal and engage through the formal comment process, and we stand ready to work with the Federal Reserve and other regulators to promote a balanced framework that supports sustainable mortgage production and warehouse lending, robust servicing capacity, and continued access to affordable housing financing,” he said.
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