Regulators urged to relax capital rules for mortgages by banks

The groups said the existing framework after the financial crisis was designed to strengthen banks’ resilience. But they argue that the mortgage market has changed significantly since then. Reforms such as the Ability-to-Repay and Qualified Mortgage rules now limit risky features such as negative amortization, option ARMs, interest-only loans, and mortgages without documentation.

Banks’ participation in mortgages fell during that period. Banks accounted for roughly 60% of mortgage production and 95% of MSR ownership in 2008. By 2023, these shares had fallen to approximately 35% and 45% respectively.

The issue received renewed attention this week after Fed Vice Chair Michelle Bowman expected regulators to consider a recalibration of how residential mortgages and MSRs are treated under the capital rules. A broader 2023 Basel III proposal was later abandoned.

The trade groups’ letter was addressed to Bowman, Comptroller of the Currency Jonathan Gould and FDIC Chairman Travis Hill.

Central to the request is how much capital banks must maintain for mortgages. The groups argue that on-balance sheet loan risk weights should better reflect actual credit performance, especially by including loan-to-value ratios and recognizing the additional protection provided by private mortgage insurance and other risk-sharing instruments.

At the same time, they called the current 250% capital requirement on MSRs overly punitive and proposed reducing it to 100% for all banks. They also urged regulators to increase or eliminate existing limits on how much MSRs can count toward core capital, and to exempt smaller banks that opt ​​for the Community Bank Leverage Ratio from these limits.

The letter also addressed warehouse lending: short-term lines of credit that banks provide to independent building societies (IMBs) to finance loans before they are sold. The groups proposed reducing the current 100% capital requirement on warehouse lines to 50%, arguing that banks have control over collateral and can recover money if a counterparty goes bankrupt.

“Adequate capital reduces the likelihood of bank failures that threaten broader financial stability, which can be costly to households, financial institutions and taxpayers,” the groups wrote. “However, excessive capital requirements that are inconsistent with empirically derived risk assessments can negatively impact the cost of and access to credit.”