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Risk-based capital requirements for mortgage loans

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  • Paul S. Calem
  • Michael LaCour-Little
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    Abstract

    We develop estimates of risk-based capital requirements for single-family mortgage loans held in portfolio by financial intermediaries. Our method relies on simulation of default and loss probability distributions via simulation of changes in economic variables with conditional default probabilities calibrated to recent actual mortgage loan performance data from the 1990s. Based on simulations with varying input parameters, we find that appropriate capital charges for credit risk vary substantially with loan or borrower characteristics and are generally below the current regulatory standard. These factors may help explain the high degree of securitization, or regulatory capital arbitrage, observed for this asset category.

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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2001-60.

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    Date of creation: 2001
    Date of revision:
    Handle: RePEc:fip:fedgfe:2001-60

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    Related research

    Keywords: Mortgages ; Loans ; Risk;

    This paper has been announced in the following NEP Reports:

    References

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    1. Yongheng Deng & John M. Quigley & Robert Van Order, . "Mortgage Terminations, Heterogeneity and the Exercise of Mortgage Options," Zell/Lurie Center Working Papers 322, Wharton School Samuel Zell and Robert Lurie Real Estate Center, University of Pennsylvania.
    2. Douglas W. Diamond & Raghuram G. Rajan, . "A Theory of Bank Capital," CRSP working papers 363, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
    3. Crouhy, Michel & Galai, Dan & Mark, Robert, 2000. "A comparative analysis of current credit risk models," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 59-117, January.
    4. Berger, Allen N. & Herring, Richard J. & Szego, Giorgio P., 1995. "The role of capital in financial institutions," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 393-430, June.
    5. Alan Greenspan, 1998. "The role of capital in optimal banking supervision and regulation," Economic Policy Review, Federal Reserve Bank of New York, issue Oct, pages 163-168.
    6. Michael B. Gordy, 1998. "A comparative anatomy of credit risk models," Finance and Economics Discussion Series 1998-47, Board of Governors of the Federal Reserve System (U.S.).
    7. Eduardo S. Schwartz & Walter N. Torous, 1993. "Mortgage Prepayment and Default Decisions: A Poisson Regression Approach," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 21(4), pages 431-449.
    8. Campbell, Tim S & Dietrich, J Kimball, 1983. " The Determinants of Default on Insured Conventional Residential Mortgage Loans," Journal of Finance, American Finance Association, vol. 38(5), pages 1569-81, December.
    9. Jones, David, 2000. "Emerging problems with the Basel Capital Accord: Regulatory capital arbitrage and related issues," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 35-58, January.
    10. Kau, James B, et al, 1992. "A Generalized Valuation Model for Fixed-Rate Residential Mortgages," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 24(3), pages 279-99, August.
    11. Michael B. Gordy, 2002. "A risk-factor model foundation for ratings-based bank capital rules," Finance and Economics Discussion Series 2002-55, Board of Governors of the Federal Reserve System (U.S.).
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    Cited by:
    1. Cowan, Adrian M. & Cowan, Charles D., 2004. "Default correlation: An empirical investigation of a subprime lender," Journal of Banking & Finance, Elsevier, vol. 28(4), pages 753-771, April.
    2. Calem, Paul S. & LaCour-Little, Michael, 2004. "Risk-based capital requirements for mortgage loans," Journal of Banking & Finance, Elsevier, vol. 28(3), pages 647-672, March.
    3. Jacobson, Tor & Lindé, Jesper & Roszbach, Kasper, 2004. "Credit Risk versus Capital Requirements under Basel II: Are SME Loans and Retail Credit Really Different?," Working Paper Series 162, Sveriges Riksbank (Central Bank of Sweden).
    4. Perli, Roberto & Nayda, William I., 2004. "Economic and regulatory capital allocation for revolving retail exposures," Journal of Banking & Finance, Elsevier, vol. 28(4), pages 789-809, April.

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