White Papers for Basel II Capital Accord (Basel II)

An analysis of the potential competitive impacts of Basel II capital standards on U.S. mortgage rates and mortgage securitization

Federal Reserve Board

U.S. regulators have proposed that the new Basel II capital standards would be required of only the largest or most internationally active depositories, while other depositories could choose between opting into such standards or remaining under the existing capital standards. We consider potential impacts of this “bifurcated” approach on competition in the market for residential mortgages. Specifically, we analyze whether this approach could translate into: (1) a cost advantage, and correspondingly a pricing and/or profit advantage, in mortgage markets for the depository institutions that adopt the new Basel II standards, and/or (2) provide incentives for these adopters to retain mortgages in their own portfolios.
In the prime mortgage markets, we find that mortgage rates are likely to be largely unaffected by the adoption of a bifurcated Basel II capital standard because such rates would continue to reflect GSE capital requirements. In addition, prime mortgages are priced using uniform pricing methods, which suggests that a pricing advantage would not result from differences in capital requirements across depositories. Without a pricing advantage, an adopter’s market share of prime mortgage funding would be unaffected. As for near-prime and subprime loans, we conclude that capital allocated to back residential mortgages would continue to reflect market-determined capital needs, and therefore, their mortgage rates also would remain unchanged.
Our main conclusions are: (1) it is unlikely that there would be any measurable effect of Basel II implementation on mortgage rates and, consequently, any direct impact on the competition between adopters and nonadopters for originating or holding residential mortgages; (2) the most significant competitive impact might be the pressure on GSEs to lower their guarantee fee to adopters for prime mortgages; and (3) adopters might have increased profits from some mortgages relative to nonadopters because they will capture some of the deadweight losses that occur under the current regulatory capital frameworks imposed on depositories and on securitizers, but nonadopters would likely retain their mortgage market positions.
To the extent that adopters seek a credit agency rating that is better than A-, that mortgage pricing is more risk-sensitive, or that the system of prompt corrective actions impinges on depositories’ decision-making with respect to capital holdings, competitive impacts would be smaller than we predict. Potential income gains could flow in the long-run to adopters or homeowners, but we remain reasonably certain that nonadopters would be largely unaffected by the implementation of Basel II capital standards.
^ The opinions, analysis, and conclusions of this paper are solely the authors’ and do not necessarily reflect those of the Board of Governors of the Federal Reserve System. We thank Tom Boemio and Brad Case for their assistance with understanding Basel I and Basel II capital standards, Gerhard Fries, Arthur Kennickell, and Kevin Moore for their helpful suggestions on using the Survey of Consumer Finances, Cathy Gessert, Jonathan Hershaff, and Laura Kawano for their excellent research assistance, and Glenn Canner, Ed Ettin, Michael Gibson, David Jones, Jonathan Jones, Paul Kupiec, Myron Kwast, David Malmquist, and Steve Oliner for their insightful comments and suggestions.

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