Response to consultation on RTS on conditions for capital requirements for mortgage exposures
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In terms of setting the levels, we support the UK Building Societies Association in saying that it is not an exact science and calling for the levels to be set at the upper bound of the indicative range. It suggests the following indicative levels for loss expectations:
• up to 1.5% (corresponding to maximum losses of 2.8%) = 35% risk weight is sufficient
• above 1.5% but not more than 5% = 35% to 100% risk weight
• above 5% = risk weights should be set in the top range of 100% to 150%.
However, we are concerned that the option to increase risk weights might be exercised without due consideration of levels of own funds that will be built up via the CRD IV buffer framework, which are designed to act as a macro-prudential cushion against losses resulting from systemic risks
The indicative benchmarks should be accompanied by a requirement for the competent authorities to provide a detailed disclosure of how these benchmarks translate into loss rates and loss experience e.g. number of losses, loss amounts, vintage and ageing considerations etc. Without such analysis it will be difficult to assess the level of conservatism in the benchmarks.
Yes. The conditions seem sensible. In particular, the condition that the current LGD floor and downturn LGD assumptions referred to in Article 2(f) must be taken into consideration by the NCAs is appropriate.
Do you agree with the adjustments allowed to be made to the average exposure weighted LGD on the basis of the forward-looking immovable property market developments?
Yes. However, the requirement for competent authorities to consider ‘the expected evolution in immovable property market prices and the expected volatility in those prices…’ and ‘the time horizon over which the forward-looking property market developments are expected to materialise…’ should be accompanied by a requirement for the competent authorities to make explanations public as to the reasoning behind their views on the future direction and timing of property price movements. Without such explanations it will be difficult to assess the level of conservatism being applied in the authorities’ thinking and avoid suspicion of over-conservatism and subjectivity.
Do you agree that it is not appropriate to set indicative benchmarks for the setting of higher minimum LGD values because of the specificities of national immovable property markets and because of the relationship of the LGD parameter with the other internal model parameters?
Yes. The differences in national markets, particularly in certain asset types, and the complicated interaction between LGD and other models would make this particularly difficult.
Question 2: Do you agree with the conditions for specification of the loss experience and the loss expectations? Do you agree with the adjustments allowed to be made to the loss experience on the basis of the forward-looking immovable property market developments?
The qualification in article 2(1)(c) – namely, ‘unless other mitigating factors justify deviation from such benchmarks’ – should be elaborated such that it is clear which factors and circumstances would entitle a competent authority to deviate. The same applies to articles 2(3)(a) and 5(5)(c) (we suspect the latter may have been numbered incorrectly). The definition of ‘high’ uncertainty is subjective, with the result that competent authorities may exercise undue conservatism. To guard against this and in the interests of transparency generally, competent authorities’ assessments and determinations should be made public.Question 3: Do you agree with the indicative benchmarks for the assessment of the appropriateness of the risk weights and to guide the setting of higher risk weights across immovable property markets in different member states as specified in Article 4(3) and 4(4)? What levels of these indicative benchmarks would be most appropriate and why?
The ‘first argument’ is logical and in our view the better of the two on the basis that it is consistent with the approach to risk-weighting that is enshrined in the CRR. Also, in relation to the ‘second argument’, the consultation quotes 0.3% as the benchmark for increasing risk weights above 100%. However, impact of losses exceeding 0.3% is an increase in the risk weight for residential mortgage loans from 35% to 100%. This would make the lower bound 0.3% rather than 0.10%.In terms of setting the levels, we support the UK Building Societies Association in saying that it is not an exact science and calling for the levels to be set at the upper bound of the indicative range. It suggests the following indicative levels for loss expectations:
• up to 1.5% (corresponding to maximum losses of 2.8%) = 35% risk weight is sufficient
• above 1.5% but not more than 5% = 35% to 100% risk weight
• above 5% = risk weights should be set in the top range of 100% to 150%.
However, we are concerned that the option to increase risk weights might be exercised without due consideration of levels of own funds that will be built up via the CRD IV buffer framework, which are designed to act as a macro-prudential cushion against losses resulting from systemic risks
The indicative benchmarks should be accompanied by a requirement for the competent authorities to provide a detailed disclosure of how these benchmarks translate into loss rates and loss experience e.g. number of losses, loss amounts, vintage and ageing considerations etc. Without such analysis it will be difficult to assess the level of conservatism in the benchmarks.
Question 4: Do you agree with the specification of the term of “financial stability considerations”?
Yes, broadly. It is entirely sensible to require a competent authority to act to curtail a significant decline in the financial system or a material disruption in the flow of lending to the economy should losses materialise. It should be borne in mind that a competent authority may have already exercised its power to limit lending on financial stability grounds, e.g. loans with a high loan-to-value ratio, when considering an increase in risk weights or LGD. If such a measure has already been deployed, a competent authority should consider the cumulative mitigating impact of its actions before increasing capital requirements. Added to this should be a condition that higher risk weights should not be used in response to firm-specific issues for which Pillar 2 is the right tool.Question 5: Do you agree with the other conditions for the setting of higher risk weights? (Please provide your feedback related to the indicative benchmarks (in Article 3(3) and 3(4)) in your response to Question 3 above.)
Yes, the conditions seem reasonable. However, a competent authority should publish its analysis and impact assessment (carried out pursuant to article 4(1)) in the interests of transparency. Our comments on the indicative benchmarks are above in our answer to Question 3.Question 6: Do you agree with the conditions for specification of the exposure weighted average LGD and the LGD expectation? Do you agree with the adjustments allowed to be made to the average exposure weighted LGD on the basis of the forward-looking immovable property market developments? Do you agree that it is not appropriate to set indicative benchmarks for the setting of higher minimum LGD values because of the specificities of national immovable property markets and because of the relationship of the LGD parameter with the other internal model parameters?
Do you agree with the conditions for specification of the exposure weighted average LGD and the LGD expectation?Yes. The conditions seem sensible. In particular, the condition that the current LGD floor and downturn LGD assumptions referred to in Article 2(f) must be taken into consideration by the NCAs is appropriate.
Do you agree with the adjustments allowed to be made to the average exposure weighted LGD on the basis of the forward-looking immovable property market developments?
Yes. However, the requirement for competent authorities to consider ‘the expected evolution in immovable property market prices and the expected volatility in those prices…’ and ‘the time horizon over which the forward-looking property market developments are expected to materialise…’ should be accompanied by a requirement for the competent authorities to make explanations public as to the reasoning behind their views on the future direction and timing of property price movements. Without such explanations it will be difficult to assess the level of conservatism being applied in the authorities’ thinking and avoid suspicion of over-conservatism and subjectivity.
Do you agree that it is not appropriate to set indicative benchmarks for the setting of higher minimum LGD values because of the specificities of national immovable property markets and because of the relationship of the LGD parameter with the other internal model parameters?
Yes. The differences in national markets, particularly in certain asset types, and the complicated interaction between LGD and other models would make this particularly difficult.