“EMF-ECBC Warns against Loss of Sensitivity in Internal Rating Based Approaches”
Brussels, 29 June 2016 – For immediate release
The European Mortgage Federation- European Covered Bond Council (EMF-ECBC) believes that capital requirements should be founded on risk-based approaches. The view is presented in the EMF-ECBC’s recent response to the Basel Committee on Banking Supervision’s proposal on Reducing variation in credit risk-weighted assets – constraints on the use of internal model approaches.
The BCBS’s proposal could unduly curb the ability of a bank to gauge its risk and could result in a net negative result for the economy, the EMF-ECBC warns. More specifically, the EMF-ECBC’s response highlights the following key issues in the BCBC’s proposal:
The EMF-ECBC is of the opinion that the currently ongoing revisions to the capital framework (credit risk, market risk and operational risk) should suffice to achieve the Basel Committee’s objectives of reducing excessive variability in risk-weighted assets, and that there should be no need for output floors. Floors are hard to reconcile with a risk-based approach. They might impede risk-sensitivity and even introduce perverse incentives leading to severe misallocation of resources.
Advanced Internal Ratings Based Approach
The EMF-ECBC also believes that a fine-tuning of IRB models can deliver significantly better results than removing the IRB approaches for certain exposures or limiting the use of the Advanced Internal Ratings Based Approach (A-IRB).
The EMF-ECBC believes that A-IRB input floors will not properly address unintended risk weight variation. Nevertheless, they could serve to address potential underestimation of risks, if the input floors are calibrated based on the data availability and the performance of the internal models. Input floors could be activated only in case underestimation of risk is proven. The alignment of definitions and supervisory practices should be prioritised with respect to the introduction of parameter floors.
Additionally, the concept of specialised lending should not include homogenous and common residential or commercial real estate exposures where abundant and reliable data is available, even if they share some of the features with specialised lending. A material increase in the level of capital required for buy-to-let assets will imply to investors that they are more risky than residential owner-occupied mortgage lending. Industry-wide historical arrears rates data in a number of markets show this not to be the reality.
In commenting on the Basel Committee’s proposal, Luca Bertalot, EMF-ECBC Secretary General, stated:
“IRB approaches are vital and effective tools for the determination of banks’ credit risk. Particular caution should be exercised in moving towards output floors and in limiting the use of the approaches for certain types of exposures. This could unduly raise capital requirements for a substantial number of financial institutions, giving rise to proportionality problems and perverse incentives and resulting in damage to the real economy.”
The EMF-ECBC response to the Basel Committee’s proposal on Reducing variation in credit risk-weighted assets is available here.
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Notes to the Editor:
Established in 1967, the European Mortgage Federation (EMF) is the voice of the European mortgage industry, representing the interests of mortgage lenders and covered bond issuers at European level. The EMF provides data and information on European mortgage markets, which were worth over 6.9 trillion EUR at the end of 2014. As of June 2016, the EMF has 19 members across 14 EU Member States as well as a number of observer members.
In 2004 the EMF founded the European Covered Bond Council (ECBC), a platform bringing together covered bond issuers, analysts, investment bankers, rating agencies and a wide range of interested stakeholders. As of June 2016, the ECBC has over 100 members across 26 active covered bond jurisdictions and many different market segments. ECBC members represent over 95% of covered bonds outstanding, which were worth over 2.5 trillion EUR in total at the end of 2014.
In June 2014, the EMF and the ECBC came together to form the Covered Bond & Mortgage Council (CBMC), which replaced the European Mortgage Federation as the legal name under which both entities operate, although in practice, both the EMF and ECBC brands are maintained and used to identify the two areas of focus within the CBMC’s scope.
The Covered Bond Label Foundation (CBLF) was established in 2012 by the EMF-ECBC. The Covered Bond Label website became fully operational on the 1st of January 2013, with the first Labels being effective since then. As of June 2016, the website features 14 National Transparency Templates, 78 issuer profiles and information on 91 labelled cover pools. The Covered Bond Label website currently provides issuance data on over 4,200 covered bonds, amounting to a total face value of over 1.4 trillion EUR, out of which over 2,000 covered bonds already include information on the Liquidity Coverage Requirement (LCR).