ABA Banking Journal - October 2008 - (Page 48)
BASEL II IMPACT mercial and industrial and commercial real estate loans—have lower risk-weights under Standardized Basel II. Delinquent assets, short-maturity commitments, and ABCP (asset-backed commercial paper) liquidity facilities are among the few asset classes that require more regulatory capital under Basel II. For example, the 20% risk-weight currently drawn by FHA and VA mortgage loans are not risk-weighted under Standardized. This represents significant capital savings for an asset class championed by recent federal legislation. (See Briefing, p. 7.) Overall, Standardized risk-weights represent a material capital savings over existing rules One particularly important element of Table One is the new risk weight for C&I and CRE exposures smaller than $1 million. Standardized Basel II assigns a 75% Table One Asset classes for which risk-weights change under Standardized Basel II Asset Class Basel I risk-weight Basel II risk-weight risk-weight to assets in the “regulatory retail” category, a group that includes not just traditional consumer loans but any exposure (other than residential mortgage) smaller than $1 million, so long as it is managed within a well-diversified portfolio. One can only speculate on how regulators will ultimately assess portfolio diversification, but we assume here that all C&I and CRE exposures under $1 million in size will qualify for regulatory retail treatment and the lower risk weight. Given that small-ticket C&I/CRE makes up 22% of the median bank’s balance sheet, the ability to demonstrate portfolio diversification is critical. First lien mortgage Junior lien mortgage FHA/VA mortgage and SBA loans Consumer C&I/CRE < $1mm 90+ delinquent/non-accrual assets ABCP liquidity facilities Unused short-term commitments ** credit conversion factor 50% 100% 20% 100% 100% 100% 10% 0% varies by LTV (avg ~ 34%) varies by LTV (avg ~ 90%) 0% 75% 75% 150%* 20% 10%** * delinquent low-LTV mortgages are still risk-weighted at 100% under Basel II Source: Standardized Basel II NPR; Second Pillar Consulting estimates Table Two Standardized first-lien mortgage risk-weights Consolidated LTV net of PMI Proportion of industry loans Standardized risk-weight 95% Weighted-average 54.3% 26.7% 10.9% 3.0% 2.8% 2.2% 100.0% 20% 35% 50% 75% 100% 150% 34% Source: Federal Reserve Board Survey of Consumer Finances, 2004; Second Pillar Consulting estimates Table Three Industry Capital Savings for Standardized Basel II Number of banks (excludes “core” banks that must go Advanced) 75th percentile capital savings (% of existing tier 1 capital) Median capital savings (% of existing tier 1 capital) Proportion of banks with no capital savings Median share buyback facilitated (% of existing shares) Median asset growth facilitated (% of existing asset base) Source: Second Pillar Consulting estimates 7,629 8.6% 4.5% 22.5% 6.3% 4.3% The offset: operational risk This Basel II capital advantage is somewhat offset by the introduction of a capital charge for operational risk that does not exist under Basel I. The operational risk capital charge serves to cover unforeseen loses that might arise due to failed systems and processes, fraud, human error, or natural disaster. Under the Advanced version of Basel II, banks calculate this charge with complex models and varied data sets on operational events and controls. The Standardized version takes a far simpler approach—the operational risk capital charge is a multiple of trailing three-year average gross income (the sum of net interest income and noninterest income). Profitability might seem a perverse proxy for operational risk. Banks with large processing units might have proportionally higher profitability and larger operational exposures, but the link seems tenuous. In fact, one could argue that the internal pressures faced by less profitable banks will increase the likelihood of operational failure. Nonetheless, the proposed Standardized rule is quite clear: more profitable banks must hold more capital. Depending on the institution’s balance sheet, the capital savings of lower asset risk-weights may or may not outweigh the additional operational risk capital levied against profits. To assess the overall impact of Standardized compliance, we built a model that calculates prospective capital requirements for each U.S. bank. We culled most of the necessary bank-specific data from publicly available 2008 first quarter call report, Y-9, and TFR (thrift) filings, though we make assumptions Subscribe at www.ababj.com 48 OCTOBER 2008/ABA BANKING JOURNAL
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