Basel 3 Standardised floor and default observations on residential mortgages in the EU
On 3 January 2017 the Basel Committee of Banking Supervision (BCBS) announced that it needs more work before the Committee can reach agreement on the package of proposals which would lead to Basel IV. One of the proposals was to introduce a Standardised floor. With the Standardised floor, the Committee wants to limit unexplained differences in the Risk Weighted Average (RWA) calculations of individual banks. Banks who have applied for the Internal Ratings Based Approach (IRBA) can calculate their own Probability of Default (PD), Loss Given Default (LGD) and Exposure at Default (EAD) estimates which are the inputs for the Basel RWA calculations. With the introduction of Standardised floor, the banks need to use the higher of RWA (determined through a new developed Standardised approach multiplied by a still-to-be determined percentage) and the RWA (based on their IRBA calculation).
Regarding the Standardised Approach for residential mortgages, the Committee have proposed to make the RWA calculation dependent on the value of the property in relation to the size of the loan, so-called loan-to-value (LtV). The higher the ratio – house value divided by loan value – the higher the RWA, thus the more the bank needs to put aside for regulatory capital.
OSIS have analysed the default performance of c. 10 million European residential mortgage loans published by the European DataWarehouse and compared the observations per LtV bucket between the various countries.
The observations show large discrepancies between two groups of countries. In one group we have Italy, Spain, Portugal and Ireland and in the other Sweden, Germany, The Netherlands, Belgium, France and the UK. On average the default rates in the first group are three times higher than the second group. This is interesting information for when the Committee wants to give proposals further thought.
In the OSIS tool below, the user can select countries and different LtV buckets to make any comparison – the defaults rates are shown on a quarterly basis. The source data is derived from loan level data of securitization transactions. In these transactions, banks have the option to repurchase loans from the underlying pool of assets which could hide observed defaults. Not all banks choose to repurchase and therefore the user can choose to filter out transactions where any repurchase have taken place.