OTS commented on the development of, and concurs with, OCCís RIA. Rather than replicate that analysis, OTS drafted an RIA incorporating OCCís analysis by reference and adding appropriate material reflecting the unique aspects of the thrift industry. The full text of OTSís RIA is available at the locations for viewing the OTS docket indicated in the ADDRESSES section above. OTS believes that its analysis meets the requirements of Executive Order 12866. The following discussion supplements OCCís summary of its RIA.
The NPR would apply to approximately eight mandatory and potential opt-in savings associations representing approximately 46 percent of total thrift industry assets. Approximately 70 percent of the total assets in these eight institutions are concentrated in residential mortgage-related assets. By contrast, national banks tend to concentrate their assets in commercial loans and other kinds of non-mortgage loans. Only about 35 percent of national bankís total assets are residential mortgage-related assets. As a result, the costs and benefits of the NPR for OTS-regulated savings associations will differ in important ways from OCC-regulated national banks. These differences are the focus of OTSís analysis.
Benefits. Among the benefits of the NPR, OCC cites: (i) Better allocation of capital and reduced impact of moral hazard through reduction in the scope for regulatory arbitrage; (ii) improved signal quality of capital as an indicator of institution solvency; and (iii) more efficient use of required bank capital. From OTSís perspective, however, the NPR may not provide the degree of benefits anticipated by OCC from these sources.
Because of the low credit risk associated with residential mortgage-related assets, OTS believes that the risk-insensitive leverage ratio, rather than the risk-based capital ratio, may be more binding on its institutions.96 As a result, these institutions may be required to hold more capital than would be required under proposed credit risk-based standards alone. Therefore, the NPR may cause these institutions to incur much the same implementation costs as banks with riskier assets, but with reduced benefits.
Costs. OTS adopts the OCC cost analysis with the following supplemental information on OTSís administrative costs. OTS did not incur a meaningful amount of direct expenditures until 2002 when it transitioned from a monitoring role to active involvement in Basel II. Thereafter, expenditures increased rapidly. The OTS expenditures fall into two broad categories: policymaking expenses incurred in the development of the ANPR, this NPR, and related guidance; and supervision expenses that reflect institution-specific supervisory activities. OTS estimates that it incurred total expenses of $3,780,000 for fiscal years 2002 through 2005, including $2,640,000 in policymaking expenses and $1,140,000 in supervision expenses. OTS anticipates that supervision expenses will continue to grow as a percentage of the total expense as it moves from policy development to implementation and training. To date, Basel II expenditures have not been a large part of overall expenditures.
Competition. OTS agrees with OCCís analysis of competition among providers of financial services. OTS adds, however, that some institutions with low credit risk portfolios face an existing competitive disadvantage because they are bound by a non-risk-based capital requirement Ė the leverage ratio. Thus, the agencies regulate a class of institutions that currently receive fewer capital benefits from risk-based capital rules because they are bound by the risk-insensitive leverage ratio. This anomaly will likely continue under the NPR.
In addition, the results from QIS-3 and QIS-4 suggest that the largest reductions in regulatory credit-risk capital requirements from the application of revised rules would occur in the residential mortgage loan area. Thus, to the extent regulatory credit-risk capital requirements affect pricing of such loans, it is possible that core and opt-in institutions who are not constrained by the leverage ratio may experience an improvement in their competitive standing vis-ŗ-vis non-adopters and vis-ŗ-vis adopters who are bound by the leverage ratio. Two research papers Ė one by Calem and Follain,97 and another by Hancock, Lenhert, Passmore, and Sherlund98 addressed this topic. The Calem and Follain paper argues that Basel II will significantly affect the competitive environment in mortgage lending; Hancock, et al. argue that it will not. Both papers are predicated, however, on the current capital regime for non-adopters. The agencies recently published an ANPR seeking comment on various modifications to the existing risk-based capital rules.99 These changes may reduce the competitive disparities between adopters and non-adopters of Basel II by reducing the competitive advantage of Basel II adopters.
Further, residential mortgages are subject to substantial interest rate risk. The agencies will retain the authority to require additional capital to cover interest rate risk. If regulatory capital requirements affect asset pricing, a substantial regulatory capital interest rate risk component could mitigate any competitive advantages of the proposed rule. Moreover, the capital requirement for interest rate risk would be subject to interpretation by each agency. A consistent evaluation of interest rate risk by the supervisory agencies would present a level playing field among the adopters -- an important consideration given the potential size of the capital requirement.
- The leverage ratio is the ratio of core capital to adjusted total assets. Under prompt corrective action requirements, savings associations must maintain a leverage ratio of at least five percent to be well capitalized and at least four percent to be adequately capitalized. Basel II will primarily affect the calculation of risk-weighted assets, rather than the calculation of total assets and will have only a modest impact on the calculation of core capital. Thus, the proposed Basel II changes should not significantly affect the calculated leverage ratio and a savings association that is currently constrained by the leverage ratio would not significantly benefit from the Basel II changes. Return to text
- Paul S. Calem and James R. Follain, ďAn Examination of How the Proposed Bifurcated Implementation of Basel II in the U.S. May Affect Competition Among Banking Organizations for Residential Mortgages,Ē manuscript, January 14, 2005. Return to text
- Diana Hancock, Andreas Lenhert, Wayne Passmore, and Shane M Sherlund, ďAn Analysis of the Competitive Impacts of Basel II Capital Standards on U.S. Mortgage Rates and Mortgage Securitization, March 7, 2005, Board of Governors of the Federal Reserve System, working paper. Return to text
- 70 FR 61068 (Oct. 20, 2005). Return to text