Recent events in the credit markets will have put paid to any lingering doubts over the need for the forthcoming Basel II capital adequacy requirements and the necessity for firms to have tight financial controls in place.
In summing up what the regulators will be looking for in regards to Basel II, the Council of Mortgage Lenders states: “Basel I required lenders to calculate a minimum level of capital based on a single risk weight for each of a limited number of asset classes, for example, mortgages, consumer lending, corporate loans, exposures to sovereigns.
"Basel II goes well beyond this, allowing some lenders to use their own risk measurement models to calculate required regulatory capital whilst seeking to ensure that lenders establish a culture with risk management at the heart of the organisation up to the highest managerial level.”
The bottom line is that under the new rules, mortgage lenders will have to have a better understanding than ever before of the risks carried by their various lending portfolios and how they can effectively manage those risks.
Key areas
In a market which has already embraced statutory regulation and is increasingly working towards a more professional footing, it is only right that the financial checks and controls behind lending activity should also evolve.
One of the key areas Basel II has impacted is firm’s capital adequacy requirements but the area that is perhaps of more interest to the intermediary is the wider effect Basel II will have on businesses as a whole. The entire psyche of many firms is likely to change and for those truly embracing Basel II there will be a different approach taken from product design through to the handling of repossessions.
Many have questioned, particularly in light of the tightened credit environment, whether the availability of products at the extremity of the mortgage market will become a real problem. Basel II should not necessarily stop lenders from creating books of business with the same risk profile as they have done in the past; however it will make them much more aware of the liabilities involved and ensure they are best positioned to guard against them. As such it is possible that some lenders may not wish to lend as much in some areas of the market as they have done in the past.
Is it worth it?
There is no doubt that getting to grips with Basel II has been an expensive and time-consuming business for everyone concerned, but we have to ask ourselves if this effort has been worth it and whether the changes will deliver genuine benefits to the market.
Looking at things from that basis, is it realistic for any mortgage lender not to accept that having a detailed understanding of the risks and liabilities carried by its products, puts it in a better position to operate on a sustainable and successful footing? If, through a better understanding of their business, some mortgage lenders choose to alter the make up of the portfolios they create, then surely this is also a step in the right direction? Offering products which stand up in both favorable and challenging market conditions will create a more sustainable business model which in turn will deliver improved lender stability.
Over the last decade particularly, the UK mortgage market has shown itself to be an incredibly innovative, fleet-footed and sophisticated environment in which to do business. There have been a raft of new products brought to market and many of these have carried new concepts in lending, rather than just tinkering with what was already available. Of course, the lenders bringing these new products to market will have researched their likely performance, but it is unlikely they will have gone into as much detail as will be required come next year.
Not a barrier to innovation
Basel II shouldn’t be viewed as a barrier to product innovation. On the contrary, the rules will inform product development and, as lenders develop more rigorous and robust process for portfolio risk management, it will give them more confidence in their product mix. This in turn will provide the intermediary with an added level of certainty that once products come to market, they are sufficiently resourced to stay there for the immediate future.
Basel II is not the answer to all of the problems in the market and it will not prevent potential issues ever arising in the future over liquidity or poorly performing books of business.
Instead it will make firms reserve appropriately against their liabilities, assess their operations with a view to potential risks and give them a better understanding of how to steady themselves when waters get choppy. This is a very welcome development.
However firms should also realise that 1 January represents the beginning and not the end of the journey. For mortgage lenders, assessing and redefining their financial position and capital position is something that will be an ongoing duty and for those who get it right, there will be significant commercial advantages to be had.
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