How much capital do mortgage lending institutions have to hold compared with other types of financial institution?
The minimum level of capital required to be held by financial institutions will depend on the risk profile of their assets (encapsulated in the risk weighting), their operational risk and any requirement under Pillar 2 to allow for risk factors not captured in Pillar 1 (such as risk caused by interest rate mismatches between assets and liabilities). Under Basel I mortgages carried a 50% risk weight, against 100% for unsecured personal and corporate loans. Basel II takes a more granular approach by stipulating a 35% risk weight for loans with a loan-to-value ratio (LTV) of up to 80%. Loans to highly rated corporate borrowers (ie, relatively safe companies) have seen an even larger reduction in risk weighting but loans to many other corporates continue to be weighted 100%. For banks using the retail IRB approach, the risk weight attached to mortgages depends on the lender’s historical loss experience, subject to downturn assumptions, which drives the internal risk model. This can give ri
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