The Central Bank of Ireland published a Note that examines the key contributing factors to risk-weight density on mortgage loans in the country.
The Central Bank is conducting a review of its macro-prudential framework for bank capital, including the interactions of macro-prudential buffers with other elements of the capital regime, such as minimum requirements and risk-weighted assets. Risk-weights are calculated under global rules established to ensure that banks with riskier assets have more capital to be able to absorb higher potential losses on these assets. This Note examines residential mortgages covered by Internal Ratings-based (IRB) models and highlights the need for careful comparison with other European countries, as average Irish retail mortgage risk-weights are around twice the reported European averages. The Note examined two key parameters in risk-weight modeling—probability of default (PD) and loss-given default (LGD)—both of which were found to be higher than European averages. The higher risk-weights in Ireland reflect a number of factors, including:
- Higher default risk of the stock of Irish mortgage exposures, driven by loans issued before the financial crisis that remain on balance sheets of banks
- Length of time it has taken for banks to resolve distressed loans arising from the financial crisis, including through repossession
- Implications of the internationally agreed regulatory framework requirement for loss estimates to reflect an economic downturn, which is particularly severe given the loss experience from the financial crisis in Ireland.
The Note concluded that the differential in risk-weighting for Irish mortgage loans when compared with the European loans will narrow over time, partly because loans originating before the financial crisis will gradually be replaced by newer loans issued under stronger lending standards. Also, it is expected that introduction of Basel III reforms will lead to higher risk-weights for banks in other countries for whom modeled risk-weights are considered too low.
Keywords: Europe, Ireland, Banking, Risk-Weighted Assets, Lending, Mortgage Lending, Loan Origination, Basel, Regulatory Capital, Macro-Prudential Policy, Central Bank of Ireland
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