XXV Edition

1-2 December 2016"

Specialising in Risky Mortgages: Unintended Consequences of Basel II

Benetton Matteo, London School of Economics
Eckley Peter, Bank of England
Garbarino Nicola, Bank of England
Kirwin Liam, Bank of England
Latsi Georgia , 4most Europe

Since Basel II was introduced in 2008, two approaches to calculating bank capital requirements have co-existed: banks' internal models, and a less risk-sensitive standardised approach. Using a unique dataset for the UK mortgage market, 2005-2015, and novel identification, we provide the first empirical evidence that this leads smaller lenders to specialise in higher risk lending, leading to systemic concentration of risk. Adopting internal model leads to reduced interest rates for lower- risk loans, and a corresponding portfolio shift. A 1pp reduction in risk weights causes a 1.3bp reduction in interest rates. Our results are relevant to live policy debates.

Area: Banking

Keywords: risky mortgages; Basel II

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