WASHINGTON — Federal Reserve Board Governor Susan Schmidt Bies told a room full of credit union representatives that she personally was supportive of the idea of risk-based capital in general.
Clarifying that she was not speaking for the Federal Reserve Board, Bies said she is generally supportive of the idea of risk-based capital, but difficulties for smaller institutions should be considered in implementation. "I firmly believe capital should follow risk," she stated in response to a question from former NCUA Chairman Dennis Dollar during NCUA Vice Chairman Rodney Hood's Risk Mitigation Summit. "If not, you can get a false sense of security."
However, the impact on smaller institutions must be considered, Bies said referring to BASEL II and Ia. "We have to be cautious about how we have to move forward," she said.
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Generally on the subject of risk management she said she was encouraged to see more sessions on involving entire organizations–enterprise risk management–to fully assess all risks. But effective ERM is not only about managing risk, Bies said. "Good ERM means it proactively seizes opportunities when presented," she explained. She noted that in the current environment regulators have been focusing on the mortgage concentrations financial institutions have on their books, but ERM can apply to all aspects of any business. Bies included in ERM: oAligning the entity's risk appetite and strategies; oEnhancing the rigor of the entity's risk-response decisions;
oReducing the frequency and severity of operational surprises and losses;
oIdentifying and managing multiple and cross-enterprise risks;
oProactively seizing on the opportunities presented to the entity; and
oImproving the effectiveness of the entity's capital deployment.
She cited the COSO–Committee of Sponsoring Organizations of the Treadway Commission–framework, which consists of (1) internal environment, (2) objective setting, (3) event identification, (4) risk assessment, (5) risk response, (6) control activities, (7) information and communication, and (8) monitoring.
Specifically speaking to mortgages, Bies noted, "Supervisors have also observed that lenders are increasingly combining nontraditional mortgage loans with 'risk layering' practices–such as not evaluating the borrower's ability to meet increasing monthly payments when amortization begins or when interest rates on adjustable rate mortgages rise due to indexing or at the end of a 'teaser' rate period."
She said regulators are using more limited or no documentation loans. "Although some lenders may have used elements of nontraditional mortgage products successfully in the past, the recent easing of traditional underwriting controls and the sale of some types of nontraditional products to subprime borrowers may generate losses on these products greater than has been observed in the past."
Bies also pointed to the increasing use of no equity down payments through simultaneous second liens. "The greater prevalence of risk-layering practices and sales of nontraditional mortgage products to nonprime borrowers have occurred in the past few years as competition for borrowers and declining profit margins has prompted lenders to loosen their credit standards to maintain loan volume in a slowing environment." –[email protected]
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