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Kroll: Prudent regulation not necessary to check nonbank boom

Cause of the crisis was fraud, not lack of capital

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Compared to its peers in the market, the booming non-bank mortgage servicing market — dominated by Ocwen (OCN), Nationstar (NSM), Walter (WAC) — should not be required to fulfill formal capital requirements and other types of prudential regulations, according to the latest white paper from Kroll Bond Ratings Agency.

Currently, there is a lot of debate revolving around non-bank financial companies on developing regulations and supervisions like that traditionally apply to insured depository institutions (IDIs). The head of research at Kroll, Christopher Whalen, told HousingWire that the research offers those same regulators the data necessary to make informed decisions.

"Nonbank servicers do not require the same capital levels as a large bank lender," he said. That said, of all the nonbanks, Ocwen's level of capital to total assets is staggeringly high.

However to Kroll, regulatory efforts to impose capital requirements on non-bank financial institutions such as mortgage loan seller/servicers need to first consider three factors.

First, the company said that most non-bank financial companies operating in the mortgage space have significantly higher levels of tangible capital and lower risk-weighted assets than IDIs. (As seen in the chart below. Click chart for larger image)

Second, the new capital requirements in a way ignore the real point of the financial crisis, “namely the vulnerability of IDIs and non-banks which perform bank-like functions to a sudden decline in investor confidence and a related drop in market liquidity.”

Third, it is not clear why capital requirements on non-banks are appropriate since they are already dependent upon the commercial banking system for short-term funding and are effectively prohibited from capitalizing their asset and maturity transformation activities in the short-term debt capital markets.

“We believe that imposing capital requirements similar to those applicable to IDIs may not be appropriate given the existing capital levels and true risk profiles of these entities,” the report said. “After all, the original reason for prudential standards for banks was deposit insurance and the sense that IDIs could impose risks on tax-payers. Non-banks don’t have similar risk-taking opportunities or incentives.”

Overall, Kroll said, “In our view, the real issue behind the 2007-2009 financial crisis involved securities fraud and the resulting withdrawal of investor liquidity behind various classes of securities issued by off balance sheet vehicles, not a lack of capital in either IDIs or non-bank firms.”

Instead of putting the blame in nonbanks, the true roots of the financial crisis “relate more generally to incomplete sales of securities issued by off balance sheet vehicles, transactions which in the first instance should have been booked as secured borrowings with full capital support.” 

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