The Federal Financial Institutions Examination Council has proposed making it easier for banks with strong risk management programs to invest in mortgage derivatives.
The exam council would drop a mandatory test that financial institutions now use to gauge the sensitivity of their mortgage-backed securities to wide swings in interest rates, according to a proposal published Oct. 3 in the Federal Register.
Many institutions that considered the mandatory test a hassle gave up on mortgage derivatives and switched to less restrictive, but equally risky, investments. Institutions instead would have to prove that they have developed their own risk-management policies and controls for making investment decisions. The broad risk-management guidelines laid out in the proposal would apply to all securities purchases, not just mortgage derivatives.
"It makes a lot of sense," said Sarah A. Miller, senior government relations counsel at the American Bankers Association. "The bulk of our members have put in place these safeguards."
Comments on the proposal are due Nov. 17.
Regulators said the test for mortgage derivatives served its initial purpose of protecting banks with weak investment know-how, but they said it has become "antiquated" and "Draconian."
"Its usefulness has passed," said Michael L. Brosnan, director of treasury and market risk for the Office of the Comptroller of the Currency.
"The whole banking industry has become much more sophisticated," said Miguel D. Browne, manager of policy, risk management, and operations for the Federal Deposit Insurance Corp.
Currently, institutions are not permitted to hold a mortgage derivative whose value would change more than 17% if interest rates were to soar or plunge 3%.
The government adopted that standard after financial institutions- particularly small banks buying collateralized mortgage obligations- suffered heavy losses on mortgage derivatives in the late 1980s and early 1990s. Banks had $2 billion invested in high-risk mortgage securities as of June 30, a tiny speck of the $820.5 billion of assets invested in securities, according to the Federal Reserve Board.
Regulators said it is unclear whether institutions will aggressively pursue mortgage derivatives. Some are not yet ready, they said.