Regulators Introduce New Risk Retention Rule for Banks

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Proposal would require banks to retain some risk on most securities they issue.

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Six federal agencies, including the Federal Deposit Insurance Corporation (FDIC), the Securities and Exchange Commission, and the Department of Housing and Urban Development, have jointly proposed a new rule that would require banks to retain at least five percent of the credit risk for assets-backed securities they issue.

The new rule, which would implement a provision of the Dodd-Frank Act, grants an exception for “qualified residential mortgages.” The agencies are using a far more stringent definition of “qualified residential mortgages” than banks had lobbied them to use.

To qualify, such mortgages must satisfy strong underwriting and risk retention standards. Loans must include a 20 percent down payment and a maximum loan-to-value ratio of 80 percent. Borrowers must also have strong credit histories.

Banks argue that adopting the more stringent requirements will reduce the output of mortgage lending and slow the recovery of the mortgage securitization market.

However, FDIC Chair Sheila Bair claims that the stringent requirement will give investors the confidence to trade asset-backed securities and provide banks with “economic incentives to avoid losses.”

The agencies seek public comments through June 10, 2011.