From the Regulators

Global financial regulators have published a set of recommendations designed to help prevent future failures of mortgage insurance.

By James Langton |

The Joint Forum, which encompasses the the Basel Committee on Banking Supervision, the International Organization of Securities Commissions (IOSCO) and the International Association of Insurance Supervisors (IAIS), released its final report on mortgage insurance Tuesday, which examines the interaction of mortgage insurers with mortgage originators and underwriters, and their role in the global financial crisis.

The report makes a set of recommendations for policymakers and supervisors that aim at reducing the likelihood of mortgage insurance stress and failure amid tail risks, such as the recent financial crisis, which demonstrated that mortgage insurance is subject to significant stress in the worst tail events.

"In the worst cases, failure of a mortgage insurer may occur leading to resolution of the insurer, whereby some of the most extreme tail risk may revert to the lender at the very time that the insurance would be most needed, potentially creating systemic risk," it says.

The report notes that it's difficult to make any set of recommendations for a complex system, as there may be unintended consequences to any particular policy.

Nevertheless, it does recommend: that policymakers consider requiring that mortgage originators and mortgage insurers align their interests; regulators should ensure that mortgage insurers and originators maintain strong underwriting standards, and that they should correct deterioration in underwriting standards stemming from behavioural incentives; that supervisors should require mortgage insurers to build long-term capital buffers during the troughs of the underwriting cycle to cover claims during its peaks; that regulators should try to prevent cross-sectoral arbitrage which could arise from differences in the accounting between insurers' technical reserves and banks' loan loss provisions, and from differences in the capital requirements for credit risk between banks and insurers, or from the use of alternatives to traditional mortgage insurance; and, that they should apply principles developed by the Financial Stability Board (FSB) to ensure sound residential mortgage underwriting practices.

"Mortgage origination and mortgage insurance were at the very core of the financial crisis. The Joint Forum recommendations on mortgage insurance provide guidance to national policymakers and supervisors in order to avoid mistakes of the past and strengthen resilience in the future," said Thomas Schmitz-Lippert, chairman of the Joint Forum and executive director international policy at the German federal financial superivory authority, known as BaFin.