HIGHER SCHOOL OF ECONOMICS
National Research University
(Moscow, Russia)
http://www.hse.ru/en/
December 8, 2011
Financial Stability Board
Email: fsb@bis.org
Dear Sirs,
Financial Stability Board Consultation Paper on
Principles for Sound Residential Mortgage Underwriting Practices
The National Research University Higher School of Economics (HSE) is one of the leading
Russian economic research and educational establishments actively carrying out the empirical
research and policy response analysis.
Banking sector is one of HSE primarily research focus. The continued research in the area of
banking within The Laboratory of the Banking Institute of HSE includes the analysis of banking
regulation, approaches to banking risks management, banking sector performance analysis,
efficient banking branches allocation etc.
The National Research University Higher School of Economics (HSE) is pleased to submit
comments on the Consultation Paper ‘Principles for Sound Residential Mortgage Underwriting
Practices’ [further on – CP, or Principles’] released by the Financial Stability Board on October
26, 2011 and available at http://www.financialstabilityboard.org/publications/r_111026b.pdf.
The comments are presented in two parts:
(a) ‘General Comments’ referring to the Consultation Paper on a whole;
(b) ‘Pointwise Comments’ referring to particular points of the Consultation Paper.
We hope our comments would be of use for promoting financial stability at the worldwide and
countrywide levels when dealing with the residential mortgages underwriting.
In case of further questions, please, do not hesitate to get in touch through email
(penikas@gmail.com), telephone (+7.495.772.95.90, ext. 2081) or fax (+7.495.772.95.90, ext.
2101).
Dr. H. Penikas
Lecturer
Economics Department
General Comments
It is highly demanded to draw the timeline of the document implementation, as well as the
timeline for adopting corresponding local regulatory documents.
March 30, 2012 is thought to be the appropriate deadline for Principles’ implementation, whether
June 30, 2013 might be the adequate date for local regulation adoption.
Pointwise Comments
P. i – Definitions:
“Equity: Difference between the appraised value of the property and the total claims held
against the property.”
To avoid miscommunication when using term ‘equity’ for capitalizing bank’s exposures a
term ‘quasi-equity’ is proposed as actually the mortgage borrower does not provide a formal
balance sheet and his equity can not be reliably estimated not accounting for his endowment, for
example.
“Collateral: The property or property rights upon which the residential mortgage loan is
secured”, “Mortgage: A loan that is collateralised against a residential property, including
purchase, home equity lines of credit (HELOCs) and refinancings”.
We would welcome terms “property” and “real estate” to be explained in greater detail.
Particularly, it is desirable to highlight whether the term “property” is only limited to “real
estate” or not.
“A borrower’s underlying income capacity is a key input into effective mortgage
underwriting” (P. 2 – Principle 1).
Proper definition of ‘income’ is welcomed, i.e. whether it assumes the possibility of
having several sources of income or the term ‘income’ is only limited to the principal place of
work.
P. 1 – Introduction - “Internationally agreed Principles will help to strengthen residential
mortgage underwriting practices and enable supervisors to more effectively monitor and
detect the erosion of underwriting practices particularly when the housing market is
booming”.
Apparently, the boom on the housing market can be caused by instability on other markets.
That is why it is necessary to differentiate the treatment of countries non-equal by the level of
housing market development.
P. 2 – Principle 1 – “While income verification can help to measure a borrower’s “ability to
repay”, other financial information (e.g. credit scores, credit registers) can help to measure
a borrower’s historical “propensity to repay”.
(1) Those borrowers with zero credit history should not be discriminated in favour of
those who have one. It is suggested to use comparability approach for those who do not have a
credit history to be treated as a borrower with similar characteristics.
(2) There are countries where in-house written IT procedures for scoring are preferred to
the outsourced ones being cheaper and providing minimal risk of confidential data loss.
2
Primarily for these very countries it is advised to list the data and algorithms requirements for
providing proper scoring calculation.
Basel II quantitative and qualitative requirements for using IRB-approaches (including
the overall statistics history of 5 years and reliable, including no-missing data of 3 years) might
be used as the starting point for mortgage data and scoring procedures requirements.
Certification of procedures by local Central Banks would provide additional guarantee on the
reliability and soundness of the lending institutions.
(3) International research1 suggests that households and individuals tend to underestimate
(deliberately or non) their income received. That is why it is proposed to extend the presented
documents list with the data on expenses made (particularly, on durable goods purchases;
households tend to keep proving documents to be able to apply for guarantees or discounts).
P. 2 – Principle 1.1 – “For borrowers who are self-employed or entrepreneurs, lenders may
require even more extensive history or third-party verification to document income and
profit capacity.”
It is recommended to amend the ‘third-party verification’ by the possibility of using
guarantors when applying for mortgage.
P. 2 – Principle 1.3 – “When misinformation provided by the borrower is detected, lenders
should have recourse as appropriate to the jurisdiction’s legal system”.
The ‘best practice’ mechanisms of dealing with the mentioned situations is welcomed to
be described in greater detail. Break-even clauses for the situations described might be listed
being linked to the recovery and resolution plans of the lending banks.
P. 3 – Principle 2.1 – “Jurisdictions should ensure that lenders appropriately assess
borrowers’ ability to service and fully repay their loans without causing them undue
hardship.”
Foreign exchange risks are to be stress-tested when the mortgage lending occurs in a
currency different from the local one. It might be important for a list of countries that
demonstrated significant and unexpected local currency depreciation vs. US dollar during 20082011, e.g. 20-80% (cf. figure below).
1
E.g. Gardes F., Duncan G., Gaubert P., Gurgand M., Starzec Ch. Panel and Pseudo-Panel Estimation of CrossSectional and Time-Series Elasticities of Food Consumption: The Case of U.S. and Polish Data // Journal of
Business & Economic Statistics. 2005. Vol. 23.; Gardes F., Gaubert P., Langlois S. Pauvrete et convergence des
consommations au Canada. CRSA/RCSA, 1999; Gardes F., Louvet Ph. La convergence internationale des structures
de consommation. Paris: CREDOC, 1986.
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120%
RUR
100%
80%
KZT
60%
UAH
40%
BYR
20%
0%
2008-01
2008-07
1 RUR
2009-01
2009-07
2010-01
100 KZT
2010-07
1000(0) BYR
2011-01
2011-07
10 UAH
Figure 1. RUR, KZT, UAH, BYR exchange rates to USD depreciated 20-80% from their Jan.01, 2008 values.
For particular occasions (countries with highly volatile exchange rates) local Central
Banks may decide to limit mortgage lending to only local currency loans to prevent
reinforcement of crisis effects. The recommendation is in line with the one by the European
Systemic Risk Board of 21 September 2011 on lending in foreign currencies (ESRB/2011/1), OJ
C 3422 suggesting that “National supervisory authorities are recommended to: 1. monitor levels
of foreign currency lending and of private non-financial sector currency mismatches and adopt
the necessary measures to limit foreign currency lending;” (cf. Recommendation B, p. 2).
P. 4 – Principle 2.4 – “It is important that customer information be clear, concise, reliable,
comparable, easily accessible, timely, and comprehensive (i.e. the information should also
take into account the effect of variation in interest rates and the joint effect of the loan and
any other product linked to it).”
As the previously mentioned research shows households from the US, Canada, Poland
tend to demonstrate similar behavioral patterns when making decisions on vital issues like food
or accommodation and consequently on mortgage loan borrowing. In order to work out proper
scoring procedures the united international anonymous database for mortgage borrowers is to be
created. Financial Stability Board is welcomed to grant access to the data base for research
fellows encouraging the investigation of common international trends to be accounted for when
granting mortgage loan in a particular country.
P. 4 – Principle 3 – “While it is common for individual lenders to apply a cap on LTV
ratios, it is not necessary for regulators and supervisors to mandate such a cap if they
satisfy themselves that the underwriting standards are sufficiently prudent and are
unlikely to be eroded under competitive pressure. However, jurisdictions may consider
imposing or incentivising limits on LTV ratios according to specific national
circumstances.”
Central Banks might consider it reasonable to announce changes in LTV cap values same
time when announcing changes in countercyclical capital buffer value.
2
URL: http://www.esrb.europa.eu/pub/pdf/recommendations/ESRB-2011-1.1.pdf?8ea53ba9db16433119d9726344a76dbc
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P. 5 – Principle 4 – “Lenders may want to outsource certain tasks to external parties such
as appraisers.” and p. 6 – Principle 4.6 – “appraisers meet certain qualification
requirements”
Local regulatory authorities (The Central Bank or The Ministry of Finance) might
consider it necessary to form a list of appraisers and their qualification requirements to be
authorised for mortgage collateral assessment. That is regarded necessary for the countries where
the market discipline is not developed enough.
P. 6 – Principle 4.3 – “Property appraisals should not reflect expected future house price
appreciation.”
Decrease in value of mortgage underlying asset needs to be stress-tested to evaluate the
prepayment risk as the bank would be faced with the necessity to pay out its long-term liabilities
it borrowed to finance the mortgage portfolio.
P. 6 – Principle 5 – “Mortgage insurance is used in some jurisdictions as a form of credit
support for mortgage loans”
It is welcomed to explain whether the term ‘mortgage insurance’ stands for insurance on
behalf on the borrower (e.g. life insurance), on the side of a lender (e.g. relevant CDS contract
purchase) or both.
P. 7 – Principle 5.3 – “Through the use of mortgage insurance, credit risks, particularly
those for high LTV loans, are transferred from lenders to insurers and often concentrate
the risks to a smaller number of institutions.”
This means that the mortgage insurers could become the sources of systemic risk for the
financial system. This should be properly accounted for by the regulatory authorities by
extending the treatment of systemically important financial institutions (SIFIs) by including
mortgage insurers to the SIFIs list.
P. 8 – Principle 6.3 – “…the supervisor could specify that initial LTV ratios above 100
percent are not acceptable under any circumstances or that stated income is not acceptable
and lenders should always conduct due verification”.
For example, in Russia LTV ratios vary from 0.3 to 0.9. On the contrary, in Australia or
in the USA, low LTV ratios (which are below 0.8) are associated with the lower rates for low
risky borrowers and allow lenders to deal separately with highly risky borrowers. Therefore, it is
recommended to consider combined-loan-to-value ratio (CLTV) that is calculated as follows:
i value of loani
CLTV 
total value of the property
On the other hand, there is the issue of repricing induced by rapidly changing market
environment. The minimum repricing period of 6 months is suggested to be introduced. Being
more frequent it would increase the uncertainty for individual borrowers and might lead to
worsening financial instability in times of crisis.
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P. 8 – Principle 7 – “Jurisdictions should provide for appropriate monitoring and
supervision of mortgage underwriting practices.”
Though “The FSB Principles for Sound Residential Mortgage Underwriting Practices
aim to provide a framework for jurisdictions to set minimum acceptable underwriting standards”,
it is important from the supervisory perspective to describe the treatment of mortgage portfolio
securitisation. In particular, it seems logical to foresee restricting securitisation operations in a
manner that the from abroad acquired mortgage loan portfolio is to satisfy the requirements of
the bank home jurisdiction for the deal to be accepted.
P. 8 – Principle 7.1 – “These powers could include:collecting data … or requiring other
agencies to collect data for this purpose on their behalf”
When stating the need to collect data for the benefit of regulation and supervision,
changes to local regulation on confidential data processing are likely to be mentioned.
Research Team
Andrievskaya I.K.; Lvov N.P.; Malkov E.S.; Penikas H.I.
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