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Friday, April 23, 2010

Risk Retention Will Constrain Lending

One of the many troubling provisions in S.3217, the regulatory restructuring bill currently pending in the Senate, is one requiring an across-the-board five% risk retention on all loans sold by an originating bank (Sec. 941).

This provision may have a dramatic impact balance sheet of any bank that is not exclusively a portfolio lender – an impact that will reduce lending capacity and make it harder to fund operations.

Section 941 requires the bank regulators to establish a five% risk retention requirement on virtually all loans that are sold – mortgage loans, commercial loans, and credit card loans all would be covered. Here is an example of the impact of this requirement on a small bank:
  • For every $200,000 loan made and sold by the bank, $10,000 would have to be retained on the bank’s books.
  • Given a 10% capital charge on that $10,000, the bank would have to hold $1,000 more in capital.
  • Imagine that the bank makes and sells 100 of those loans per year. On $20 million in originations, the bank would have to retain $1 million of the loan amount on their books, and add another $100,000 in capital. A bank originating and selling $100 million in loans would have to retain $5 million on their books and come up with another $500,000 in capital.
  • The retained risk will cause the bank’s portfolio to grow, and their lending capacity to be constrained, if the bank cannot raise additional capital.
Raising new capital in this economy is not an easy thing to do. This means that the additional capital constraint from the risk-retention requirement takes away funds that could have been used for other mortgages, personal loans or small business loans. The impact is substantial, as each dollar of capital supports up to $10 dollars of lending. Simply put, this provision would force banks to allocate capital away from lending to cover the risk-retention requirement. Such an artificial shift is not a good result even in the best economic times; it’s certainly a very poor result in a weak and barely growing economy when credit available is critical to a sustainable recovery.

For more information on the many negative impacts this legislation will have on banks and the communities they serve, click here and the “Documents of Interest” column at the right.

I urge you to send a letter to your Senators to stop this bill from moving forward until a balanced and sensible approach can be crafted.

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