Hi there Dopey
Nice post... Very good material that covers lots of the issues. The point about the 50% risk weighting of residential mortgage lending is spot on! I would argue that this was the single greatest cause of the bubble in home lending that led to the GFC!
There are two elements to the Basel liquidity requirements:
1. The requirement to hold AAA (or highly) rated bonds (that can be easily sold or repoed to generate cash to meet calls on deposits). APRA is negotiating with BIS for a variation on the requirement because of the shortage of Australian Government bonds. The question you raise is whether RMBS are an appropriated collateral if the underlying assest are inflated in value. I don't see this as too much of a problem because the loan will be limited to the RMBS marked-to-market less a haircut. If this is managed in a disciplined way, the RBA shouldn't take any losses on these transactions.
2. The more contentious Basel III issue is the requirement for banks to lengthening the duration (weighted average time to maturity) of the liabilities (mostly deposits) for a closer match with the duration of the assets. This has implication for profitability as banks have always played the curve, lending long and borrowing short. Now they will be force to pay up for deposits up the curve causing the margins to contract.
Solvency is a separate matter. The Basel Accords deal with this through capital adequacy requirements applied to Credit risk, operational risk and market risk. I could comment at length on this but not at 4:45pm....
I would observe that in US and Europe at the moment, solvency is a short term problem and unless it is dealt with we wont get a chance to worry about it long term.
Cheers
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