Bair: Only safest mortgages will escape risk rule

Sheila Bair, chairman of Federal Deposit Insurance Corporation, speaks at the Independent Community Bankers of America’s (ICBA) 2011 National Convention and Techworld in San Diego, California March 22, 2011.

SAN DIEGO, California (Reuters) - Only the safest of U.S. mortgages will be spared from a rule that will call for banks to keep on their books a portion of the loans they originate, U.S. bank regulator Sheila Bair said.

Bair, chairman of the Federal Deposit Insurance Corp, said the exemption needs to be small to ensure that banks don't go back to pre-crisis practices of writing shoddy mortgages and then selling them off through securitization.

She also said the rule shouldn't hurt small banks because most of them already hold onto the home loans they make rather than sell them to investors.

"We think it should be narrowly defined," she said in an interview with Reuters, about the exemption. "I also think it is going to be a very small slice of the market."

The FDIC board will lay out a proposal on March 29 on the so-called "risk retention" rule.

The proposal is required by last year's Dodd-Frank financial reform law. It will force loan securitizers to retain in their portfolios at least 5 percent of the value of loans, rather than shifting all of the risk to investors who buy the loans, unless the loans meet certain standards.

One of those standards is expected to be a 20 percent down payment from borrowers.

Small banks and some lawmakers have complained that 20 percent is too high a bar and that it will restrict housing credit because banks will be reluctant to make loans if they have to keep too much risk on their books.

Bair said that community banks should not be affected by the rule because they retain many of the home loans they make, instead of selling them to investors.

"It's hard for me to say how this can really come back on them," she told Reuters on the sidelines of the Independent Community Bankers of America's annual convention.

Stephen Wilson, an Ohio banker and chairman of the American Bankers Association, wrote Bair on Monday arguing that narrowly defining what mortgages can escape the new "skin-in-the-game" requirement will hurt small banks because they will have to raise more capital to offset the risk they will have to keep on their books.

He said this additional capital is "is especially difficult and costly for smaller institutions to raise."

Bair said she believes the fears of community banks will be tempered when they see that the actual rule will not affect how they do their business.

Next week the FDIC board will also unveil a proposed rule for the "living wills" that large financial companies will have to write so that regulators have a road map for liquidating them if they become insolvent.

The Dodd-Frank law gives the government the power to seize and liquidate a large, failing company whose downfall would be a threat to the financial markets if it were not broken up and sold off in an orderly manner.

(Reporting by Dave Clarke; Editing by Steve Orlofsky)