Specialisation in Mortgage Risk Under Basel II

Since Basel II was introduced in 2008, two approaches to calculating bank capital requirements have co-existed: lenders’ internal models, and a less risk-sensitive standardised approach. Using a unique dataset covering 7 million UK mortgages for 2005–15, and novel identification, we provide empirical evidence that the differences between these approaches cause lenders to specialise. This leads to systemic concentration of high-risk mortgages in lenders with less sophisticated risk management. Our results have broad implications for the design of the international bank capital framework.