Proposal for calculating regulatory capital requirements for reverse mortgages

Iván de la Fuente, Eliseo Navarro and Gregorio Serna

Socio-Economic Planning Sciences, 2023, vol. 88, issue C

Abstract: In the current context in which many people worry about the sustainability of pension systems, reverse mortgages are gaining popularity because they are a way to supplement elderly people's incomes. However, it is necessary to provide banks with an adequate risk measurement and management procedure for reverse mortgages to increase the commercialization of these products, which will result in greater well-being for the retirement age population. In this paper, we propose a method to measure risk and estimate the regulatory capital requirements for a portfolio of reverse mortgages owned by a financial institution according to Basel II and III. The method considers house price risk, mortality risk and interest rate risk; consequently, regulatory capital requirements need to be computed using a Monte Carlo simulation procedure. The proposed method is general and can accommodate several scenarios for reverse mortgage specifications, including fixed or variable mortgage rates and different income stream schemes (with the lump sum as a particular case). The results for the U.K. show that reverse mortgage providers face higher risk when the lender initially advances a higher amount, with the lump-sum case indicating the highest risk, for relatively younger borrowers, the female population, higher interest rates and floating mortgage rates.

Keywords: Reverse mortgages; Option pricing; Mortality modeling; House price modeling; Interest rate risk; Regulatory capital requirements (search for similar items in EconPapers)
JEL-codes: G21 G22 J14 R3 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:soceps:v:88:y:2023:i:c:s0038012123001714

DOI: 10.1016/j.seps.2023.101659

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