The Basel II capital requirements could eliminate the current risk-based capital incentives for banks to sell their low-risk conventional loans to Fannie Mae and Freddie Mac, according to a report by a Washington consulting firm."Basel II turns this upside down," according to Karen Shaw Petrou, managing partner at Federal Financial Analytics Inc. Starting Jan. 1, 2008, U.S. banks will have a capital incentive to hold prime mortgages on their books and sell higher-risk loans into the secondary market, according to the FFA report on Basel II and the government-sponsored enterprises. "If the GSEs don't go higher risk, then Basel II's impact will put them in a very tight squeeze," the report says. Ms. Petrou said this means Fannie and Freddie will have to "rethink their business model." Foreign banks can implement the Basel II capital standard starting Jan. 1, 2007, which would have an immediate impact on their U.S. subsidiaries, such as ABN Amro Mortgage Group and HSBC Mortgage Corp USA, she said.

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