US banking regulators have recently launched a sweeping overhaul of capital requirements. Their primary goal is to reposition banks at the forefront of mortgage origination. Yet it seems unlikely that the new credit-risk calibration, in isolation, will reshape the market. The widespread use of loan securitization and leverage constraints could limit its impact. By reducing risk weights on credit lines extended to non-bank mortgage lenders, the reform could even undermine its intended purpose—potentially prompting banks to continue operating in the shadow of non-banks.
US banking regulators have recently embarked on an extensive reform of capital requirements. One of their main goals is to motivate banks to increase lending to households and businesses. The aim is to curb the growth of the non-banking sector—which is less regulated and more vulnerable in times of economic stress—in order to better secure the financing of the economy.
To this end, regulators propose to alleviate the capital burden associated with lending activities and to introduce greater granularity into capital requirements. Borrowers’ ability to repay their loans will now be assessed in greater detail, particularly focusing on their income. Above all, this will be taken into account when determining risk weights. This marks a departure from the existing US framework and a step towards the European model.
In the European Union, the European directives and regulations that implemented Basel II and then Basel III sought to encourage banks to select the best risks to benefit from low-risk weights, thereby reducing their capital requirements. In the United States, by contrast, the approach to measuring credit risk has remained largely faithful to Basel I, due to regulators’ historical preference for the simplest capital requirements—those that are least sensitive to risk. There is now a desire to modernise this approach and to encourage banks to originate low-risk loans, keep them on their balance sheets, and engage in servicing activities.
US regulators are particularly focused on residential real estate financing. It is true that over the past fifteen years, due to heavy financial penalties related to subprime loans and the subsequent tightening of regulations, US banks have gradually ceded market share in this sector to non-bank lenders. These non-bank entities now account for two-thirds of new mortgage originations and hold the servicing rights for more than half of the outstanding debt.
However, it seems unlikely that the introduction of a new credit risk measure alone will significantly alter the current landscape. While introducing a greater degree of granularity into capital requirements could potentially incentivise banks to originate more low-risk loans, the impact is likely to be more modest than anticipated, given to the financing structure of the US mortgage market and the existing leverage requirements.
It is important to bear in mind that in the United States, the securitization of loans is highly developed due to the federal mortgage refinancing and guarantee agencies, namely Fannie Mae, Freddie Mac and Ginnie Mae. As a result, the credit risk associated with mortgage loans is only partially shouldered by the banks, limited to the loans they retain on their balance sheets. Therefore, the risk weighting of mortgage loans is not as decisive a factor in credit supply as it is in Europe. Banks that retain all loans on their balance sheets, such as mid-sized banks, could, for their part, be incentivised to increase lending. This is contingent, however, on them having the necessary balance sheet capacity, since their leverage requirements have not been relaxed.
The reform could potentially have adverse effects. Although banks originate few housing loans, they do finance the non-banks that have taken their place. Nevertheless, regulators also plan to reduce the risk weighting of credit lines granted by banks to non-bank mortgage institutions. In doing so, they risk, contrary to their original intention, encouraging banks to continue operating in the shadow of non-banks.
