The Impact of Regulatory Arbitrage on Loan Originations : Evidence from Mortgage Banking Subsidiaries of Bank Holding Companies

This paper examines loan originations by mortgage banking subsidiaries surrounding a recent period of regulatory arbitrage. Mortgage banking subsidiaries of Bank Holding Companies (BHCs) became increasingly active players in the mortgage origination market over the past decade. At the time, the Federal Reserve Bank (FRB) had supervisory power over this group of players but lacked examination power. This changed between 2007 and 2009 due to FRB policy on consumer compliance supervision for nonbank subsidiaries of BHCs. Our empirical analysis tests for the impact of the new policy on the quantity and quality of loan originations by mortgage banking subsidiaries of BHCs. We use a diff-in-diff estimator with the control group being other FRB regulated entities. We show that loan production moved from mortgage banking subsidiaries to their affiliated depository institutions after the policy change. The intensive margin is evident in low quality loan originations prior to the change and a subsequent higher quality production. The economic impact is non-trivial as loan-to-income ratios for mortgage banking subsidiary originations decrease by 4 percent from the mean value and origination denial rates increase by a range of 9 to 33 percentage points. These findings contribute to our understanding of the evolving nexus of housing finance and financial regulatory policies. The implications drawn from this work support the call by Levitin and Wachter (2012), among others, for a new policy equilibrium