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Mortgage Companies and Regulatory Arbitrage

Mortgage companies (MCs) do not fall under the strict regulatory regime of depository institutions. We empirically show that this gap resulted in regulatory arbitrage and allowed bank holding companies (BHCs) to circumvent consumer compliance regulations, mitigate capital requirements, and reduce exposure to loan-related losses. Compared to bank subsidiaries, MC subsidiaries of BHCs originated riskier mortgages to borrowers with lower credit scores, lower incomes, higher loan-to-income ratios, and higher default rates. Our results imply that precrisis regulations had the capacity to mitigate the deterioration of lending standards if consistently applied and enforced for all types of intermediaries. Revised April 2014.

Keywords: Banking Regulation, Regulatory Arbitrage, Shadow Banking, Lending Standards, Mortgage, Foreclosure, Bank, Crisis.
JEL Codes: G21, G28, D12.

First version: September 2012. Earlier revisions November 2012 and May 2013.

Suggested citation: Demyanyk, Yuliya and Elena Loutskina, 2012. "Mortgage Companies and Regulatory Arbitrage," Federal Reserve Bank of Cleveland, Working Paper no. 12-20.

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