The Impact of Reversing Regulatory Arbitrage on Loan Originations: Evidence from Bank Holding Companies

Mortgage banking subsidiaries of bank holding companies (BHCs) became increasingly active players in the mortgage origination market during the last decade. At the time, the Federal Reserve Board (FRB) had supervisory power over BHCs, and under the Bank Holding Company Act was authorized to monitor and examine the subsidiaries of BHCs under certain circumstances. However, this authority did not clearly extend to routine examinations of nonbank subsidiaries of BHCs. 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 difference-in-differences estimator with the control group being other types of lenders. We show that loan production moved from mortgage banking subsidiaries to their affiliated depository institutions after the policy change. The quality of loans originated by mortgage banking subsidiaries of BHCs increased after the policy change: The denial rates for mortgage applications increased, loan-to-income ratios decreased, and the proportion of owner occupied houses increased in mortgage banking subsidiaries more than they did in other types of lenders.