Fed Aims to Revitalize Bank Mortgage Lending with Capital Rule Adjustments

The Federal Reserve is signaling a potential shift in regulatory approach to encourage banks to re-enter the mortgage origination and servicing market, a sector increasingly dominated by non-bank lenders. Vice Chair for Supervision Michelle W. Bowman outlined a case for recalibrating capital rules to address what the Fed views as a costly imbalance in the mortgage system.

The Shifting Mortgage Landscape

Since the 2008 financial crisis, the mortgage market has undergone a dramatic transformation. In 2008, banks originated approximately 60% of mortgages and held the servicing rights on around 95% of mortgage balances. However, by 2023, banks’ share of originations had fallen to 35%, and their servicing activity had declined to 45% . This “extraordinary” shift, as described by Bowman, has led to a significant out-migration of mortgage activity from depository institutions to non-bank lenders.

Regulatory Impact and Capital Requirements

Bowman attributed this shift, in part, to post-crisis regulatory changes, specifically capital requirements. The Fed is now considering whether these requirements appropriately reflect the actual risk profile of mortgage-related assets . The current framework may have discouraged banks from competing effectively in mortgage origination and servicing.

Proposed Adjustments to Capital Rules

The Federal Reserve is preparing to propose two mortgage-related regulatory rules designed to stabilize banks’ role in the market . Key areas under consideration include:

• Mortgage Servicing Rights: Reassessing how mortgage servicing rights are treated under regulatory capital rules.
• Risk Weights: Potentially incorporating greater risk sensitivity into capital standards, tying requirements more closely to factors like loan-to-value ratios and credit scores.
• Capital Deduction: Eliminating the deduction of mortgage servicing rights from regulatory capital.

Benefits of Increased Bank Participation

Bowman emphasized that restoring banks’ participation in the mortgage market extends beyond balance sheet strategy. Mortgage lending is seen as foundational to relationship banking, creating opportunities for cross-selling and strengthening customer ties. During times of economic stress, borrowers with loans serviced by banks were more likely to receive forbearance during the pandemic than those with nonbank servicers , highlighting the potential consumer benefits of a more balanced ecosystem.

Industry Response

The Mortgage Bankers Association (MBA) has welcomed Bowman’s remarks, stating that it has long advocated for regulatory reforms that better align capital requirements with the actual risk profile of mortgage lending and servicing . The MBA expressed its eagerness to review the forthcoming proposals and work with regulators to advance a framework that supports sustainable mortgage origination and access to affordable home financing.

Looking Ahead

Any significant overhaul of mortgage regulations will likely require coordination with other regulatory bodies and potentially legislative action. However, Bowman’s statements signal a clear intent from the Federal Reserve to reshape incentives and restore banks’ role in a sector that was once a core pillar of their business. These adjustments could reshape competitive dynamics, impacting bank revenue, customer retention, and the overall stability of the housing finance system.