Economic Consequences of Transparency Regulation: Evidence from Bank Mortgage Lending

We examine the economic consequences of a rule designed to improve consumers' understanding of mortgage information. The 2015 TILA-RESPA Integrated Disclosures rule (TRID) simplifies the mortgage disclosures provided to consumers. As a consequence, TRID-affected mortgages become a less attractive investment opportunity to banks. Our main results document that mortgage applications affected by TRID are less likely to be approved following the rule's effective date. We find evidence consistent with both a decrease in consumers' information processing costs and an increase in banks' secondary market frictions, providing insight into the potential channels through which this reduction in mortgage credit operates. We also find that banks partially compensate for reduced mortgage lending by increasing small business lending, and that fintechs absorb mortgage demand in areas with reduced mortgage lending by banks. Our study documents real actions that firms take in response to disclosure transparency regulation and contributes to the literature on the economic consequences of such regulation.     

The Neighborhood Distribution of Subprime Mortgage Lending

Subprime lending in the residential mortgage market, characterized by relatively high credit risk and interest rates or fees, has developed over the past decade into a prominent segment of the market (Temkin, 2000). Recent research indicates that there is geographical concentration of subprime mortgages in Census tracts where there are high concentrations of low-income and minority households. The growth in subprime lending represents an expansion in the supply of mortgage credit among households who do not meet prime market underwriting standards. Nonetheless, its apparent concentration in minority and lower income neighborhoods has generated concerns that these households may not be obtaining equal opportunity in the prime mortgage market. Such lending may undermine revitalization to the extent that it is associated with so-called predatory practices.     

Bank Heterogeneity and Interest Rate Setting: What Lessons Have We Learned since Lehman Brothers?

A substantial literature has investigated the role of relationship lending in shielding borrowers from idiosyncratic shocks. Much less is known about how lending relationships and bank‐specific characteristics affect the functioning of the credit market in an economy‐wide crisis. We investigate how bank and bank–firm relationship characteristics have influenced interest rate setting since the collapse of Lehman Brothers. We find that interest rate spreads increased by less for those borrowers having closer lending relationships. Furthermore, firms borrowing from banks endowed with large capital and liquidity buffers and from banks engaged mainly in traditional lending were kept more insulated from the financial crisis.     

Subprime Borrowers: Mortgage Transitions and Outcomes

Public policy concerns increasingly have focused on subprime lending. Our research uses a survey of prime and subprime borrowers to address whether borrowers inappropriately are channeled to the subprime segment, if once having taken out a subprime mortgage borrowers are stuck in this market segment, and whether borrowers face higher costs by taking out subprime mortgages. We find that subprime borrowers are less knowledgeable about the mortgage process, are less likely to search for the best mortgage rates, and are less likely to be offered a choice among alternative mortgage terms and instruments—possibly making them more vulnerable to unfavorable mortgage outcomes. Our analysis of market segmentation confirms that typical mortgage underwriting criteria are most important in explaining whether borrowers obtain prime or subprime mortgages—higher credit risk borrowers are more likely to get a subprime loan. Our results further show that search behavior and other demographic factors including adverse life events, age, and Hispanic ethnicity contribute to explaining market segment, suggesting that borrowers may inappropriately receive subprime mortgages. While we find some persistence to market segment—borrowers are more likely to take out a subprime mortgage if their previous mortgage came from the subprime segment—we also find that market segment is not immutable. Analysis of the survey responses indicates that borrowers with subprime mortgages significantly are more dissatisfied with their mortgage outcomes. This is not surprising because subprime borrowers look worse across typical mortgage underwriting criteria. Consistent with policy concerns, however, despite holding constant these and other factors, taking out a mortgage in the subprime segment, by itself, appears to increase dissatisfaction with mortgage outcomes. We do not provide a definitive answer to the question of whether subprime lending, on balance, serves homebuyers well by providing access to mortgage credit to those otherwise constrained, or rather serves homebuyers poorly by inappropriately assigning them to a market where costs are high and the ability to transition to more attractive prime mortgages remains low. Our analysis, however, does provide some empirical support for concerns raised by critics of subprime lending, and for this reason justifies continued public policy debate and analysis.     

Disparities in Mortgage Lending,Bank Performance,Economic Influence,and Regulatory Oversight

This study investigates factors affecting changes in the disparity of home mortgage denial rates between white and minority loan applicants in the U.S. during the period 1991–1997. We develop a two-stage least-squares regression model that incorporates applicant-level characteristics, neighborhood characteristics, regional economic data, and bank-specific data as explanatory variables. Some have argued that mortgage lenders were under increasing pressure from industry regulators to extend additional credit to minorities and low-income groups during the period under study. The model includes each institution's periodic CRA rating as a proxy for regulatory influence. An alternative explanation is that market forces, such as improvements in economic conditions and in bank financial condition and performance, affected default loss estimates and credit standards in a way that disproportionally benefited minority and low-income applicants. The empirical findings are consistent with the latter hypothesis. We conclude that policy makers should consider the impact of market factors when assessing the allocation of mortgage credit in a particular demographic market. The findings also underscore the importance of controlling for lender assessments of credit risk when evaluating compliance with CRA and fair lending statutes.     

Bank Lending Standards and Access to Lines of Credit

This paper examines how changes in bank lending standards are related to the availability of bank lines of credit for private and comparable public firms. Overall, we find that access to lines of credit is more contingent on bank lending standards for private than for public firms. The impact of bank lending standards is however asymmetric: while private firms are less likely than public firms to gain access to new lines when credit market conditions are tight, we find no difference between public and private firms in terms of their use or retention of pre‐existing lines. We also find that private firms without lines of credit use more trade credit when bank lending standards are tight, which is suggestive of a supply effect. Overall, the evidence suggests that “credit crunches” are likely to have a disproportionate impact on private firms. However, pre‐existing banking relationships appear to mitigate the impact of these contractions on private firms.     

The Economic Effects of Legal Restrictions on High-Cost Mortgages

We analyze the effects of state predatory mortgage lending laws, which have been a model for recent changes in the United States federal legislation enacted to regulate the mortgage contract terms common in higher-risk mortgage market segments. Using the Rothschild-Stiglitz approach to model credit markets under asymmetric information, legal restrictions are shown to reduce the use and attractiveness of mortgage credit. Consistent with model predictions, empirical results indicate that originations of regulated high-cost mortgages were significantly less than predicted in states with more restrictive laws. The differences between predicted and actual originations of high-cost mortgages in states with less restrictive laws were not significant. These differences were also not significant for non-high-cost originations across all states. Thus, credit regulation was differentially associated with reduction in originations of high-cost mortgages, and non-high-cost lending did not consistently expand in areas where high-cost mortgages were restricted.     

Regulation of Subprime Mortgage Products: An Analysis of North Carolina's Predatory Lending Law

This paper estimates the effect of North Carolina's high-cost mortgage law on the subprime mortgage market in that state. The results indicate that creditors sharply restricted lending to higher risk consumers in North Carolina following passage of the law. Creditors did not restrict lending in neighboring states or to lower risk consumers in North Carolina. These results suggest that the restriction in North Carolina was due to rationing in response to higher costs imposed by the law. The findings of this study are of importance beyond North Carolina. Other states and municipalities have proposed or passed similar or more restrictive laws. These laws risk taking back some of the gains in credit availability that lower income and higher risk consumers gained in the 1990s.     

Household Income, Termination Risk and Mortgage Pricing

The premium embedded in home mortgage loans to compensate investors for their exposure to prepayment risk is a significant component of the cost of home mortgage lending. Moreover, there is some reason to believe that prepayment risk may be lower for loans to lower-income housing borrowers, especially those that are first-time home owners. If so, investor recognition of this advantage should facilitate greater willingness to acquire portfolios of lower-income housing loans, and encourage more competitive pricing in this segment of the market. This study investigates the possibility of differential mortgage prepayment behavior between lower-income home owners and non-low income home owners. The investigation relies on samples of the American Housing Survey spanning ten years of experience from 1985 to 1995. We find no significant difference between the termination or refinancing behavior of non-low income and low-income households. This result is robust to a number of alternative specifications such as restricting the low-income test group to non-moving households and to first-time owners. The same conclusions are derived from both aggregate prepayment rates and from analysis of individual household prepayment behavior.     

Bank competition,concentration and EU SME cost of debt

Despite the plentiful debate on the effects of bank competition on SME access to finance and growth, only few studies have explored the impacts on SME cost of debt. This study examines how bank market power affects the credit costs of SMEs by using unique matched SME-bank data from 17 EU countries. We show that bank market power reduces the cost of debt for SMEs. Such a favorable effect is stronger for SMEs that are less informationally transparent, and in the economies subject to less credit information depth and business extent of disclosure. These findings support the Information-based Hypothesis, whereby market power motivates banks to invest in soft information acquisition and to build lending relationships to reduce information costs. In addition, we show that despite the favorable effects of relationship lending brought by bank market power, SME credit conditions worsen in a more concentrated banking market.     

Borrower Self-Selection,Underwriting Costs,and Subprime Mortgage Credit Supply

In the U.S., households participate in two very different types of credit markets. Personal lending is characterized by continuous risk-based pricing in which lenders offer households a continuous distribution of borrowing possibilities based on estimates of their creditworthiness. This contrasts sharply with mortgage markets where lenders specialize in specific risk categories of borrowers and mortgage supply is stepwise linear. The contrast between continuous lending for personal loans and discrete lending by specialized lenders for mortgage credit has led to concerns regarding the efficiency and equity of mortgage lending. This paper sheds both theoretical and empirical light on the differences in the two credit markets. The theory section demonstrates why, in a perfectly competitive credit market where all lenders have the same underwriting technology, mortgage credit supply curves are stepwise linear and lenders specialize in prime or subprime lending. The empirical section then provides evidence that borrowers are being effectively sorted based on risk characteristics by the market.     

Inter-industry FDI spillovers from foreign banks: Evidence in transition economies

Using a sample of nonfinancial domestic firms in transition economies from Eastern Europe and Central Asia, we examine whether and how inter-industry spillover from foreign direct investment in the banking sector occurs. Our findings show that the innovation pursued by domestic firms benefits from foreign bank penetration. However, these positive inter-industry spillovers surprisingly do not seem to work through enhanced credit access. We further find these positive spillovers to occur mainly for foreign banks that use relationship lending, domestic firms that do not export, and host countries that are less open to the global market.     

How important are small banks to small business lending?: New evidence from a survey of small firms

Typically, small banks lend a larger proportion of their assets to small businesses than do large banks. The recent wave of bank mergers has thinned the ranks of small banks, raising the concern that small firms may find it difficult to access bank credit. However, bank consolidation will reduce small business credit only if small banks enjoy an advantage in lending to small businesses. We test the existence of a small bank cost advantage in small business lending by conducting the following simple test: If such advantages exist, then we should observe small businesses in areas with few small banks to have less bank credit. Using data on small business borrowers from the 1993 National Survey of Small Business Finance, we find that the probability of a small firm having a line of credit from a bank does not decrease in the long run when there are fewer small banks in the area, although short-run disruptions may occur. Nor do we find that firms in areas with few small banks are any more likely to repay trade credit late, suggesting that such firms are no more credit constrained than firms in areas with many small banks.     

Banks’ lending behavior and monetary policy: evidence from Sweden

The main purpose of this paper is to investigate the aggregate data about bank loans which may hide significant information about the monetary transmission mechanism. This study, by disaggregating bank loans data and using the relevant interest rates in Sweden, investigates the behaviour of banks after a monetary policy tightening. By using an unrestricted VAR model and impulse response analysis, our results show that a shock on the policy rate affects the main components of the banks’ loan portfolios differently. Initially, banks do not reduce lending to firms and households and they present a sluggish reaction concerning the relevant interest rates. On the contrary, they reduce lending to mortgage credit institutions significantly since real estate lending can be considered as a risky long-term investment. Moreover mortgage credit institutions reduce lending for housing purposes to non-bank public. This reduction is mainly driven by flexible rate loans and loans secured on tenant owned apartments. Consequently, theses actions have a significant effect on real economic activity, by amplifying the initial shock from the tightening monetary policy. The latter result provides evidence of the bank lending channel in Sweden working via mortgage lending and could be very important for policy makers.     

The Exploitation of Relationships in Financial Distress: The Case of Trade Credit

This paper develops optimal pricing, lending, and renegotiation strategies for companies in relationships where one firm is highly dependent on the other. Long-term trade–creditor firm relationships induce dependent trade creditors to grant more concessions in debt renegotiations than nondependent creditors. Anticipating these larger renegotiation concessions, not only do less financially stable firms prefer trade credit, but all firms agree to pay a higher interest rate for trade credit. The model also explains the existence of "teaser" interest rates and convenience classes. Findings are consistent with those of the relationship-lending literature.     

Relationship Lending, Accounting Disclosure, and Credit Availability during the Asian Financial Crisis

We examine whether lending relationships benefit firms by making credit more available during periods of financial stress. Our main finding is that during the Asian financial crisis of July 1997 through the end of 1998, relationship lending increased the likelihood that Korean and Thai firms would obtain credit but it had no effect on Indonesian and Philippine firms. We ask if accounting disclosure might explain the observed differences among the three countries for which audit information is available. We find that for Indonesian firms with weak lending relationships, banks replace relationship lending technology with a financial-statement lending technology. Such a result does not hold for Korean and Philippine firms.     

Government intervention in the mortgage market: A study of anti-redlining regulations

This paper addresses the question of whether economic incentives exist for mortgage lenders to avoid or to minimize mortgage originations in neighborhoods inhabited primarily by low-income racial minorities. The Option Pricing Model is utilized to determine what mortgage borrower characteristics affect the market value of the mortgage contracts. It is found that existing laws do not enable mortgage lenders to vary either origination prices or mortgage terms so as to adjust for differences in the market values of mortgages. As a result, incentives are created for both the mortgage lender and the mortgage insurer to avoid originations and underwritings in areas with relatively high default probabilities. Various changes in mortgage lending regulations are suggested to eliminate these incentives, and the effects of alternative programs to subsidize mortgage borrowers with relatively high default probabilities are considered.     

Sovereign stress and SMEs’ access to finance: Evidence from the ECB's SAFE survey

We study the effect of sovereign stress on SMEs’ capital structure using restricted-access data from the European Central Bank. We find that during the sovereign debt crisis, and controlling for borrowers’ quality, firms in stressed countries became more likely to be denied credit, to be credit rationed, and to face higher loan rates. Less creditworthy firms were not more likely to become credit constrained, suggesting no flight to quality in lending. We also find that in order to make up for the decline in bank credit firms in stressed countries began relying considerably more on retained earnings and government subsidies.     

Bank Branch Presence and Access to Credit in Low‐ to Moderate‐Income Neighborhoods

Banks specialize in lending to informationally opaque borrowers by collecting soft information about them. Some researchers claim that this process requires a physical presence in the market to lower information collection costs. This paper provides evidence in support of this argument in the mortgage market for low‐income borrowers whose access to credit is limited by their inadequate credit histories. Mortgage originations increase and interest spreads decline when there is a bank branch located in a low‐ to moderate‐income neighborhood.     

The countercyclical capital buffer and the composition of bank lending

Do targeted macroprudential measures impact non-targeted sectors too? We investigate the compositional changes in the supply of credit by Swiss banks, exploiting their differential exposure to the activation in 2013 of the countercyclical capital buffer (CCyB) which targeted banks’ exposure to residential mortgages. We find that the additional capital requirements resulting from the activation of the CCyB are associated with higher growth in banks’ commercial lending. While banks are lending more to all types of businesses, the new macroprudential policy benefits smaller and riskier businesses the most. However, the interest rates and other costs of obtaining credit for these firms rise as well.