Regulatory Capital Arbitrage and the Potential Competitive Impact of Basel II in the Market for Residential Mortgages

Posted: 25 Mar 2007

See all articles by Paul S. Calem

Paul S. Calem

Federal Reserve Banks - Federal Reserve Bank of Philadelphia

James R. Follain

Federal Home Loan Mortgage Corporation (FHLMC); National Bureau of Economic Research (NBER)

Abstract

U.S. banking regulators have proposed a bifurcated system of capital regulation where the largest, internationally active banking organizations would be subject to significantly more risk sensitive regulatory capital requirements than are currently in place, while most others would remain subject to the current rules. The proposed new capital regime has the potential to affect the competitive landscape among banking institutions, particularly in the area of residential mortgage lending. We analyze the potential competitive effects of the proposed, bifurcated regulatory capital system on competition in the residential mortgage market from the perspective of the theory of regulatory capital arbitrage. We then apply the theory and available evidence to perform some benchmark calculations that suggest a significant, potential shift of market share and income to the largest banking institutions in the mortgage market.

Keywords: Basel II, mortgages, competition, capital

Suggested Citation

Calem, Paul S. and Follain, James R., Regulatory Capital Arbitrage and the Potential Competitive Impact of Basel II in the Market for Residential Mortgages. Journal of Real Estate Finance and Economics, Vol. 35, No. 2, 2007, Available at SSRN: https://ssrn.com/abstract=975103

Paul S. Calem (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

James R. Follain

Federal Home Loan Mortgage Corporation (FHLMC) ( email )

8200 Jones Branch Road
McLean, VA 22101
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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