Fed lays out plan to entice banks to do more mortgage lending

The Federal Reserve is stepping in to relax mortgage loan capital requirements in ways that could “potentially reverse the trend of migration of mortgage activity to nonbanks over the past 15 years,” said its vice chair for supervision, Michelle Bowman.

Bowman announced the plan at the American Bankers Association Community Bankers Conference, explaining that in 2023, banks originated fewer mortgages, (35%) than they did in 2008 (60%). They also serviced about 45% of mortgage balances in 2023, down from 95% in 2008.

After calling the shrink “extraordinary,” Bowman continued: “This out-migration of origination and servicing has been costly for banks, consumers, and the overall mortgage system. In part, this results from over calibration of the capital treatment for these activities, resulting in requirements that are both disproportionate to risk and that make mortgage activities too costly for banks to engage.”

Of the 10 largest lenders by mortgage origination volume in 2024, according to Bankrate, only three were traditional banks: Bank of America, Chase, and US Bank.

Bowman said banks should retain more in-house serving because it creates “strong bank connections” with customers, increasing the chances that they return to the bank for more finance services, “from checking accounts to investment services.”

“Mortgage servicing also offers distinct financial benefits. The fee income from mortgage servicing diversifies a bank’s revenue stream from an over-reliance on lending income, providing more stable income independent of the interest rate environment,” Bowman added.

As for consumers, Bowman said that fewer banks making mortgage loans results in “reduced… consumer choice and competition that drives down costs.”

Profitability question. Historically, residential mortgages have been only mildly profitable for banks. In 2024, for example, mortgage banks reported an average profit of $443 on each loan they originated, according to the Mortgage Bankers Association. The prior year, mortgage banks had an average loss of $1,056 per loan originated.

In addition, when banks hold 30-year residential mortgages on their balance sheets during a period of rising interest rates, there’s a potential for “duration mismatch and financial stability risks in the banking sector,” according to Lu Liu, finance professor at Wharton, in an article about her research on the US mortgage market.

Impacts. The Fed’s plan comes after the Federal Reserve said in August it was outlining a new plan to lower the capital risk burden on US banks, after an original proposal faced deep opposition from the banking industry.

Last October, Treasury Secretary Scott Bessent said he wanted to ensure “that modernization of our capital framework ends the capital arbitrage that drives bank lending to non-banks.”

The changes could disrupt the growing nonbank lender landscape, an industry that faces challenges due to general concerns around the softening labor market and affordability. Those trends could impact the ability of borrowers to repay their loans, according to S&P Global Ratings.

A 2022 report on the rise of nonbank mortgage lenders from the Federal Reserve found that nonbanks, as they grow in market share, “develop a specialty in servicing lower-income borrowers and increase investment in technology,” both of which led to an increase in overall service quality.

But Bowman maintained that the proposals are about “creating a resilient mortgage market that includes robust participation from all types of financial institutions,” including both bank and nonbank.

“Strengthening bank participation in these activities does not threaten the safety and soundness of the banking system. These goals are consistent.”