Fed Gov. Duke: Small Banks Need Separate Mortgage Rules

Fed Gov. Duke: Small Banks Need Separate Mortgage Rules

Fed Gov DukeFederal Reserve Governor Elizabeth Duke has called for a separate set of regulations for community bank mortgage lending, distinct from the rules being formulated to apply to larger institutions.

In a November 9 speech at the Community Bankers Symposium in Chicago, Duke said mortgage lending by community banks generally does not pose the same risks that helped to create widespread problems in subprime mortgage lending.

"I am convinced that the best course for policymakers would be to abandon efforts for a one-size-fits-all approach to mortgage lending," she said. "Balancing the cost of regulation that is prescriptive with respect to underwriting, loan structure, and operating procedures against the lack of evidence that balance sheet lending by community banks created significant problems, I think an argument can be made that it is appropriate to establish a separate, simpler regulatory structure to cover such lending."

The key questions
Duke reached this conclusion after analyzing data to answer a set of questions, she explained. First, she and Fed staff researched data reported pursuant to the Home Mortgage Disclosure Act (HMDA) to gauge the importance of community bank lending to the overall mortgage market. "The HMDA data indicate that community banks account for a significant fraction of total home loan originations each year," Duke said.

Smaller community banks, those with assets under $500 million, account for about 5 percent of originations each year. Larger community banks, with assets between $500 million and $10 billion, originate an additional 13 percent of mortgages annually. These data do not include loan originations by institutions that operate exclusively in rural areas.

The second question Duke set out to answer was: How important is mortgage lending to the community banking model? It appears to be just as important to community banks as it is to larger banks, she said, as both devote roughly 25 percent of on-balance-sheet loan portfolios to home loans. Additionally, that percentage has increased for community banks since 2008.

Assessing the risks
Finally, Duke tackled the question of whether any signs suggest that community bank lending poses the same risks as subprime lending, which shared many of the same characteristics. The short answer is no. As mortgage delinquencies reached record levels in recent years, the serious delinquency rate of mortgages held by community banks barely exceeded 4 percent. In contrast, the serious delinquency rates reached nearly 22 percent for subprime fixed-rate loans and topped 46 percent for subprime variable-rate loans.

"The regulators cannot, on their own, craft a new approach to regulating mortgage lending by community banks," Duke said. "However, I hope that this data will be useful to bankers and policymakers as they discuss more broadly the establishment of a regulatory regime that preserves the important role of community banks in mortgage lending."

November 26, 2012