Description:

Speaker JD Salas

Title “Screening, Selection and Asymmetric Regulation: Banks and Shadow Banks in the Mortgage Market”

Abstract:
This paper studies the interaction between borrower search and the sorting of borrowers into lenders according to their risk profile. The demand side generates endogenous adverse selection as a result of the search process: riskier borrowers are willing to accept higher rates because they are more likely to get rejected. The supply side endogeneizes the screening incentives of lenders as a function of their lending models, with traditional banks and shadow banks representing both extremes of the spectrum. The probability of holding loans from low creditworthiness borrowers and the regulatory oversight makes banks behave more risk-averse at origination. I document substantial heterogeneity in approval rates between banks and shadow banks and within banks depending on how many loans the bank could hold on their balance sheet. Preliminary structural estimates show that search costs are substantial, at roughly 22 bps (i.e., around $8,000 over the life of a mortgage), and that risky types get rejected with roughly an 85% probability. I propose several counterfactual exercises to address the optimal trade-off between the amount of risky loans originated and equilibrium on both the extensive and intensive margins, and policy counterfactuals, such as the optimal level at which to pool risks in the US mortgage market.