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Bank Regulatory Capital Arbitrage: Evidence from Housing Overappraisals

Author

Listed:
  • Sergio Mayordomo

    (Banco de España, 28012 Madrid, Spain)

  • Omar Rachedi

    (ESADE Business School, Universitat Ramon Llull, 08172 Sant Cugat del Valles, Spain)

  • María Rodríguez Moreno

    (Banco de España, 28012 Madrid, Spain)

Abstract

The overstatement of asset collateral values reduces bank capital requirements. We identify this novel form of regulatory arbitrage by studying housing overappraisals, the difference between housing collateral values computed by appraisers and actual transaction prices. We leverage granular loan-level data from Spain and a kink in the scheme of residential mortgage risk weights to show that tighter regulatory requirements cause larger overappraisals. This bias depends on the relationship between appraisers and banks; appraisers inflate mortgage collateral values only for their major customer banks. On average, overappraisals lower risk-weighted mortgages by 9%. Mortgage overappraisals allow banks to free up regulatory capital to support additional risk-taking in the corporate loan market.

Suggested Citation

  • Sergio Mayordomo & Omar Rachedi & María Rodríguez Moreno, 2024. "Bank Regulatory Capital Arbitrage: Evidence from Housing Overappraisals," Management Science, INFORMS, vol. 70(4), pages 2255-2271, April.
    • Handle: RePEc:inm:ormnsc:v:70:y:2024:i:4:p:2255-2271
    DOI: 10.1287/mnsc.2023.4805
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