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Bank Municipal Bond Holdings and Mortgage Lending Standards

Author

Listed:
  • Vahid Saadi
  • Omar Rachedi

Abstract

We show in this paper that tax exemptions on income from municipal bonds distort bank mortgage lending standards. Banks in states with a larger tax exemption hold more municipal bonds on their balance sheets. These holdings expose banks to local risks, in particular to real estate risk as municipal bonds are financed to a large extent via property tax revenues with a large elasticity with respect to house prices. We show that banks with a higher share of municipal bonds on their balance sheets divert their mortgage originations out of their home states by relaxing their mortgage lending standards. We provide evidence that this geographical diversification is costly in that banks with higher municipal bond holdings lend to low FICO score and high debt-to-income ratio borrowers away from their home states without a corresponding risk premium in interest rates charged.

Suggested Citation

  • Vahid Saadi & Omar Rachedi, 2024. "Bank Municipal Bond Holdings and Mortgage Lending Standards," ERES eres2024-042, European Real Estate Society (ERES).
    • Handle: RePEc:arz:wpaper:eres2024-042
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    File URL: https://eres.architexturez.net/doc/oai-eres-id-eres2024-042
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    More about this item

    Keywords

    Geographical diversification; Lending standards; Mortgage originations; municipal bonds;
    All these keywords.

    JEL classification:

    • R3 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location

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