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Fintech, Regulatory Arbitrage, and the Rise of Shadow Banks

Journal: Journal of Financial Economics

Date: 20181201

Author: Buchak, Greg; Matvos, Gregor; Piskorski, Tomasz; Seru, Amit

Abstract:
Shadow bank market share in residential mortgage origination nearly doubled from 2007 to 2015, with particularly dramatic growth among online "fintech" lenders. We study how two forces, regulatory differences and technological advantages, contributed to this growth. Difference in difference tests exploiting geographical heterogeneity induced by four specific increases in regulatory burden-capital requirements, mortgage servicing rights, mortgage-related lawsuits, and the movement of supervision to Office of Comptroller and Currency following closure of the Office of Thrift Supervision--all reveal that traditional banks contracted in markets where they faced more regulatory constraints; shadow banks partially filled these gaps. Relative to other shadow banks, fintech lenders serve more creditworthy borrowers and are more active in the refinancing market. Fintech lenders charge a premium of 14-16 basis points and appear to provide convenience rather than cost savings to borrowers. They seem to use different information to set interest rates relative to other lenders. A quantitative model of mortgage lending suggests that regulation accounts for roughly 60% of shadow bank growth, while technology accounts for roughly 30%.

Link: Google Scholar

Key Findings

Growth of Shadow Banking

Shadow bank market share in residential mortgage origination nearly doubled from 30% in 2007 to 50% in 2015, with fintech lenders growing from 3% to 12%

Regulatory Impact

Increased regulatory burden on traditional banks accounts for approximately 60% of shadow bank growth between 2008-2015

Technology Disruption

Fintech lenders charge 14-16 basis points premium and use different information for pricing, with technology accounting for roughly 30% of shadow bank growth

Shadow Bank Market Share Growth

  • Shadow bank share grew from 30% in 2007 to 50% in 2015
  • Particularly strong growth in FHA lending, reaching 75% market share
  • Fintech lenders grew to represent 25% of shadow bank originations by 2015

Regulatory Burden Impact

  • Counties with higher regulatory burden saw greater shadow bank growth
  • Capital requirements, MSR treatment, lawsuits, and OTS closure drove regulatory impact
  • Shadow banks expanded most in areas where traditional banks faced constraints

Fintech Innovation and Pricing

  • Fintech lenders charge 14-16 basis point premium over traditional banks
  • Interest rate variation less explained by standard borrower characteristics
  • Fintech focuses on refinancing market and more creditworthy borrowers

Contribution and Implications

  • First systematic examination of shadow banking growth in residential mortgage market post-crisis
  • Quantifies relative impact of regulatory burden versus technological innovation
  • Highlights role of government guarantees in enabling shadow bank growth
  • Demonstrates fintech's competitive advantage in convenience rather than cost

Data Sources

  • Market share growth chart based on Figures 1-3 showing residential mortgage originations and shadow bank shares
  • Regulatory impact visualization uses coefficients from Table 8 showing impact of different regulatory measures
  • Fintech pricing chart constructed from interest rate premiums reported in Table 6 comparing lender types