Fintech, Regulatory Arbitrage, and the Rise of Shadow Banks

Abstract

Shadow bank market share in residential mortgage origination nearly doubled from 2007-2015, 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. Fintech lenders appear to offer a higher quality product and charge a premium of 14-16 basis points. Relative to other lenders, they seem to use different information to set interest rates. A quantitative model of mortgage lending suggests that regulation accounts for roughly 60% of shadow bank growth, while technology accounts for roughly 30%.

Keywords: Fintech, Shadow Banks, Regulatory Arbitrage, Lending, Mortgages, FHA

JEL Classification: G2, L5