Bank Municipal Bond Holdings and Mortgage Lending Standards

Vahid Saadi and Omar Rachedi

ERES from European Real Estate Society (ERES)

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.

Keywords: Geographical diversification; Lending standards; Mortgage originations; municipal bonds (search for similar items in EconPapers)
JEL-codes: R3 (search for similar items in EconPapers)
Date: 2024-01-01
New Economics Papers: this item is included in nep-inv, nep-mac and nep-ure
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Persistent link: https://EconPapers.repec.org/RePEc:arz:wpaper:eres2024-042

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