Regulatory changes to how banks treat mortgage assets — anticipated this week by Federal Reserve Vice Chair Michelle Bowman — may have an impact on the mortgage market over time, analysts said.
“The near-term impact on the mortgage market is likely to be somewhat limited,” Keefe, Bruyette & Woods (KBW) analysts wrote in a report published Tuesday. “There are few large banks limiting their participation specifically due to the capital treatment of mortgages or MSRs.”
Bowman, speaking at the American Bankers Association (ABA)’s 2026 Conference for Community Bankers on Monday, said the Fed will propose recalibrating the capital treatment of mortgage servicing rights (MSRs) and increasing risk-weight sensitivity for residential mortgages held on bank balance sheets.
Banks currently apply a 250% risk weight to MSRs, while mortgages held on balance sheets generally receive a standard 50% risk weight.
While regulators intended these requirements to limit excessive bank concentration in volatile, high-risk and less-liquid MSRs, they also contributed to reduced bank participation in the space. Bank shares of mortgage originations and MSR ownership fell from roughly 60% and 95%, respectively, in 2008 to about 35% and 45% by 2023.
Mario Ichaso, Wells Fargo’s senior agency residential mortgage-backed securities strategist, said the decline in bank participation for residential property (one to four unit) exposures is “likely driven less by capital treatment and more by the structurally diminished profitability of mortgage banking.”
“Intense competition from nonbank servicers — many of which continue to expand their technological advantages — has materially compressed returns,” Ichaso added.
Moving on from Basel III
In 2023, the Fed proposed the Basel III “Endgame,” which has since been abandoned. The proposal would have reduced the MSR deduction threshold for common equity tier 1 (CET1) capital from 25% to 10% for banks with at least $100 billion in assets. Currently, banks subject to advanced approaches face a 10% threshold, while those for smaller regional institutions remain at 25%.
For mortgages held on balance sheets, it also sought to introduce graduated risk weights based on loan-to-value (LTV) ratios, aligning the U.S. more closely with international standards. But the proposal drew heavy criticism for including an additional 20% risk-weight add-on.
In her speech, Bowman outlined two forthcoming proposals. One would eliminate the 250% MSR risk weight while seeking comment on an appropriate level. The other would introduce greater risk sensitivity for residential mortgage exposures, potentially tying capital requirements to LTV ratios rather than applying a uniform standard. Bowman did not provide more details.
“These potential changes would address legitimate concerns about mortgage market structure while maintaining appropriate prudential safeguards,” Bowman said. “I look forward to receiving feedback from industry and other stakeholders as we consider these modifications.”
Anticipating the impacts
KBW analysts said the most significant impact would likely be on MSRs, where banks can generate stronger returns on equity than nonbanks, assuming similar servicing costs. This is due to their ability to utilize escrow deposits. Nonbanks, by contrast, have more limited access to leverage.
For originations, analysts noted that revised capital rules could provide more favorable treatment for low-LTV (below 50%) loans.
“It’s possible that banks could offer better rates on low-LTV adjustable-rate mortgages (ARMs) that they can hold on balance sheet,” the KBW analysts wrote. “Pre-GFC, there were many banks/thrifts that focused on portfolio mortgage lending of ARMs, and a more favorable capital regime could help revive some of this activity.”
Ichaso added that some institutions may become more willing to compete for market share in an environment where nonbanks dominate originations but lack the capital buffers inherent to the banking system.
Such a shift could also affect the secondary market, since greater mortgage retention by banks would likely reduce securitization rates. It would lead to lower net issuance of conventional MBS.
“On the margin, agency MBS pools may skew slightly toward higher LTVs as lower-LTV loans are retained by banks,” Ichaso said. “The more meaningful impact may occur in nonagency markets, where prime jumbo issuance has been more active. Depending on the recalibration, high-balance, low-LTV loans could see increased on-balance-sheet retention, potentially reducing nonagency MBS supply.”
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