The recent Basel III endgame capital proposal by the federal banking agencies represents a fundamental pivot in the agencies’ approach to bank mortgage lending and servicing. By aligning U.S. capital standards with international norms and removing punitive legacy deterrents like mortgage servicing asset deductions, the agencies aim to restore the competitive standing of banks and reverse the decade-long migration of mortgage activity outside of the regulated banking sector.
The capital proposal is not solely a concern for the largest banking institutions, but instead would restore risk-based regulatory tailoring for institutions of all sizes, from the largest global systemically important banks (GSIBs) to community banks. For most community and regional banks with under $700 billion in total assets, the proposal maintains the use of simpler calculations under a standardized approach, exempting them from complex operational and other capital risk frameworks while still providing substantial capital relief.
Unlocking $643 Billion in Mortgage Lending Capacity
The proposal’s pivot on mortgage capital treatment centers on an overhaul of mortgage loan risk weighting. For balance sheet mortgage loan exposures, the proposal would replace the current flat 50% risk weight with a granular, risk-sensitive system based on loan-to-value (LTV) ratios. Under the standardized approach, non-cash flow dependent mortgages would receive significantly reduced risk weights, as low as 25% for high equity loans. All non-cash flow dependent mortgages with up to a 90% LTV would receive an equal or lower risk weight compared to current rules. The agencies estimate that the proposal would reduce the average risk weight on current bank balance sheet mortgage portfolios by 30% across standardized approach banks.
Unlike current rules, the proposed rules would allow a mortgage loan to migrate into lower LTV bands as it is amortized, progressively reducing capital charges as the borrower pays down principal (without requiring an updated appraisal on the property to transition the loan to lower LTV bands).
Banks’ market share of mortgage originations has plummeted in the post-crisis period, from nearly 60% in 2014 to approximately 36% by mid-2025. The proposed mortgage risk weight amendments should reduce balance-sheet and regulatory pressure on banks to retreat from the mortgage market (or sell off mortgage portfolios to less-regulated entities). According to the banking agencies, these risk-weighted asset reductions could translate to up to $643 billion in additional balance sheet mortgage lending capacity for standardized approach regional and community banks.
Revitalizing Banks’ Mortgage Servicing Business
To complement the proposed risk-weighting benefits for “originate-to-hold” mortgage lending models, the proposal takes the significant step of completely removing any requirement to deduct mortgage servicing assets (MSAs) from regulatory capital, which should benefit banks following originate-to-sell models (where the loan sales create on-balance sheet MSAs). As drafted, the proposal would apply a 250% risk weight to all MSAs (equal to the risk weight currently applicable to MSAs that are not deducted from regulatory capital).
Banking agency data — including that the MSA deduction elimination would have virtually no impact on risk-weighted asset levels for standardized approach banks — directly indicate that banks currently manage their MSA portfolios to remain below existing capital deduction thresholds.
So, while the elimination of MSA deduction requirements would not immediately affect bank capital ratios, this development may incentivize banks to re-enter or grow their presence in the mortgage servicing business. As the banking agencies recognized, banks’ reentry into the mortgage servicing market could allow them to better “maintain their relationship with borrowers by retaining customer-facing relationships even after transferring the underlying loans.”
The Incentive for Scale
While banks’ post-crisis retreat from the mortgage origination and servicing business has been influenced by a variety of factors, the agencies have explicitly acknowledged that post-crisis capital reforms “have imposed burdens that contributed to the migration of [these activities] outside of the regulated banking sector.” Overall, the proposed amendments are expected to broadly mitigate these existing capital burdens, with common equity tier 1 capital requirements expected to decline by nearly 3% for large regional banks subject to the standardized approach and nearly 8% for standardized approach banks under $100 billion in asset size.
However, bank boards and management should be aware that this regulatory enhancement may also require additional scale to capture these new efficiencies. The agencies admitted that the new operational costs of classifying mortgages by LTV ratios and cash-flow dependencies “may be material” for smaller banks. Consequently, while the proposal provides a roadmap for banks of all sizes to reclaim a larger share of the mortgage market, it may also provide an additional incentive toward smaller-bank consolidation to compete with the economies-of-scale advantages of regional and midsize banks.
