Mortgage Supply and Capital Regulation in Low Interest Rates Settings

The global financial crisis has led to a reduction in nominal interest rates in many countries around the world. Switzerland has been no exception. The Swiss National Bank (SNB) reduced its policy rate to near zero in 2008 and into negative territory in 2015 to stem pressure on the Swiss Franc to appreciate. These rate cuts have partially transmitted to lending, deposit rates, and resulted in strong growth in mortgage lending and real house prices. Looking at bank-regional level data, we find that small domestic banks have mostly contributed to this expansion in mortgage lending, while the two big, global systemic banks (UBS and Credit Suisse) have lost their market share in most cantons.

In the aftermath of financial crisis, bank capital regulation has been significantly tightened based on Basel III and Swiss-specific requirements. UBS and Credit Suisse have been required to hold additional capital buffers relative to smaller financial institutions due to their systematically important nature. Capital requirements aim to limit bank leverage and make the financial system more resilient.

This paper develops a model with two types of banks (big and small) and monopolistic competition in the deposit and mortgage market, which we calibrate to the Swiss banking sector. The model can replicate the contemporaneous expansion in mortgage lending and change in market shares seen in the data if the monetary policy rate is brought into negative territory and capital requirements on the big banks are stricter than for small ones. Any of the two policies in isolation fails to match the empirical evidence.