Bank Regulation, Construction Financing, and the Supply of New Housing

Construction loans are especially important for small- and medium-sized home builders. Unlike large public builders, which can raise money through bond markets and outside investors, smaller firms generally depend on local banks to finance land purchases and construction. These relationships can be difficult to replace because construction projects require specialized monitoring and local knowledge. If banks withdraw from this market, builders may be unable to obtain comparable financing elsewhere.

We studied two major regulatory changes that took effect in 2013: the phased implementation of Basel III capital requirements and stress tests required under the Dodd–Frank Act. Both policies were intended to make large banks more resilient after the financial crisis. However, since construction loans are relatively risky and require substantial capital under these rules, the policies may have encouraged the largest banks to reduce this type of lending.

Our research uses deed records that track the financing and sales activity of nearly 18,000 US single-family home builders. From these records, we identified the banks that financed each builder and examined how lending changed after 2013. We classified banks as stress-tested if they participated in at least one federal supervisory stress test between 2013 and 2019. Before the reforms, these large banks originated roughly 42 percent of bank-originated construction loans between 2010 and 2012. Their share fell from 43 percent in 2011 to 19 percent in 2019. The decline reflected not only lower loan volumes but also a retreat from several local markets. Across the 500 most populous counties, the average market share of stress-tested banks in construction lending fell from 36 percent in 2011 to 14 percent in 2019, and there were approximately 600 instances between 2011 and 2019 in which a stress-tested bank exited a county. Nonbank lenders did not replace the lost credit—perhaps because they lack the expertise to closely monitor the construction projects—indicating that the decline in lending from stress-tested banks led to an overall decrease in construction credit.

We then compared home builders that had borrowed from stress-tested banks before the reforms with those that had borrowed only from other lenders. After 2013, builders with prior relationships with stress-tested banks experienced a 31.5 percent decline in borrowing and an 11.0 percent decline in new home sales relative to the comparison group. We observed similar patterns when comparing builders operating in the same metropolitan area and accounting for differences in builders’ size and geographic reach.

The evidence suggests that the reforms disrupted banking relationships rather than simply reducing lending across the board. Among builders that had relationships with both types of banks, relationships with stress-tested banks were 12.4 percentage points more likely to end after the reforms than relationships with other banks. After 2013, builders that had previously relied on stress-tested banks experienced a 29.4 percent increase in borrowing distance relative to builders that had borrowed only from other banks. In addition, after 2013, construction loans originated by stress-tested banks were 11.3 percentage points less likely to be secured by vacant land (generally considered the riskiest collateral), reflecting these banks’ need to reduce risk.

We also considered the effects of these banking regulations by comparing counties with different levels of exposure to stress-tested banks during 2004–2007, before the financial crisis. We compared changes before and after 2013 between more-exposed and less-exposed counties within the same broad regional housing market. Counties with greater exposure experienced larger declines in construction lending and new home sales. An increase in exposure equal to the difference between the 25th- and 75th-percentile counties was associated with a 17.5 percent decline in construction lending and a 5.6 percent decline in new single-family home sales.

Greater exposure to stress-tested banks was also associated with higher house prices. More-exposed counties experienced a 1.5 percent additional increase in house prices by 2017 relative to less-exposed counties in the same regional market. Consistent with larger home builders facing fewer financing frictions and therefore being less affected by the credit supply shock, our research finds that they gained market share: By 2017, the combined share of new home sales accounted for by the five largest local builders was 1.5 percent higher in more-exposed counties relative to less-exposed counties in the same regional market.

While a complete evaluation of bank regulation is beyond the scope of this study, our findings indicate that the increased capital requirements and stress tests had unintended consequences that affected the housing supply and may have contributed to the recent decrease in housing affordability. Although these policies may have strengthened the banking system, they constrained lending in markets that depend on local relationships and specialized knowledge. In the long run, we expect the market to adjust—for example, our research finds that the market share of public home builders, which are less reliant on construction loans, has increased substantially in the past decade. However, our evidence suggests that the reduction in housing construction during the transition was substantial.

Note
This research brief is based on Sheridan Titman et al., “Bank Regulation, Construction Financing, and the Supply of New Housing,” SSRN Working Paper no. 6425842, revised September 2026.