US Treasury Secretary Janet Yellen flagged risks posed in the mortgage market Friday, as regulators released recommendations to address the sector's vulnerabilities.
"The vulnerabilities of nonbank mortgage companies can amplify shocks in the mortgage market and undermine financial stability," said Yellen at an open session of a Financial Stability Oversight Council (FSOC) meeting.
She added that the council has laid this out in detail for the first time.
Nonbank financial companies do not have a full banking license but can offer various banking services.
On Friday, Yellen said further action is needed to promote sound operations and address liquidity and other risks.
Nonbanks originate and service most of US residential mortgages, a share that has risen since the 2008 financial crisis, according to Yellen who chairs the FSOC.
This means that exposures to the sector have grown substantially.
Such companies present risks as their business model makes them "especially susceptible" to housing market fluctuations like changes in housing prices and interest rates, she said.
They also rely on the value of mortgage servicing rights, which could slump in a housing market downturn.
Widespread disruption in the mortgage market, Yellen noted, could "lead to a temporary restriction of mortgage credit," making credit harder to obtain for certain borrowers.
In its report released Friday, the FSOC urged state regulators to improve standards and "require recovery and resolution planning" by major nonbank mortgage servicers.
It also encouraged Congress to set up a fund, financed by the industry, to provide liquidity to failing nonbank mortgage servicers.
The fund should be designed to help with the continuity of servicing, such as with "loss-mitigation activities for borrowers and advancement of monthly payments to investors," said the report.
Such a fund should also avoid bailouts funded by taxpayers.
Nonbank mortgage lenders include United Wholesale Mortgage and Rocket Cos.
In February, Yellen said regulators have been eyeing risks in this sector.
