We study the real impacts of capital regulation caused by the reallocation of mortgage servicing rights (MSRs). Using U.S. credit registry data, we show that Basel III’s stricter MSR regulation induced banks to transfer riskier MSRs, leading to a market- wide shift toward non-bank servicers. We develop a model showing that the privately optimal allocation of MSRs may not minimize agency conflict in a non-integrated mortgage market. Comparing foreclosure rates, a sufficient statistic for welfare in the model, we show that the reallocation of MSRs decreased agency conflicts and enhanced investor welfare at the expense of borrowers.