EBA and ESRB have published their opinion, following a notification by the Central Bank of Estonia (Eesti Pank) to extend a measure to impose a credit institution-specific minimum level of 15% for the exposure-weighted average of the risk-weights applied to the portfolio of retail exposures secured by mortgages on immovable property to obligors residing in Estonia. The measure applies to credit institutions that use the internal ratings-based (IRB) approach for calculating regulatory capital requirements. The Central Bank of Estonia intends to extend the measure to ensure that banks hold sufficient own funds to cover systemic risks related to housing loans and to act as a backstop limiting any further decrease in risk-weights. Based on the evidence submitted, EBA does not object to the extension of the proposed measure, which will be applied for two years. ESRB also opines that the extension of the period of application of the existing stricter national measure applicable in Estonia has been assessed as justified, suitable, proportionate, effective, and efficient.
In its opinion, EBA acknowledged the concerns of Eesti Pank over the build-up of risks in the residential real estate sector, the risk stemming from the macroeconomic environment, and the high concentration of IRB banks in the housing loan market in the country. EBA reiterates its support for measures that strengthen the resilience of the banking sector against negative macroeconomic shocks. At this juncture, Eesti Pank projects a slight overvaluation in the housing market and has issued communications about tightening of requirements for issuing housing loans. Nevertheless, Eesti Pank does not see a bubble in the housing market. Going forward, expectations of further house price increases are also supported by elevated household savings and changes in the second pillar of the pension system, which allow households to withdraw pension savings. These funds, when available starting from September 2021, could be channeled to the housing market, leading to larger down-payments, further house price appreciation, and ultimately increases in lending. Based on this analysis, EBA does not object to the two-year extension of the period of application of the measure.
Two IRB banks are operating in Estonia, which according to the figures provided by Eesti Pank have an aggregate market share of 75% in housing loan stock. During the application period of the original measure, the average risk-weights of IRB banks continued to decline further and the risk-weights floor measure, therefore, provides a backstop. Thus, discontinuing the measure could result in a sizable decrease of capital requirements for the retail residential real estate portfolio of the two IRB banks while concerns about the housing market and risks related to residential real estate lending are increasing. Moreover, it is uncertain how defaults and losses on the retail residential real estate portfolio will behave in the aftermath of the COVID-19 pandemic.
In addition, EBA reiterates its concerns over why other measures laid down in the Capital Requirements Regulation and Directive (CRR and CRD) cannot address risks to the resilience of the banking system stemming from developments in residential real estate markets. EBA also reiterates concerns over the calibration of the risk-weights measure using a stress test. EBA highlights that in the information provided by Eesti Pank, it has not been clarified sufficiently whether the risks considered by the measure have already been accounted for as part of additional capital guidance (Pillar 2 Guidance). EBA notes that the measures which adjust risk-weights and are calibrated based on stress tests can lead to double-counting of risks and capital requirements. In light of the structural nature of risks in the residential real estate market and the trends in the projections of risk-weights by IRB banks, EBA invites Eesti Pank to closely monitor the situation and reassess the appropriateness of the notified measure once risks surrounding the housing market have abated.
Keywords: Europe, Estonia, Banking, Macro-Prudential Measures, CRR, Basel, Residential Real Estate, Credit Risk, IRB Approach, Systemic Risk, Risk Weighted Assets, Opinion, EESTI Pank, EBA
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