November 26, 2018

ESRB published a report that analyzes the financial stability risks and vulnerabilities related to the commercial real estate markets in EU. The report studies both common trends across EU countries as well as country-specific vulnerabilities and finally discusses the possible policy instruments available to address such vulnerabilities.

The report reveals that banking sector in some countries remains highly exposed to commercial real estate, but non-banks and foreign investors also seem to be playing an increasingly important role in commercial real estate markets. Some instruments and measures, which mainly target the banking sector, are available to macro-prudential authorities seeking to address commercial real estate-related vulnerabilities. EU legislation, through the Capital Requirements Directive (CRD IV), provides instruments that can address commercial real estate-related vulnerabilities in the banking sector using capital-based measures, which include increased risk-weights, loss given default (LGD), or own fund requirements. Moreover, the Alternative Investment Fund Managers Directive (AIFMD) includes instruments that can be used to address commercial real estate-related vulnerabilities in investment funds through leverage limits as well as liquidity management tools such as the suspension of redemptions. Depending on the availability of borrower-based measures in national legislation, measures such as loan-to-value (LTV) limits and debt service coverage ratio/interest coverage ratio (DSCR/ICR) floors can also be used to address commercial real estate-related vulnerabilities.

The report highlights that capital-based measures may also be implemented to increase the resilience of the financial sector and to influence cyclical developments in commercial real estate markets. The effective regulation of risk-weights for commercial real estate exposures in many countries would require adjustments under the internal ratings-based (IRB) approach. This is because risk-weights for most of the bank exposures are based on IRB models in many countries, although most countries have implemented measures to increase commercial real estate risk-weights using the standardized approach. However, EU legislation limits countries’ possibilities with regard to correcting or increasing risk-weights for IRB banks to address commercial real estate vulnerabilities. Finally, the report recommends that, given the rising importance of non-bank and cross-border financing in commercial real estate markets, it is important to investigate whether new instruments should be made available and, in addition, implemented beyond banking.

 

Related Link: Report (PDF)

Keywords: Europe, EU, Banking, Commercial Real Estate, CRD IV, IRB Approach, Standardized Approach, Macro-prudential Measures, ESRB

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