The Basel Committee on Banking Supervision (BCBS) published a newsletter providing details on its internal discussions regarding credit risk issues in real estate and leveraged loan markets. The standard-setter highlights the need for banks to maintain prudent risk management practices on real estate and leveraged loans, as supervisors have observed higher risk lending and deficient practices in some areas.
In its recently held workshops with private-sector participants and bank supervisors, focus was on risks and vulnerabilities in real estate and leveraged loan markets, along with the supervisory perspectives and practices across various jurisdictions. The workshop highlighted that the COVID-19 pandemic has exacerbated credit risk, also noting that the supervisory authorities have responded to the increased risk through heightened supervision, deep-dive reviews, and the use of certain macro-prudential tools. A combination of high inflation, low interest rates, and impact of pandemic have led to increase in house prices and are likely to impact the commercial real estate market too, as higher development costs are likely to erode yields and reduce new development. Structural transformation in terms of how individuals work and consume products have also impacted businesses and demand for certain types of residential and commercial real estate. Meanwhile, supervisors continue to focus on ensuring that banks maintain strong credit underwriting standards for both residential and commercial real estate financing.
Supervisory authorities have also adopted different approaches to supervising bank exposures to leveraged loans. These approaches, which are both supervision and regulation-focused, reflect the diversity of leveraged finance transactions, including leveraged buyouts, highly leveraged corporates, collateralized debt and unsecured exposures. With respect to this aspect of the market, BCBS notes the following:
- Pandemic has exacerbated the risks mainly due to increased leverage and structural adjustments across certain industries and sectors. In the current environment, there is an increasing bifurcation between stronger and weaker credits, with the latter likely to struggle to service debt or refinance given higher interest rates and wider credit spreads.
- Private debt markets have expanded, allowing borrowers to access a wider range of financing options; however, increased involvement of private funds may also increase the channels of potential risks between banks and non-bank financial institutions.
- Risk management practices at some banks are considered adequate, while others have exhibited deficiencies in their management of risks related to the underwriting pipeline, stress metrics, loss-given-default estimates, and risk appetite frameworks.
Related Link: Newsletter
Keywords: International, Banking, Credit Risk, Covid 19, Newsletter, Real Estate, Leveraged Lending, CRE, Lending, Collateralized Loan Obligations, Loss Given Default, Basel, BCBS
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