Basel III: “Real estate financing risks being inappropriately treated”

Berlin, January 24, 2023

vdp sees light and shadow in the ECON vote on the banking package

The Association of German Pfandbrief Banks (vdp) takes an ambivalent view of the report adopted today by the Committee on Economic and Monetary Affairs (ECON) of the European Parliament on the EU banking package.

“Compared to original considerations, signs are currently emerging of an important easing of requirements for the banking industry over the implementation of the Basel III reform which takes the traditional features of the European financing markets into account. In particular, we welcome the signs of relief for low-risk residential real estate financing as well as for unrated corporates,”

Jens Tolckmitt, the vdp’s Chief Executive, commented. These achieved compromises would now have to find their way into the final package.

“On the other hand, we are troubled by the fact that it was only possible to agree on transitional arrangements in these areas and that the privileged treatment does not appear to cover low-risk first-ranking commercial real estate financing as well. This does not do justice to the safety of this asset class. Overall, real estate financing risks being inappropriately treated.”

Today’s vote by the ECON takes its bearings from the content of the draft legislation on the EU banking package that the European Commission presented in autumn 2021. It is an extensive revision of banking supervisory requirements that primarily concern the final implementation of the Basel III reform and will significantly increase the capital burden placed on European credit institutions. Already in November 2022, the Council of the European Union had positioned itself as supporting the regulations proposed by the European Commission. This means that all three institutions agree in principle that the negative effects on financing business stemming from the Basel Committee’s original recommendations on the banking package will at least be mitigated. 

The signs of relief with regard to how exposures are treated under the output floor refer in particular to financing for companies without a rating from an external rating agency as well as to residential real estate financing. Specifically, the latter involves halving the risk weight from 20% to 10% if the exposures meet certain additional requirements, such as an institution-specific hard test with a loss ratio of no more than 0.25% – in terms of a bank’s corresponding real estate portfolio. However, this capital relief is to apply only until 2032, with the ECON now proposing a possibility to extend this transition period by a maximum of four years.

“Why treat the same low-risk business differently in the future than today?”

But the vdp fails to understand why these easing measures should only apply temporarily and are not to be extended to include the financing of commercial real estate.

“Residential real estate exposures with a low loan-to-value ratio, the low-risk nature of which has, moreover, been proven by satisfying hard test requirements, should not per se be subject to a greater capital surcharge than higher-risk transactions, and should therefore benefit from this regulation on a permanent basis,” Tolckmitt emphasized. “After all, why should business that is considered low-risk today and will meet the same criteria in ten or twenty years’ time be treated differently in the future than today?”

In addition, the vdp argues that special treatment also needs to be given to low-risk commercial real estate exposures.

Following the ECON vote, the European Parliament is likely to vote on the banking package in its next plenary session. The so-called trilogue will then take place in Brussels, with the European Commission, the Council of the European Union and the European Parliament negotiating their respective proposals on the EU banking package. 

The vdp will, moreover, continue to stress that regulatory measures such as  Basel III ultimately stand in the way of achieving political goals. The sustainable transformation of the economy, the energy-efficient refurbishment of the building stock and the creation of affordable housing will require massive investments going forward. In the vast majority of cases, these will have to be financed by the banking industry. “The more difficult lending is made for banks, the less likely it is that political visions can become reality,” Tolckmitt warned. As an example, he referred to certain energy-efficient property refurbishments that are to be classified in the Basel III framework as ADC (acquisition, development and construction) exposures and, in the case of commercial real estate, are to be assigned a risk weight of 150%. This figure, which corresponds to the risk weight for defaulted assets, would make the financing of refurbishments significantly more expensive, rendering it more difficult to implement the green transformation.