It would be unusual to see bankers welcome with open arms regulation intended to keep them in check, but the arrival of so-called ‘Basel IV’ has been greeted by many as a compromise they can live with.
Eighteen months ago, noises from the Basel Committee suggested that the revision to its third banking accord would clamp down on banks using their own models to work out how much capital must be held in reserve against assets. A more rigid ‘standardised’ system looked likely to funnel assets into rigid risk categories, with real estate lending expected to be viewed as risky business.
Much international wrangling later, and the Basel IV deal agreed in December seems less stringent than many feared, with internal risk-weighting models permitted – albeit subject to measurement against risk estimates calculated through the standardised approach.
The upshot is, there’s no such thing as perfect regulation – but Basel rules, when they are eventually fully implemented by 2027, will allow at least some room for real estate lenders to allocate varying degrees of risk across the different types of loan they write.
The drawn-out Basel process demonstrates how difficult financial reform is. But it also serves as a reminder of how important it is, including for real estate lending. The catastrophic role that property lending played in the global financial crisis cannot be forgotten and self-policing alone will not prevent it happening again.
There is a lot of knowledge and experience in Europe’s real estate banking sector and lessons have undoubtedly been learnt. Lending practises at the top of this cycle are very different from the last. The danger, however, is that memories fade, senior personnel change and individual banks do not want to be the first to forfeit market share, despite that creeping feeling that values are losing touch with market reality.
Regulation has undoubtedly clipped some banks’ wings, but the European property debt markets have evolved, with liquidity provided from alternative sources of capital. In turn, that dynamic shift is raising questions about how the non-bank lending world ought to be monitored. Sponsors might have to look outside the banking sector and pay more to source loans for riskier property strategies. However, keeping such risk out of the banking system ultimately makes it more robust.
The challenge for the industry is ensuring that regulators are aware of the nuances of real estate lending – the varying degrees of risk between different sectors, locations and types of loans – to contribute to the optimum treatment of the asset class. Influencing regulators is difficult and it is not the industry’s prerogative to decide how it is regulated, however, ongoing dialogue between regulators and bodies such as CREFC Europe and the UK’s Property Industry Alliance can help property get a fair hearing.
It will only be with hindsight years from now that the effectiveness of regulation on real estate banking becomes apparent – the consequences of a lack of regulation pre-2008 speak for themselves. Ultimately, a sensible regulatory regime is in the interests of creating a more robust and sustainable European real estate lending market as well as protecting the economy and society. Getting regulation right might be challenging but attempting to get it right is essential.
In a series of upcoming features, Real Estate Capital will examine the regulation shaping European real estate finance.
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