Time to slot shared database into property risk weighting system

Real estate is a tricky asset class. For two years now the Financial Services Authority – which has been regulating banks and other lenders – has been trying to push UK banks to ensure that they are holding enough capital in reserve to withstand downturn-level losses on their real estate loans.

The regulators justifiably doubt the banks’ internal methods for calculating this: they were clearly shown to be flawed during the last downturn.

However, as Investment Property Databank’s independent study shows, the FSA’s own proposal – slotting – is also flawed and  has the potential to produce very serious collateral damage.

This report comes at a good time. Two years ago, the banks – with notable exceptions – were in denial about the inadequacy of their risk-weighting systems. The FSA, meanwhile, was entrenched in its view that its version of slotting was the only way to sort out the mess and bring some stability into property lending.

Since then, both sides have moved,  if painfully slowly. Bankers Real Estate Capital has spoken to accept that slotting is here to stay and want to make it work. For its part, the FSA – which is being folded into the Bank of England – has backed off from a potentially dangerous guillotine for introducing slotting and is taking a hard look at how the system can be improved.

For the benefit of the whole real estate market, the decision about how slotting can be improved should be made as urgently as possible. At the same time, this flap about banks’ property lending and how to control it has highlighted another fundamental issue: the largely inadequate data on their loans.

Talk to anyone who has carried out due diligence on a bank’s loan portfolios and they will have hair-raising stories of basic information that is simply not there, or which can only be pieced together with great effort.

This black hole is particularly astonishing given that real estate is the third biggest asset class and – as we have already seen at least twice over – lending against it  has the potential to bring down the UK financial system.

The obvious answer is for UK banks to pool their data and give it to an independent third party to analyse. Institutions, REITs and funds have done this with their direct property holdings for 25 years. So why not lenders?

The benefits of doing so are obvious: sharing the costs of a single databank would be far cheaper for them than each building and managing their own one, while a pooled databank would also provide a much more complete picture of the UK lending market and how it is performing. Banks could see how their loan books performed relative to the wider market. And finally, it would give the regulators some reliable hard data on real estate lending to monitor.