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What is the right amount of regulation?

As Donald Trump aims to repeal Dodd-Frank and the Basel Committee tightens its requirements, global banking regulation is in flux.

As Donald Trump aims to repeal Dodd-Frank and the Basel Committee tightens its requirements, global banking regulation is in flux.

In typically blunt fashion, US President Donald Trump has said he wants to “do a number” on Dodd-Frank, the banking regulation brought in by his predecessor to strengthen the US financial system.

Speaking to his big-hitting business advisory panel the day he signed an executive order for a review of the regulation, Trump said he expects to cut a lot of Dodd-Frank “because frankly, I have so many people, friends of mine, that have nice businesses – they just can’t borrow money”.

Trump’s “number” on Dodd-Frank will require the co-operation of Congress, so its future is uncertain. But let’s assume that it is rolled back; European real estate bankers could feel the impact.

Most obviously, it would increase the competitiveness of American banks versus European banks as their costs of capital dropped, affecting all business areas – including real estate. US property lenders already have more options than their European counterparts for getting debt off their balance sheets, with commercial loans able to be distributed through a functioning CMBS market and multifamily debt through the Fannie Mae and Freddie Mac agencies.

The future participation of the US in global banking forums such as the Basel Committee on Banking Supervision is also far from assured, with Trump’s assault on regulation unlikely to end with Dodd-Frank.

This comes as Basel moves forward with its revisions to the Basel III regulation. Basel IV could have a particular impact on how European real estate lenders do business. A key plank is replacing internal methods of calculating risk weighting with a more standardised approach, similar to the UK’s ‘slotting’ regime, in which loans are allocated to certain risk ‘buckets’ depending on key criteria.

There are valid arguments from European property lenders that the proposed Basel regulation does not adequately account for the nuances of real estate lending, with standardised allocations of risk likely to penalise certain types of lending, particularly when it comes to construction finance. Some critics point to the UK where clearing banks subject to slotting have become increasingly risk-averse.

Although the implementation of banking regulation should be subject to rigorous debate, it remains a necessity across Europe, and few real estate lenders would dispute that. While US banks have largely recapitalised since the global financial crisis, many of their European cousins are hamstrung by huge piles of non-core legacy debt, a good deal of which relates to property lending. Italy, where the government is bailing out the weakest banks, springs to mind. Although 2008 seems a long time ago, its ramifications are still being felt.

During the current cycle, real estate lending has been generally conservative. Senior lenders have been largely disciplined, sticking to 60 to 65 percent loan-to-value ratios and leaving higher-leverage lending to alternative capital providers. The amount of equity in the market has also helped to subdue borrower demand for highly leveraged loans.

But post-crisis regulation has played a key role in keeping the banking market, including the real estate banking market, in check. As we move further away from 2008, and as European banks gradually recapitalise, it is right that elements of regulation should be questioned. But the need for it remains. Some will look on the assault on US banking regulation with envy, but lessons from the past should be remembered.

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