After the warning of the European Systemic Risk Board (ESRB) less than a week ago, it is the turn of the European Central Bank (ECB) to issue its warning this Wednesday, February 16: according to it, the real estate market presents major vulnerabilities threatening eurozone banks. On the one hand, the demand for office real estate is falling with the rise of teleworking, and on the other hand, the indebtedness of individuals is swelling with their desire to acquire more spacious properties after the long periods of confinement.
“Targeted” review of a sample of highly exposed banks
Admittedly, the risks of a real estate bubble fueled by the policy of extremely low or even negative interest rates and by a very flexible prudential policy have long been spotted by central bankers. Corn in his latest newsletter to date, the ECB seems to be really worried about thecommercial real estate and theresidential real estatespecifying in passing that these two sectors will be subject to closer surveillance.
It considers that the exposure of banks to the commercial real estate markets constitutes a major vulnerability,” announcing in passing the establishment of a “targeted review” aimed at a sample of banks particularly concerned.
Possible increase in provisions for credit risk
According to the ECB, the effect of teleworking would combine with the massive rise in e-commerce to weaken commercial real estate (offices and shops):
“The increase in remote working and online shopping could lead to structural changes in the office and retail market, with rents expected to fall in the medium term. This could weaken the financial position of borrowers and lead to higher credit losses for banks that have a high proportion of bullet loans, fully unsecured loans or non-recourse loans. »
She specifies:
“If market prices go down, the value of bank guarantees will also drop. This means higher loan-to-value ratios and, therefore, may require banks to increase their provisions to cover credit risk. »
Exposure to CREs high in Germany, France and Italy
Banks’ exposures to the commercial real estate sector are significant, notes the ECB in its letter: around 8% of the supervised banks’ total loans and more than 20% of their total corporate loans.
In absolute values, exposure to commercial real estate (or CRE for Commercial Real Estate) are particularly high in Germany, France and Italy. In other countries such as Cyprus, Slovenia and Estonia, their relative size is large, with CRE exposures representing more than 40% of total corporate loans.
The residential real estate sector (or RRE for Residential Real Estate) is also caught in this trap: if we combine the potential overvaluation of house prices on the one hand and the rise in household debt on the other, we can fear the medium-term effects of probable price corrections.
In detail, support measures during the pandemic have helped to maintain household incomes, while favorable financing conditions have allowed households to obtain financing for the purchase of a home at interest rates historically low. But the demand for housing has swelled as teleworking has tended to encourage individuals to seek a larger living space. As a result, while residential construction has picked up, labor and material shortages along with global supply chain bottlenecks have weighed on the construction sector’s ability to increase production. housing supply, housing prices have soared. But as price and loan dynamics outpace household income growth, household indebtedness rises, and there is also an increased risk of collateral overvaluation and price correction over the medium term. This adds to the banks’ medium-term vulnerabilities.
According to ECB figures, total loans and advances to households secured by residential property increased by 3.6% between September 2020 and September 2021. In contrast, total loans and advances to businesses and households did not increased by only 1.7% over the same period.
Dysfunction of supply chains and energy transition
Regarding the prolonged problems in global supply chains caused by the pandemic which have caused a significant increase in construction costs, the ECB warns that banks whose portfolios contain a high level of exposures to properties under construction will be more at risk.
The ecological transition is also a factor to be taken into account. In the EU, buildings account for around 40% of energy consumption and 36% of greenhouse gas emissions, and around 35% of its buildings are over 50 years old. The real estate sector, particularly commercial, is therefore highly exposed to climate-related transition risk.
Real estate bubble ?
On February 11, it was the CERS that sounded the alarm. The ESRB? This is the body set up by the European Union in 2010 to avoid the return of the gigantic financial crisis of 2008, hence its name in extension, the “European Systemic Risk Board”. And systemic risk there could be because the strong demand for housing in Europe, linked in particular to very favorable borrowing conditions, is driving prices up and increasing the financial fragility of the sector.
For example, in Germany, where studies estimate between 19% and 23% the overestimation of the price of housing, the CERS recommends in particular to impose a binding limit on the ratio relating the amount of the credit to the purchase value of the housing. The higher this ratio, the greater the risk of the loan.
Past ESRB recommendations do not always produce the expected effects, as evidenced by several countries (Denmark, Finland, Luxembourg, Netherlands and Sweden), “the vulnerabilities have persisted despite recent measures put in place to address them”notes the Committee.
In five other countries, including France, the ESRB considered on the contrary that a policy “appropriate and sufficient” helped calm the situation. Last year, the number of mortgages increased by 4.6% in France, according to the CSA/Credit Logement observatory.
This phenomenon of overheating is spreading, warned, already last November, Luis de Guindos, Vice-President of the ECB:
” There is no definition of “bubble”. You know there is a bubble when it bursts. But our position is clear: sn the residential real estate market, there are clearly pockets of price overvaluation that go beyond the fundamentals. And this trend has continued during the pandemic. So far, it has been a localized phenomenon, but it is becoming more and more general in the euro zone,” he explained to Les Echos in an interview. reproduced by the ECB on its website.