Austrian Federal Economic Chamber, Division Bank and Insurance
Using “expected evolution in immovable property market prices and the expected volatility in those prices, including an assessment of the uncertainty around these expectations” (lit. e) and “expected evolution in meaningful macroeconomic key variables that could affect the solvency of borrowers, including an assessment of the uncertainty around these expectations” (lit. f) seems rather unfeasible for a forward looking horizon of up to three years due to the unpredictability of sudden events (like e.g. Corona outbreak in early 2020 and its consequences of the real estate markets that are unclear till today). Further “other data indicators and sources” (lit. i) shall be specified in advance – otherwise ex-post observations cannot be included in the expectations.
Including climate risks in the determination of the loss expectation for collateral (mainly real estate assets) would duplicate their consideration. Chronic climate risks have already to be included in the valuation of the collateral assets and are reflected in the market values used for the collateral in the credit decision process. Further, several of these risks (mainly flood, landslide and avalanches) are covered by primary or secondary insurance of the collateral assets.
Pillar 1 risk estimates resulting from IRB models are not intended to mimic a stress test but should still be appropriate for an economic downturn in accordance with Article 181(1)(b) CRR. In this context, Par. 1 of Article 2 should, in our view, clarify when introducing the concept of “macroeconomic imbalances impacting on LGD estimates beyond the economic cycle” that those are reasonably to be expected and not reflect severe stress scenarios.
In our view, the following considerations should additionally be taken into account when assessing the appropriateness of minimum LGD values according to Par. 2 of Article 2:
• The calibration of minimum LGD values should not be procyclical in nature as this may ultimately pose a risk to financial stability rather than supporting it.
• Apart from their adequacy for an economic downturn, in accordance with Article 181(1)(a) CRR, LGD estimates are calculated based on long-run averages of realized LGDs with historical observation periods as broad as possible containing data from various periods with differing economic circumstances. Additionally, according to Article 181(1)(e) CRR, LGD estimates taking into account the existence of collateral shall not be solely based on the collateral’s estimated market value and take into account the effect of the potential inability of institutions to expeditiously gain control of their collateral and liquidate it. In this context it should be considered by the authorities in their assessment whether the macroprudential imbalances are already sufficiently reflected in the historical observation period or covered by the general requirements specific to own-LGD estimates, in which case they would already be reflected in the LGD estimation.
As regards Par. 2(e) of Article 2, the purpose of the benchmarking analysis should be better explained, i.e. it is intended to identify unwarranted systematics in LGD estimates induced by the specific macroeconomic imbalances rather than by the banks’ compliance with legal requirements on LGD estimation. In fact, banks should be encouraged to give priority to the remediation of potential deficiencies in the estimation of risk, while setting macroprudential requirements in such a situation would appear to be the wrong supervisory tool. Otherwise, unintended incentives could be set for the banks, impacting the further development of their underlying IRB models.
Due to various ongoing new regulatory reporting requirements (Basel III+, Basel IV, COVID), we would like to avoid any additional new initiatives which increase the regulatory reporting burden on the banking sector.
Moreover, we would like to point out that both EBA in drafting RTS and the authorities in applying the future rules have to bear in mind and take into consideration the build-in buffer Art 125 and 126 CRR entail for exposures fully and completely secured by mortgages when assessing the appropriateness of risk weight for immovable property.
In detail, Art 125 para 2 (d) CRR requires that the part of the loan to which the preferable 35% risk weight is assigned does not exceed 80% of the market value of the property in question or 80% of the mortgage lending value of the property (residential property). Art 126 para 2 (d) CRR mirrors this requirement for commercial immovable property, meaning the preferable 50% risk weight part of the loan must not exceed 50 % of the market value of the property or 60 % of the mortgage lending value.
Therefore, the CRR as standard already requires buffers (20% residential, 50%/40% commercial immovable property) for the value of the property securing an exposure. I.e. even in case of the event that the residential immovable property market is overheating and real estate is overvalued e.g. 20%, the requirement of Art 124 would still ensure the full securitisation of the exposure.
CRR II mandate given to EBA/ESRB
The mandate given to EBA does neither require the application to all exposures regardless of the time of origination (before or after the final delegated act will be published), nor does it exclude the possibility to increase risk weights or impose stricter criteria to newly originated exposures (no retroactive application).
The CRR II according to Art 124 para 4 (and Art 164 para 8) mandates EBA in cooperation with ESRB to develop Draft RTS to specify inter alia the types of factors to be considered for the assessment of the appropriateness of the risk weights referred to in Art 124 para 2. According to para 2, the authority may increase the risk weights applicable to exposures within the ranges of
• 35-150% for exposures secured by mortgages on residential property;
• 50-150% for exposures secured by mortgages on commercial immovable property;
or impose stricter criteria than those set out in Art 125 para 2 or 126 para 2, where the authority concludes that the risk weights set out in Are 125 para 2 or 126 para 2 do not adequately reflect the actual risks related to exposures to one or more property segments fully secured by mortgages on residential property or on commercial immovable property located in one or more parts of the territory of the Member State of the relevant authority, and if it considers that the inadequacy of the risk weights could adversely affect current or future financial stability in its Member State.
Application to stock and new or only new is a factor to be considered for the assessment of the appropriateness
With this in mind, we believe the Co-legislators gave EBA the necessary flexibility to specify either the criteria authorities will use in their assessment whether increased risk weights are appropriate. This includes the possibility to assess, where the financial stability makes it necessary to increase risk weights, whether all exposures should be subject to increased risk weights or whether it is sufficient to increase it e.g. just for newly originated exposures.
We believe applying restriction/increases to exposures originated after publication of the final act should be the default opinion for authorities where increasing risk weights or imposing stricter criteria is necessary as it would be the more proportionate measure. In general, entities addressed by regulatory requirements should be able to rely on regulatory requirements in application at the time of origination.
Adequate reflection of actual risks
It can be assumed that risk weights and requirements currently applicable sufficiently reflect actual risks for exposures secured by mortgages on immovable property. However, we understand that circumstances in the financial or real economy might swiftly change in the future and authorities must be provided with the right tools to address risks to the financial stability.
(In)adequacy of risk weights considering the current or future financial stability
Coming back to the EBA mandate in Art 124 CRR II, the mandate requires authorities to consider whether the inadequacy of risk weights could adversely affect either the current or future financial stability.
The decision of “application to originating exposures” meaning that the stock will remain subject to the former risk weight and “all exposures including the stock” as the more impactful variant should considered examples of the reflection of “time” as one of the criteria used in their assessment whether increased risk weights are appropriate
Text suggestion to be included in Draft RTS
“Article 3a Assessments for application regarding the time component
The types of factors set out in Article 1 or the conditions set out in Article 2 may be applied by an authority referred to in Article 124 (1a) and in Article 164 (5) of Regulation (EU) No 575/2013 to exposures originated after [insert … e.g. 12 months after publication of the final delegated act in the OJEU] or all exposures taking into account the current or future financial stability in its Member State, as appropriate.”
Furthermore, we believe that some form of “balancing mechanism” should be introduced. In detail this would mean where the authority has decided to increase the risk weights applicable to exposures, an individual identified exposure would not be subject to the increased risk weight if the institution can demonstrate that the exposure secured by immovable property is oversecured in equal proportion.
E.g.: authority A in member state M decides to increase the risk weight for newly originated exposures fully and completely secured by mortgages on residential property to 70% (instead of 35%). The exposure amount is 400.000 EUR while the market value of the immovable property is 1 million EUR. The credit institution may apply a preferred risk weight of 35% for the full exposure as the exposure is oversecured in equial proportion (if the authority had not have increased the risk weight, market value of 500.000 EUR would have been sufficient (80% of the exposure amount, default according to Art 125 para 2 CRR- however, the risk weight has been increased by 100%, in order to have the preferential treatment the market value has to increase by 100%, meaning the part of the loan to which the preferable 35% risk weight is assigned must not exceed 40% (half of 80%) of the market value).
RTS should only apply to new exposures originating after the publication of the final delegated act
We advocate to ensure that any possible future measure regarding the risk weight of immovable property must be limited to newly originated exposures. This would prevent unwarranted risk weight increases, furthermore we are of the opinion that legacy exposures would be disproportionately overvalued as in particular mortgage loans are concluded with a duration of several decades. Over the time, the over securitisation of the exposure will increase as the credit claims is reduced due to repayment and the value of the immovable property will typically be increased.
Limiting the scope of possible future risk weights
The EBA Draft RTS refer to the EBA Guidelines on subsets of exposures in the application of a Systemic Risk Buffer (EBA/GL/2020/13) in its Art 1. In this vein, we believe it is crucial that any possible future measure regarding the risk weight of immovable property must be targeted and tailored to the specific sectors which materialise the risk.
Sufficiently long enough period of observation regarding loss experience
We advocate for refining the definition of the loss experience used by the EBA Draft RTS in order to ensure that the period which is used to determine loss experience is long enough to provide meaningful data, i.e. at least three years. A minimum period of three years would in our opinion ensure that the assessment can be done using stable data and prevent distorting results. However, we believe for the same reason that “statistical outliers” should not be considered or at least the outliers should be taken into account appropriately for the assessment of higher risk weight according to the EBA Draft RTS.
Relation to funding the green transition
The Commission considers financial institutions to have a key role in funding the transition while housing does contribute significantly to GHG emissions. Therefore, authorities should be cautious to not jeopardize the green building transition it their assessment whether increased risk weights are appropriate. We want to raise awareness that in the light of the far reaching initiatives by the European Union and the commitment of its Member States to mitigate climate change according to the Paris Agreement granting loans to finance the green transition of the economy must be ensured and therefore any increase of risk weights for exposures fully and completely secured by mortgages should be avoided.
Austrian Federal Economic Chamber, Division Bank and Insurance