An area of acute concern for the Financial Policy Committee is lenders’ reluctance to admit to the losses they are likely to make on commercial real estate, which accounts for about half of all corporate lending.
Andrew Haldane, FPC member and the Bank of England’s executive director for financial stability, said on Thursday: “Our recommendation has been with an eye, in particular, to the commercial property market.”
Commercial real estate loans are particularly susceptible to losses because of high loan-to-value ratios. A fifth of outstanding debt is on properties worth less than what companies owe the banks. Many loans need to be refinanced and more than a third are already subject to forbearance, leaving banks exposed if credit conditions were to tighten.
Andrew Bailey, who is on the FPC and heads bank supervision at the Financial Services Authority, has expressed concerns. He told the FT in October that banks’ methods for assessing risks posed by commercial property loans were “bogus”.
Mr Haldane said a portfolio-by-portfolio examination of British banks’ loans held on commercial property overseas had raised additional fears. “Six months ago, we said it was already the case then that there was some degree of underproviding on commercial property loans,” he said. “And having looked at some portfolios outside of the UK, we think that the extent of that provisioning might be greater still.”
Mr Bailey said last month that transactions in the sector were so large and so idiosyncratic it was all but impossible to build models to determine whether an individual loan would default and what the losses might be.
Banking supervisors have told banks they plan to change the rules for determining how much capital they will have to hold against the sector. Rather than rely on their own models, banks must use “slotting”, in which loans are assigned to categories with specific capital requirements attached. A final version of the categories is expected next year.