Life is an inherently risky business. From the moment we are born (itself a vey risky process) until the moment we die we are subject to constantly varying degrees of risk in everything we do. Of course, for much of the time, much of the risk may simply be ignored, but there times when something more than passivity is needed. In these cases it seems to me that there are three approaches: that of normal, sensible folk which is to be careful and take out suitable insurance; that of the Americans which is to assume that all accidents or adverse happenings are preventable and find somebody to sue afterwards; and that of the politicians and allied trades which is to legislate and regulate risk out of existence, an undertaking as prone to success as King Canute’s tidal management (which, to be fair, even he said would not work). And thus to an interesting property talk last week at DTZ which asked whether new regulations will help the European banking sector overcome the crisis and, in particular, what this is likely to mean for real estate lending.
As I have written here before (Trust, The Crisis) moral failure was at the root of the banking crisis and it follows that there is a limited amount regulation can do to make up for the lack of probity which allowed personal gain to be put above prudent management of risk, be it the risks faced by the banks themselves or the way risks were transferred to unwitting customers or counter-parties through the sale of complex derivative instruments the true economic effect of which few seem really to have really understood. Be that as it may, one of the answers is more regulation (although, oddly, not the return, it appears, to the separation of banks’ commercial lending from their own account investment bank trading activities) including the regulations set out in Basel III. These strengthen bank capital requirements and introduce new regulatory requirements on bank liquidity and bank leverage, designed, of course, to reduce overall risk. This is not the place for a detailed summary of Basel III but it seems – as a gross over-simplification – that Basel III (whose requirements are to be implemented over the period 2013 to 2019) does not encourage the taking of risk in real estate. Which is all very well, you may say, but what does it mean in practice, in Poland?
Polish banks are unlikely to be dramatically affected as they already exceed the required minimum capital ratios. However, of more significance for Poland is the fact that as many Polish banks are foreign owned, they have relied on intra-group cross-border financing and it these “corridors of liquidity” which the new regulations have shut down as capital has migrated to the foreign parents to shore up their capital needs and which has caused liquidity problems here. The local regulators in Poland would like Polish banks to take more responsibility for risk taking in the local market rather than for this to be driven by the needs of the foreign parents. Because banks will have to hold more capital, real estate lending will become more local and, since banks will need to take longer term financing which is at higher cost to the banks than the short term financing obtained by way of retail deposits, longer term real estate lending might be encouraged. Polish banks will take up some – but, perhaps, not all – of the slack caused by the withdrawal of foreign real estate lenders, particularly for development (as opposed to investment) financing.
Interestingly, while the banks grapple with Basel III, which causes banks to decrease the risk weighting of real estate loans, one of the effects of the EU’s Solvency II Directive may well be to lead to insurance companies filling the lending gap as Solvency II, in effect, encourages lending and discourages owning of real estate. Insurance companies have always been active in the real estate investment market but it is not yet clear what their expectations as to returns will be as lenders: for banks it is simply LIBOR (or whatever) plus x per cent, but for insurance companies?
In summary, the effect of all this new regulation, seems to be that more real restate lending in Poland will be by Polish as opposed to foreign banks, new institutions will enter the real estate lending market but since GDP growth is slowing, and it is always risky to lend in a declining market, overall lending activity will decline (which itself contributes to a decline in GDP). But who really knows – after all, predicting the future is the riskiest business of all.