Banks exposed to downside risks as residential real estate markets get overheated, EBA Report finds

• House prices across the EU have increased substantially during 2021. This has raised concerns about overheating and the potential for significant price declines in residential real estate markets.
• Higher interest rates driven by increased inflation combined with the prospect of slower economic growth will likely put financial pressure on lower income and over-indebted households.
• These developments clearly point to higher risks in banks’ mortgage portfolios.
• Banks should follow prudent loan origination policies and enhance their monitoring of mortgage loan portfolios to identify promptly pockets of risks.

The European Banking Authority (EBA) published today a thematic note on EU banks’ residential real estate exposures. EU banks reported more than EUR 4.1 trillion of loans and advances collateralised by residential immovable property. This corresponds to 1/3 of all loans towards households and non-financial corporates.

Demand for housing has been robust in recent years. The high demand for housing reflected the low interest rate environment combined with changing preferences due to the Covid pandemic. Strong capital and liquidity positions of EU banks enabled them to fulfil, to a great extent, this demand, expanding their exposures towards mortgage loans. At the same time, supply of housing was not able to keep up with the demand due to lack of housing investments in previous years, construction constraints as well as supply-chain disruptions caused by the pandemic. As a result, in many EU countries, house prices recorded high growth rates which caused concerns of overheating markets.

The macroeconomic environment has deteriorated abruptly, and the probability of a recession has increased. High inflationary pressures and resulting increases in interest rates have driven up living costs without corresponding increases in income. This is a challenge, particularly for lower income and highly indebted households. Geopolitical uncertainty and energy crisis weigh on consumer and business confidence. Although employment rates are still high, demand for housing and real estate markets could still be affected by these developments.

Close to one third of EU banks’ loans is towards mortgages. In the last years, banks have increased substantially their exposures towards this segment. Although there are some early signs of asset quality deterioration in mortgage portfolios, such risks have not materialised yet.

There are factors that may offset the negative impact on bank mortgage portfolios in case of an abrupt decline in house prices. Banks have applied more prudent standards of loan origination and stricter risk management, thanks to enhancements in the regulatory framework and several macroprudential measures applied in the residential real estate markets. Banks currently report lower loan-to-value ratios than in previous years. Finally, some borrowers have locked-in fixed interest rates for longer periods, which protects them from the current increase in interest rates.

The current level of downside risks stemming from residential real estate exposures is increasing. Supervisors and banks should continue to closely monitor developments in the market and in mortgage portfolios. It is, therefore, important to early detect loans that are unlikely to be repaid, timely recognise and adequately provision against loan losses.

Note to the editors

The EBA publishes ad-hoc thematic notes on topics of interest besides the general risk assessment of the EU banking sector. This note analyses vulnerabilities stemming from residential real estate exposures. The note leverages on the EBA’s supervisory data as well as publicly available data sources.