Signs of growing worry about the seemingly unstoppable rise in the price level of German residential housing are becoming increasingly apparent at the country's two financial watchdogs, the BaFin and the Bundesbank. The two institutions, particularly the Bundesbank, have been making jittery statements about the market on practically a monthly basis for some time now. As a result, lending banks are now being compelled to build in a further 2% capital reserve against their lending to the residential property market.
As part of its general ruling on the markets in February, the Bonn-based BaFin increased the ratio of banks' countercyclical capital buffer to 0.75% of risk-weighted assets. This had been lowered to zero percent in the wake of the COVID-19 pandemic from its earlier level of 0.25%.
BaFin has now also introduced a new sectoral systemic risk buffer, effective from 1st April, which is specifically intended to hedge against residential real estate lending. Banks will be required to set aside 2% of their residential real estate financing from their equity capital, from its current level of zero. This will have the effect of making loans more expensive, in addition to the higher charges to borrowers resulting already from already increased interest rates.
Banks will be granted a transition period to comply with the new higher risk puffer requirements, although they have to be fully compliant by February 2023.
The introduction of the capital buffers follows on from analysis by the Financial Stability Committee (AFS), which includes representatives of the Federal Ministry of Finance, the Bundesbank and BaFin, as well as the European Systemic Risk Board, all of whom are concerned about the upward pressure on residential property prices.
BaFin CEO Mark Branson had said back in January that the aim was to preventively strengthen the resilience of the German banking system: "With a view to financial stability, it is now time to switch to prevention mode," he said.
He said he was not expecting a credit crunch. The amount of residential lending outstanding amounts to €1.6 trillion, and banks would be able to shoulder the extra burdens, he said. The counter-cyclical capital buffer would amount to €17 billion, while the sectoral systemic risk buffer would come to €5bn. Most banks had enough capital for this, with only a little having to be newly accumulated, he said.
The German banks and the real estate industry are not as sanguine as the financial watchdogs. The lending banks commented in a collective statement: "The increase in capital requirements across the board will significantly restrict the lending capacity of banks and savings banks," they said. Activating the counter-cyclical capital buffer would be tantamount to pulling on the handbrake, and hampering their new business underwriting.
Their views were echoed by the ZIA, the central lobbying association for the real estate industry. ZIA sees an imminent tightening of credit as a result of the banks having to deal with the sectoral systemic risk buffer plus the simultaneous increase of the countercyclical capital buffer. ZIA president Dr. Andreas Mattner said: "Such measures have a counterproductive effect and take us a big step away from the German government's self-declared goal of building 400,000 new flats a year."
Jürgen Michael Schick, President of the German Real Estate Association IVD also indicated the banks were likely to pass on their higher costs to both new and follow-up business. He added, "In view of the banks' minimal overall loss rate on residential real estate loans, we find BaFin's move frankly incomprehensible."
Representatives of the real estate industry also believe the measures will have little effect in putting a brake on the housing market, with the extra 2.75% equity capital being held by the banks in reserve from February 2023 merely likely to lead to deteriorating lending conditions for bank customers.
According to Reiner Braun, CEO of research consultancy Empirica, the measures are "probably most likely to hurt potential owner-occupiers,.who already have financing problems and in particular too little equity." Those most likely to be affected - if at all - are those buying single-family homes. The market for multi-family housing, which are mainly bought by equity-rich investors, would likely be unaffected. For big institutional investors, little will happen as long as the interest rate effect remains low, and the banks don't radically change their lending policies, he believes.
Dr. Louis Hagen, CEO of Münchener Hypothekenbank in his day job, and also President of the Association of German Pfandbrief Banks, naturally downplays the possible effects of banks' passing on higher charges. Most banks are sufficiently capitalised and do not need to raise new capital, he said. For them, the higher capital requirements would not have a significant impact on their lending conditions. "Of course, it is possible that there will be the odd institution that will need additional equity capital and will allow the higher cost shares to flow into the loan conditions. However, I do not believe that this will have a significant influence on market interest rates," said Hagen.
If the banks do feel tempted to pass on the charges, this is likely to play further in to the hands of alternative debt lenders, who have been making inroads into the lending space traditionally occupied by the banks. Whole loan and mezzanine lenders have been increasing their market share as the banks increasingly look to cherry-pick the most attractive lending opportunities.
If prices of residential housing continue to rise faster than rents - which they have been doing - the financial authorities have the power to introduce even heavier measures, such as introducing new upper limits on LTVs. Germany already has strict regulations for the granting of residential property loans - as anybody who's ever tried to borrow money can testify - in the form of the Regulation on the Determination of the Mortgage Lending Value (Beleihungswertermittlungsverordnung) and the Residential Property Credit Directive (Wohnimmobilienkreditrichtlinie). In addition, the implementation of elements of Basel III, with its equally strict capital requirements, is still pending.
The ZIA believes there are more productive ways of dampening down price inflation in residential real estate - and these involve the focus on creating more housing to meet real demand. "All in all, these measures will hit the real economy and thus also the real estate industry hard", it says. "A measured and evidence-based approach to systemic risks would therefore be the more appropriate instrument when introducing further capital measures, instead of a blanket setting of sectoral capital buffers."
