- Introduction
With the adoption of the Basel III-Reform changes to the Standardised Approach for credit risk weightings, Europe also introduced a significant overhaul of the SA regime for real estate exposures. The new risk weight treatment maintains the distinction between residential and commercial mortgages but adds further granularity according to the type of financing of the exposure (dependent or not on income streams generated by the collateralised property) and according to the phase the property is in (construction phase vs. finalised property). In general terms, residential mortgages (RE) are not contingent on income, and are subject to the same treatment, provided that the security title is valid and the additional qualitative requirements are met. The part of the exposure that exceeds 55% of the property value, after the deduction of any senior or pari passu ranking liens not held by the institution, shall be assigned a risk weight of 20%. The remaining part of the exposure, if applicable, shall be treated as an exposure that is not secured by residential property. In instances where the RE does not meet the requisite standards, it is imperative to assign risk weights in accordance with a risk-weighted table that is aligned with the Loan-to-Value ratio.
- Regulatory Framework
The new rules are set out in Articles 124 to 126a of CRR3, which have been significantly amended; these amendments were introduced as a result of the Basel III standards issued by the Basel Committee.
- Purpose of the changes in regulation
As is well known, the modernisation of the rules on credit risk weighting (and, to a lesser extent, the rules on credit risk mitigation) under the Basel III reforms proposed by the Basel Committee, aims to bring the rules governing this key aspect of prudential supervision of banks into line with the latest insights and with developments in society over the past decades. This has led to a comprehensive upgrade of the regime, creating a more modern framework that is better prepared for the future.
- Impact for the industry
If we now apply the latest rules on risk weighting for residential real estate, it cannot be concluded that, overall, there is a significant reduction in the capital requirements for such positions, despite the across-the-board reduction to a risk weight of 20% for the first tranche of the loan if the proper qualitative risk management requirements are met. The result, if all the rules are followed, leads to a slightly lower risk weight for such exposures compared with the ‘old’ regime that was in force in Europe prior to the introduction of CRR3 (i.e. before 1 January 2026). This is mainly due to the fact that if the strict rules for qualitative risk management are not met, one falls back on applying a regime that bears similarities to the old rules (in quantitative terms), but once applied, there is hardly any significant difference as regards capital requirements.
