Delay slotting to develop new finance vision, PIA says

The Property Industry Alliance is warning that a “hasty” and “forced” introduction of slotting regulations on UK banks could set up a downward spiral in property values.  It is calling for an industry-wide review “to develop a vision for real estate financing”.

Slotting, the classification system the Financial Services Authority wants UK banks to use to calculate how much capital they have to set aside to cover losses on property loans, “is a key regulatory risk”,  PIA says in its latest report on UK commercial property debt risk.  “Forced slotting will reduce lending banks’ ability to hold existing commercial real estate debt and offer new commercial real estate loans.

“We suggest that there should be a full impact assessment on the banking and real estate markets and economy as a whole, to avoid a potentially unnecessary, but foreseen, dramatic impact on the banking and real estate markets.”

The FSA wants UK banks to use slotting because it does not think the internal risk models they have used to decide how much capital they need to put aside when making real estate loans are fit for purpose.  Consequently, it has adopted a strategy of talking to banks individually to get them on a “glide path” to slotting.

But the PIA believes the slotting system is too blunt an instrument when it comes to allocating capital against property loan risks; for example, that it imposes too high a capital requirement on high-quality investment loans.

“If a risk model could be developed which meets the minimum criteria for approval by the FSA, then this would avoid many of the issues”, the PIA notes.   “Indeed now might be a very good time to reflect on the levels of risk inherent in real estate loans, both to support the development of better risk models and to capture data to enable better management of the next property cycle.”

The PIA is also seriously concerned that UK banks will now start to increase significantly their rate of foreclosures on property loans, flooding the market and triggering a downward spiral in property values. This would not only undermine the value of the collateral in their loan books, but also hit the value of the institutional-grade portfolios held by pension funds and insurance companies.

“A key question is whether banks have made adequate provision against existing property loans”, the PIA says.

Alex Catalano, Consultant Editor