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Real estate capital requirement rules 'won't work' – EC report

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EUROPE - An expert committee convened by the European Commission has urged higher capital requirements on real estate lenders, suggesting current holdings of risk-weighted assets are low compared with the losses incurred by past real estate-driven crises.

In a report published this week, the committee, chaired by Finnish central bank governor Erkki Liikanen, also backed an earlier proposal that regulators be given powers to cap maximum loan-to-value (LTV) ratios.

"In the past, LTV values well over 100% significantly fuelled the build-up of real estate credit and pricing bubbles," said the report.

"National regulation to allow authorities to set up LTV caps and EU-level harmonisation of the actual definition and use of such restrictions should be a priority in the further development of an effective set of macro-prudential tools."

Liikanen's committee implied that recent regulatory attempts to settle capital requirements had been too soft.

"While banks' loss absorbency will increase, it is unclear that the new capital rules will be sufficient to limit trading risks or incentives for excessive real estate (and other) lending," it said.

In contrast to CRD IV's introduction of a countercyclical buffer that left national authorities to adjust risk weights for exposures based on national cycles, the report called for a coordinated European effort "to foster greater consistency of model outcomes and to impose more conservative parameters where needed".

Likewise, it recommended augmenting Basel III's capital requirements with additional measures including non-risk-based capital cushions.

"Capital requirements will address the risks linked to real estate lending only to the extent that competent authorities make proactive use of the possibility to modify real estate risk weights based on the economic cycle," the report said.

Despite a reading of the financial crisis already described as "simplistic" by critics, Liikanen's committee stopped short of claiming higher capital requirements would prevent another bubble.

"Real estate bubbles have consistently put the banking system in peril over the years," it said in a footnote.

"Addressing real estate bubbles probably requires the use of several instruments, [including] prudential policy and monetary policy."

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