Macro environment points to higher risks in EU banks’ mortgage portfolios

EU banks mortgages

The European Union’s banks are exposed to downside risks as residential real estate markets get overheated, a new report finds.

EU banks reported more than EUR 4.1 trillion of loans and advances collateralized by residential immovable property, the report published by the European Banking Authority (EBA), finds. 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-19. 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. 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, the report says. 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.