Last week we reported that new banking regulations threatened the recovery of the commercial property market. Here we take a closer look at ‘slotting’ and how it affects commercial lenders and borrowers.
Over 12 months ago, the Financial Services Authority (FSA) recommended that UK banks reassess the risk levels on their commercial loan books. The Bank of England and the City watchdog were uneasy about lenders’ internal guidelines for calculating the credit risks for commercial property loans.
They believed the banks were not setting aside enough capital to cover these risks. The FSA suggested new rules that would require banks to hold more capital against loans secured against commercial property.
After the proposal was made, bankers and property companies warned that these changes may have a negative impact on commercial property values and effectively “derail the prospects of recovery.” In spite of the concerns, the FSA confirmed that all banks in the United Kingdom will be required to comply with the new capital rules.
British banks are required to switch to the new capital calculation method, which is being referred to as slotting’ for all commercial loans. The exception to the rule is if the banks can demonstrate their models for determining risk levels are already “accurate and conservative.”
Under the slotting system, all performing property loans are assigned to one of four categories called “buckets” with a risk weight ranging from 50-250 percent.
These risk weights determine how much capital must be held against potential losses on each loan. This process, which is expected to increase the cost of lending, has already started and must be completed by the time the banks report their half-year results in the summer.
The new capital rules will mean higher borrowing costs for commercial property investors and developers.
Some projects under consideration outside of London may have to be scrapped it has been warned.
The system is also expected to be tough on landlords in the regions, who are already dealing with economic uncertainty and falling property values.
Industry experts have warned that the move will serve to increase the gap between the value of properties in London and those located in other regions of the United Kingdom.
It may even decrease the likelihood of economic recovery.
The banks also have concerns that tougher regulations will restrict their ability to offer financing for new property development.
Phil Tily, the managing director of real estate group IPD recently observed that the decision to introduce slotting for banks means the door will be opened to alternate lenders, such as specialist debt funds and insurers.
He stated, “The problem is that a lot of these are not covered by the FSA, or other watchdogs, so they risk pushing property lending into an unregulated sector.”
With many predicting that this year will see a bottoming out of the market before the beginning of the recovery stage, any legislation that may hinder this process will not be welcomed by the industry.
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