Eesti Pank continues to require caution from two large banks to reduce the risks from housing loans
Eesti Pank has kept in place the requirement that Swedbank and SEB Pank have to apply a risk weight of at least 15% of the portfolio of housing loans in calculating the need for capital to cover the risks from mortgage loans issued in Estonia.
Eesti Pank considers that the requirement that has applied since autumn 2019 remains necessary because notably more housing loans have been issued this year than earlier and so systemic risk in this area has not diminished. The central bank’s aim in this is to make sure that banks have sufficient capital to cover the risks from mortgage loans.
The loan losses on housing loans have been very small in recent years. As a result the model-based assessment of larger banks allows them to calculate less capital to cover the risks, meaning the risk weights reflecting the riskiness of the mortgage loans have been reduced further. It is not impossible though that the economy could perform substantially worse in the future. If the economy is facing hard times, it becomes more difficult for people to repay their loans, while real estate prices could drop sharply. These problems coinciding could significantly increase the loan losses of the banks. The floor for the risk weights is an important tool for Eesti Pank in ensuring that the banks hold sufficient capital if the economy turns down.
The central bank considers it very important that the banks in Estonia hold enough capital, as this allows them to cover the loan losses that could occur in a recession and to keep issuing new loans at the same time. Banks with sufficient capital are also able to help find solutions for clients facing arrears on payments. The first year of the Covid-19 pandemic gave a good example of this, as the banks operating in Estonia offered broad payment holidays and so made it easier for businesses and households to survive the initial shock.
The risk weight floor currently applies to Swedbank and SEB Pank in Estonia, as they assess risk assets using internal models in which the risk calculation is affected a great deal by earlier loan losses. The floor does not apply to the other commercial banks as they use the simpler standard approach in Estonia, where a fixed and uniform risk weight of 35% is used for mortgage loans in calculating risk exposures for capital requirements.
Eesti Pank learned the lessons of the previous economic crisis by introducing three requirements for housing loans in March 2015 to protect both borrowers and banks from excessive risk taking. The three requirements are that the amount borrowed may not exceed 85% of the value of the real estate used to secure it, all the monthly loan and lease payments of the borrower taken together may amount to only 50% of the borrower's net income, and housing loans may not be issued for more than 30 years.
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