Financial Stability Note: Property funds and the Irish commercial real estate market

• Financial Stability Note outlines that property funds’ investment in Irish commercial real estate has brought risks as well as benefits, which supports the need to explore possible macroprudential policy interventions
• Macroprudential policies including the mortgage measures and bank capital requirements have protected borrower and bank resilience despite the exceptional shock of the pandemic
• Central Bank to conduct multi-year macro-prudential policy framework review across three pillars: the mortgage measures, the bank capital regime, and market-based finance

Today the Central Bank of Ireland has published a Financial Stability Note “Property funds and the Irish commercial real estate market”. The Note explores how Irish property funds’ investment in Irish commercial real estate has grown in recent years.

Speaking on Friday at a virtual workshop on Borrower Finances, Financial Stability Assessment and Macroprudential Policies, Deputy Governor, Sharon Donnery highlighted the findings of the Financial Stability Note, “The growth of Irish property funds since the Global Financial Crisis has brought with it many benefits, including the diversification of financing channels for Commercial Real Estate away from domestic investors towards international investors and a reduced reliance on debt financing intermediated by Irish retail banks. This increases risk sharing and reduces domestic interconnectedness. However, an implication of this structural trend is that it increases the sensitivity of the Irish Commercial Real Estate market to global shocks.”

Ms Donnery continued “More broadly, given the growth of Irish property funds in recent years, the resilience of this form of financial intermediation matters more today for the overall functioning of the Commercial Real Estate market than it did a decade ago. The analysis in the Note supports the need to explore possible macroprudential policy interventions in this area, such as leverage limits and options to limit liquidity mismatches, to strengthen the property fund sector’s overall resilience to potential future shocks.” Concluding that “developing a comprehensive macroprudential framework for the non-bank sector remains an important priority for the Central Bank.

The Deputy Governor also spoke about how macroprudential policy measures implemented in recent years had enabled the financial system to absorb rather than amplify the shock of the pandemic.

Reflecting on the effectiveness of the mortgage measures, she said “Looking at the Loan to Income and Loan to Value ratios, which are the instruments regulated by our measures, we see clear evidence that higher debt burdens have been associated with greater payment break take-up. For example, those borrowers with an LTI of 4 were twice as likely to opt for a payment break as those with an LTI between 2 and 2.5, reflecting the link between borrowing levels and repayment difficulties.” Counterfactual analysis also shows that “house price levels could have been approximately 25% higher in the year prior to the pandemic had the mortgage measures not been in place”.

Ms Donnery also discussed bank capital measures noting that reforms introduced since the last financial crisis, had improved the quantity and quality of capital on bank balance sheets globally. She discussed the stark contrast in Ireland between capital levels in the banking system at the start of the pandemic relative to 2007, when banks were wholly incapable of absorbing the financial crisis. By contrast, bank capital levels have remained above regulatory minimum levels since last March, with minimal evidence for damaging reductions in credit supply.

Despite the progress, the Deputy Governor noted that the “operating environment for our macroprudential regime is constantly evolving, and at certain junctures, a deeper review of our frameworks is necessary”. Ms Donnery outlined that in 2021 and into 2022, the Central Bank will conduct a multi-year macro-prudential policy framework review across three pillars: the mortgage measures, the bank capital regime, and market-based finance.

Note

The Financial Stability Note entitled “Property funds and the Irish commercial real estate market” was written by Pierce Daly, Kitty Moloney and Samantha Myers.

Deputy Governor Donnery’s full address entitled Macroprudential Policy – Lessons in the Pandemic Era” can be read in full here.