A senior economist from the European Central Bank has sounded a note of calm about the institution’s stance on the risks posed by European lenders’ exposure to the commercial property sector.
During a keynote interview at the PERE Network Europe Forum Event on April 16, hosted by PERE, Livio Stracca, deputy director general, macro-prudential policy and financial stability at the ECB, played down previous notes of concern from the Frankfurt-based institution about the risks posed by the sector.
Stracca said the central bank’s concern about lenders’ property exposure at this point was not extreme. “Overall, so far, we have not found very worrying situations,” he said.
The ECB’s greater focus currently, in terms of risks posed by the real estate sector, is on the liquidity of the open-end property funds industry, he explained. He also said private real estate debt funds are not a currently a high concern for the bank, although he added the wider private credit sector is becoming increasingly evaluated.
In March, Bloomberg reported ECB vice-president Luis de Guindos said the ECB still views commercial real estate contagion as one of the main risks for European financial stability and is actively monitoring the situation.
However, speaking at the PERE event this week, Stracca said risk from real estate bank lenders was of lower concern to the ECB than the risks posed by the real estate investments of non-bank financial institutions.
“In the banking sector… the aggregate exposures are not large. Around 5 percent of loans are exposed to real estate,” Stracca said. “But, of course, they are concentrated. So, there are some individual intermediaries that have been highly exposed.
“You never know how financial turmoil starts. You can never be so complacent. It can always be the case that the failure of a particular intermediary will trigger contagion.”
“Markets also work a lot by psychology, so it’s not necessarily the case that you can say ‘this bank is small and therefore there’s no risk.’ Crises can start from every corner, so even if the aggregate exposure is not worrying at all, still of course you can always have a trigger for turmoil.”
Some German “mono-liner” banks, which specialize in real estate, are “suffering more than others,” Stracca said, meaning the situation in Germany is more tense than in other eurozone nations. However, Stracca expressed his belief the banking sector is “well prepared,” with high capital ratios.
“In commercial real estate, we have seen rising losses. But due to the fact the exposure is not that large, and the banks are better capitalized, the overall effect has not been very large.”
Rather, according to Stracca, the liquidity of open-end real estate investment funds is an area of more concern. “For the non-bank [financial institutions] sector, the biggest issue is the open-end real estate funds. It’s a liquidity issue. In some European countries, 40 percent or more of the commercial real estate market is controlled, held, by real estate funds.”
“So of course, you have these illiquid assets and liquid liabilities. We have seen, in Austria, exceptionally high redemptions. So, this liquidity mismatch is a concern. It’s a sector over €1 trillion, so it’s not a marginal one.”
While the ECB has an eye on risk from the real estate investment funds sector, Stracca said private real estate debt funds are not currently a significant concern for the bank. He did, however, explain the wider private credit industry is coming more into the ECB’s purview, and will be the focus of a feature in the ECB’s next financial stability review, in June.
“Private credit is estimated to be [a market of] €100 billion, so less than one tenth of the real estate funds. It’s true it’s very opaque, so we don’t know much about it. So, we are looking at it, it’s important, but I don’t think it’s a big risk in the real estate sector in particular. Much of this [is] not concerned with the real estate sector.
“Private credit doesn’t seem to be a key concern for the real estate market. The real estate funds, the liquidity mismatch seems to be a more important factor.”
An increased regulatory focus on the private credit industry is not likely in the near future, Stracca said. “We are sticking to learning about it and trying to understand the data. On that space, I would not expect any short-term initiatives,” he said. “My sense is [we are in] a phase of understanding, not yet the phase of regulatory initiatives.”
On concern about real estate investment funds, he added: “There is not yet a proposal on the table, but the Financial Stability Board has already made recommendations, [and] the commission is about to publish the macro-prudential review, which we are told will include something on investment funds.”
Potential rate cuts
Stracca spoke at the PERE Network Europe Forum days after the ECB’s governing body kept interest rates stable for a fifth consecutive time. Comments by ECB president Christine Lagarde were interpreted by some as an indication of a potential rates cut as early as June.
Stracca discussed what the governing body will be considering between now and the next rates decision. “It all depends on the inflation outlook. Inflation has come down in some parts, the goods sector, food and so on. But in other parts, services inflation is quite persistent. Wage data are encouraging in the sense that wage growth is moderating but the data is patchy, so we need to see further data. Overall, [data] confirming that inflation really is going persistently down, particularly in services, will be the key factor.”
The eurozone narrowly avoided recession in Q4 2023, with zero growth, following a mild contraction in Q3. However, Stracca denied recession is inevitable. “It’s totally avoidable. The economies are recovering, and the growth projections are going up. So, I cannot exclude it for sure, but I don’t think it’s likely we’ll have a recession.”
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