The Bank of Estonia (Eesti Pank) has urged caution on the part of two significant banks in issuing home loans and instigated specific requirements for the two banks in particular, in order to mitigate risk against any potential future downturn and at a time when the real estate market is particularly active.
The central bank has retained a requirement that Swedbank and SEB have to apply a risk weight of at least 15% of their portfolio of housing loans when calculating the need for capital to cover risks relating to mortgage loans issued in Estonia.
The risk weight floor currently applies to Swedbank and SEB in Estonia, since they assess risk assets using internal models in which the risk calculation is affected a great deal by earlier loan losses, the central bank says.
This threshold does not apply to the other commercial banks, as these generally use a simpler standard approach in Estonia, where a fixed and uniform risk weight of 35% is used for mortgage loans, when calculating risk exposures for capital requirements.
The Bank of Estonia said it took on board lessons learned in the previous economic crisis in 2010, including by introducing three requirements for housing loans in March 2015, which protected both borrowers and banks from excessive risk-taking.
The three requirements are that the Loan to Value (LTV) rate may not exceed 85%, that all the monthly loan and lease payments of the borrower taken together may amount to only 50% of a borrower’s net income and that terms may not be longer than 30 years.
With respect to SEB and Swedbank, the central bank applied the terms in autumn 2019 and said they remained necessary at a time when the housing market had been buoyant and many home loans had been issued, following the 2020 coronavirus crisis.
The second quarter of this year in fact saw a record number of real estate deals concluded.
The central bank says its aim in this is to make sure that banks have sufficient capital to cover the risks from mortgage loans.
Loan losses on housing loans have been modest in recent years, meaning banks have been taking into account less capital to cover risks, which in turn makes risk weights reflecting the riskiness of the mortgage loans fall further.
However, a hedge against another economic downturn, homeowners struggling to make their loan repayments and a fall in real estate prices is needed, the central bank says, and which in turn would impact banks themselves.
Banks need sufficient capital both for their own health and when finding solutions for clients facing arrears on payments, the central bank says, citing as an example of the latter loan payment holidays permitted in the early stages of the pandemic. (ERR/Business World Magazine)
