Another Questionable Decision by The Federal Reserve

The Federal Reserve last Thursday released a proposal that would implement a global agreement known as Basel III. This agreement is a regulatory standard that proposes minimum capital requirements and liquidity standards for all financial institutions worldwide.

I know what you’re thinking as I was thinking it too: I’m tired of reading another boring article on banking regulations. But I would encourage you not to delete this blog post before you get a “view from 35,000 feet” on how Basel III is going to impact the commercial real estate industry. It could have an enormous adverse impact on our industry if not implemented gradually.

From our perspective the most egregious new implementation being proposed by Basel III is assigning a higher risk weight to commercial real estate loans of 150%, up from a current risk weight of 100%. How does that affect the bank? The more risk, the more capital that’s required by financial institutions to have on hand as a buffer. So the more they lend on commercial real estate the higher their capital requirement. If they lend on other assets, home loans or businesses for example, they will not be required to hold as much in reserve.

So what do you think the banks are going to do when this new rule is fully implemented? Do you think they will lend more or less on commercial real estate? Of course, the tendency will be to lend less. And how do you think in real terms that will be done? I think there will be fewer banks lending on commercial real estate and those that do will find a plethora of ways to make it that much more difficult to get a loan approved and closed (as if we need more banking regulations to slow down the loan approval process).

This isn’t me just “crying wolf.” Fitch Ratings estimated last week that the world’s 29 largest banks will need to raise another $566 billion by the end of 2018 to meet these new international liquidity requirements against risk. Where is that going to come from?

I wonder why they consider commercial real estate so risky? The Great Recession was brought about by a housing bubble and lax underwriting standards for qualifying borrowers of home loans, not because of excesses in the commercial real estate industry. So why pick on us? Why make commercial real estate the scapegoat? The Federal Reserve needs to think this through and figure out what the ramifications are to our economy if this is fully implemented. Basel III ultimately means less lending on commercial real estate which means a slower economy which means fewer people being employed.

I’m all in favor of reforming the banking industry (remember I’m in favor of Dodd Frank) but increasing the risk weight for commercial real estate may be over the top. There’s got to be someone on The Federal Reserve Board of Governors who has enough common sense to understand this and has the courage of his convictions to push back. Don’t you think?

Sources: Basel III, Wikipedia; Fitch Ratings: World's Biggest Banks May Need To Raise $566 to Comply With New International Rules, Huffington Post, June 7, 2012; Fed ups capital buffer for commercial real estate, Market Watch, The Wall Street Journal, June 7, 2012; Federal Reserve unveils Basel III bank capital proposal, The Economic Times, June 8, 2012.