Will Basel III Advance?
The Potential Impact on Commercial Real Estate and Real Estate Lending
By Dov Hertz
As a new administration begins to impact Washington, DC, the fate of Basel III and the prospect of its partial or full implementation has drawn increasing attention. Basel III, a set of international banking regulations developed by the Basel Committee on Banking Supervision, aims to strengthen the regulation, supervision, and risk management of banks worldwide. The new standards are designed to bolster financial stability and reduce the risk of future economic crises. However, the new rules would have a significant impact on U.S. banks, the commercial real estate (CRE) markets and commercial real estate lending.
What Is Basel III?
Basel III refers to the third phase of a series of the international banking regulations. Designed to enhance the stability and resilience of the global banking system, Basel III focuses on capital adequacy, stress testing, and liquidity. The goal is to ensure that banks have enough capital on hand to weather financial storms without collapsing or relying on taxpayer bailouts, as happened during the 2007-2008 financial crisis.
At the heart of Basel III is the requirement for banks to hold higher levels of high-quality capital. These capital reserves are intended to safeguard against potential losses from bad loans and economic downturns. While the regulation is fundamentally aimed at enhancing the safety of financial institutions, it can have unintended consequences on lending behavior, especially when capital reserves are dramatically increased.
Concerns for Commercial Real Estate
In July 2023, the Federal Reserve, alongside other key regulatory bodies like the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC), proposed a drastic overhaul of U.S. bank capital requirements, dubbed the “Basel III Endgame Regulation.” Under this proposal, major banks with over $100 billion in assets would have been required to increase their capital reserves by an average of 16%, with the largest institutions needing to raise their reserves by as much as 19%.
For the commercial real estate sector, this proposal was alarming. Banks are responsible for a significant portion of the $6 trillion in U.S. commercial real estate loans, with over half of all banks holding real estate loans as a major component of their portfolios. The prospect of requiring banks to hold significantly more capital would have reduced their ability to make loans, especially to sectors like commercial real estate, which was already grappling with tightening credit conditions.
Commercial real estate is a highly capital-intensive industry. With more than $1 trillion in CRE debt set to be refinanced or paid off by 2024 and 2025 the ability of banks to lend on favorable terms is crucial to maintaining market stability. Real estate developers and investors have feared that the increased capital requirements would lead to higher borrowing costs, reduced loan availability, or even a complete pullback in lending from smaller or more risk-averse banks.
Revisions to Basel III: A Reprieve for CRE
Following an intense public dialogue, which included meetings with Fed officials, lawmakers, and regulators, the Federal Reserve responded. In his September speech, Michael Barr confirmed that the Fed would be revising the Basel III Endgame Regulation to make it more palatable for the banking sector and, notably, for industries reliant on bank lending, such as commercial real estate.
Under the revised proposal, the maximum capital increase for the largest banks, those with assets over $100 billion, would be capped at 9%, significantly down from the 16%-19% range of the original version. Furthermore, non-GSIBs (Globally Systemically Important Banks), which have smaller asset bases, would face far less stringent increases in their capital reserves. Importantly for commercial real estate, the revised regulation would decrease the capital requirements for banks involved in mortgage lending, helping ensure that banks remain incentivized to continue providing financing for real estate projects.
The commercial real estate market encompasses everything from office buildings to retail spaces, industrial warehouses, and multifamily housing. The sector is a major driver of job creation, economic growth, and tax revenue for local governments. As such, ensuring that credit remains available for the financing of new developments and the refinancing of existing properties is crucial to maintaining the stability of the broader economy.
While the recent changes would not completely eliminate the challenges posed by Basel III, they represent a slightly more balanced approach to regulating the banking sector without excessively curtailing the flow of credit into critical sectors like commercial real estate.
Will Basel III Advance in its Current Form?
While the new administration has acted rapidly on a host of issues, the final fate of Basel III remains uncertain. Some have speculated that the rules may be delayed or further limited in coming months. The debate is far from over, and many CRE industry stakeholders continue to advocate for banking regulations that ensure financial stability while also facilitating sufficient credit to fuel economic growth, particularly in sectors like commercial real estate.