Abstract
In countries with highly-developed financial systems bank portfolios have high exposure, directly or indirectly, to the real estate sector. Changes in the value of real estate can have a potentially significant impact on the default risk of banks and on their profitability as a result of high exposure to the real estate sector. This is especially critical during real estate crises, when bank losses tend to increase dramatically, placing the entire financial system at risk of collapse, as it was the case of the recent international subprime crisis. This article studies the sensitivity of bank stock returns to real estate returns in 15 European countries. The results indicate that bank stocks are sensitive to real estate market conditions. There is a positive relation between bank stock returns and real estate returns after controlling for general market conditions and interest rates changes.
Highlights
In countries with highly-developed financial systems bank portfolios have high exposure, directly or indirectly, to the real estate sector. He et al (1996), Lausberg (2004) and Lu and So (2005), indicate the existence of a high concentration of activity and assets in the real estate sector by banks in the USA, Germany, and in some Asian countries.This way, in spite of all bank loans being vulnerable to general market conditions, the default risk on loans is influenced by a specific additional factor: bank real estate loans are affected by movements in the real estate market which are only indirectly related to the general economic conditions
Given the weight of real estate holdings on the balance sheets of banks, the objective of this study is to assess if bank stock returns are systematically affected by the real estate market conditions
The results show the existence of a positive and statistically significant relationship between bank stock returns and real estate market returns proxies suggesting that real estate risk could be a priced factor
Summary
He et al (1996), Lausberg (2004) and Lu and So (2005), indicate the existence of a high concentration of activity and assets in the real estate sector by banks in the USA, Germany, and in some Asian countries. This way, in spite of all bank loans being vulnerable to general market conditions, the default risk on loans is influenced by a specific additional factor: bank real estate loans are affected by movements in the real estate market which are only indirectly related to the general economic conditions. The existence of moral hazard, caused by high competition and the emphasis on size growth that followed the liberalization of the banking sector, and the loss of institutional memory regarding the possibility of
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