The Real Estate Market Risk of Banks - Revisited

Abstract

Real estate lending is a risky business. There is ample international evidence of heavy bank losses or even failures that have resulted from defaulted real estate loans. It is especially during real estate crises that losses tend to rise dramatically, sometimes to the extent of endangering the banking system as a whole. Lenders do not appear to possess all the instruments required for managing all the risks inherent in real estate loans. One reason may be that the nature of real estate risks is not yet completely understood. Especially the real estate market risk, i.e., the risk arising from a market downturn (as opposed to the risk associated with an individual property), has not been fully researched and so is usually not adequately managed. This article sheds some light on the nature of the real estate market risk of financial institutions, provides evidence of its significance and describes the status quo and likely advances in risk management in this field. It is an update on an earlier paper by the author (see: Lausberg, 2001) and also examines what changes the New Basel Capital Accord, also known as Basel II, has brought about.