Large Banks Unaware of Risks from CRE Exposure

Regulators could be downplaying the threat that commercial real estate (CRE) represents for the largest banks in the US, according to a paper by a team of academic researchers.

The ‘Shadow Always Touches the Feet: Implications of Bank Credit Lines to Non-Bank Financial Intermediaries’ paper found that the risk CRE exposure poses to large banks has not received the necessary attention or capital.

CRE exposure could have a greater impact on US community banks because they hold a higher proportion of direct loans compared to large banks with more than $100 billion in assets.

However, many regulators fail to recognize that large banks also have a significant indirect exposure to CRE through credit lines provided to non-financial entities, specifically real estate investment trusts (REITs), according to the paper.

These credit lines are only reflected on banks’ balance sheets when they are utilized, which makes it easier to underestimate the related credit risk.

The study in the paper found that when credit lines to REITs were included, CRE exposures at the nine largest banks in the US more than doubled.

Further analysis revealed that the required capital for the ten largest US banks rose from $39 billion to $69 billion once indirect REIT exposures were considered, which represents a 75% increase.

The paper also said banks with larger REIT credit line commitments also tend to have lower stock returns during crises, without benefiting from higher returns in stable market conditions.

According to the authors, this is because REITs are more susceptible to market stress compared to other non-financial borrowers.

Viral Acharya, a co-author of the paper, said: “Most people, when thinking about commercial real estate, only consider the risks associated with loans on banks’ balance sheets.

“But, in reality, banks and non-banks are always connected — you can’t fully grasp the size of the looming CRE crisis without considering non-banks drawing down their credit lines from banks.”