UK Basel 3.1: Credit risk standardised approach – real estate exposures


On 12 September 2024, the Prudential Regulation Authority (PRA) published the second part of its near-final rules on the implementation of Basel 3.1 standards through Policy Statement 9/24 (PS9/24) which offers feedback on the responses received on Consultation Paper 16/22 (CP16/22) published on 30 November 2022.

PS9/24 covers inter alia the near-final rules on credit risk, disclosures, and reporting as well as minor clarifications and corrections to the previous near-final rules published within PS17/23. The implementation date for Basel 3.1 standards has also been postponed to 1 January 2026.

A brief summary of the changes relating to ‘real estate exposures’ under the credit risk standardised approach is provided below.


Key changes to real estate exposures, under the standardised approach, include:

  • A new exposure class (‘real estate exposures’) replaces the existing ‘exposures secured by mortgages on immovable property’ and ‘speculative immovable property financing’^

  • More granular classification, based on exposure type, into ‘regulatory real estate’^^, ‘Acquisition, Development and Construction (ADC)'^^^ and ‘other real estate’ categories.

  • Risk weight ranges from 20% to 150% depending upon exposure type and other factors.

  • Residential real estate exposures to natural persons where a currency mismatch exists are subject to a risk weight multiplier of 1.5, subject to a maximum risk weight of 150%.

—————————————————————————————————————————-
^ Currently reported under ‘Items Associated with Particular High Risk’ (Article 128).

^^ ’Regulatory real estate exposure’ should meet all the following requirements:

  • it is finished, or it is a self-build exposure;

  • there is legal certainty on claims;

  • the exposure is secured by a first charge [except if the conditions in Article 124A(2)(c) are fulfilled];

  • the value of the property does not materially depend on the performance of the borrower;

  • the property is adequately insured; and,

  • it is prudently valued.

^^^ An exposure to a corporate or special purpose entity financing any land acquisition for development and construction purposes or financing development and construction of any residential or commercial real estate.


A summary of the revised classifications and associated risk weights is given below:

* The relevant counterparty risk weights are 75% for retail SMEs and 85% for corporate SMEs.

** Risk weights based on LTV:  If the Bank does not hold a first charge, the RW shall be the LTV-based RW multiplied by a factor of 1.25 if the LTV > 50%.

*** If the Bank does not hold a first charge, the RW for the entire exposure will be 100% (LTV ≤60%); 125% (≤60% LTV ≥ 80%); or, 137.5% (LTV > 80%).

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‘Residential real estate’ means a property that predominantly has, or will have, the nature of a dwelling and where the property satisfies the applicable laws and regulations enabling it to be occupied for housing purposes.

Exposure is treated as materially dependent on the cash flows generated by the property, if:

- For residential real estate - repayment is considered materially dependent, unless:

  • exposure secured by the borrower’s primary residence;

  • borrower meets three property limit;

  • social housing exposure - public housing company, or not-for-profit association; or

  • an exposure to an association or cooperative that is exclusively dedicated to providing its members with primary residences in property securing the loan.

- For commercial real estate - by default be treated as materially dependent, unless the property is used for own business purpose (annual assessment required).


Existing and revised classification and risk weights:

* The relevant counterparty risk weights are 75% for retail SMEs and 85% for corporate SMEs.

# If the Bank does not hold a first charge, the RW shall be the LTV-based RW multiplied by a factor of 1.25 if the LTV > 50%.

@ If the Bank does not hold a first charge, the RW for the entire exposure will be 100% (LTV ≤60%); 125% (≤60% LTV ≥ 80%); or, 137.5% (LTV > 80%).


How We Can Help

Banks may face a variety of challenges when preparing for Basel 3.1. At Katalysys, we have a deep understanding of prudential regulatory requirements both from the perspective of rules and practical implementation. Our team is already supporting a range of clients in this area, and includes:

  • Workshops or training to cover new requirements.

  • Gap and impact analyses.

  • Guidance on implementing industry best-practice in relation to the Basel 3.1 standards.

  • Documenting or updating assumptions and interpretations in regulatory reporting.

  • Preparation of regulatory reporting policies and procedure notes.

  • Validation of the system outputs and calculations.

  • Review of regulatory returns, including post-implementation of Basel 3.1 changes.

 For more information, please contact:

Josh Nowak

Managing Director, Risk & Regulatory Consulting

T: +44 (0)7587 720 988

E: josh.nowak@katalysys.com

Manish Patidar

Director, Regulatory Consulting

T: +44 (0)7766 001 643

E: manish.patidar@katalysys.com


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