Banks are increasing their commercial real estate (CRE) exposure as signs of another robust boom in CRE activity become evident in many markets nationwide. At the same time, regulatory scrutiny over all but the largest banks is about to ease following Congress passage of new legislation amending the restrictive Dodd-Frank regulations.
The CRE market is inevitably cyclical and more volatile than other sectors, so this report focuses on three sources of vulnerability stemming from CRE lending: (1) increased concentration of CRE loans at small and medium-sized banks, (2) the changing composition of bank CRE lending, and (3) the shifting geographic concentration of bank CRE lending.
Our analysis shows that changes in bank CRE lending practices have limited—but not eliminated—the risks to the banking system. Moreover, CRE concentrations at the bank level have risen significantly in the last five years.
Key takeaways:
Banks engaged in commercial real estate (CRE) lending on average are less risky now than they were before the 2008 Great Financial Crisis. Since the crisis, bank CRE lending has shifted away from the riskier category of construction lending and toward relatively safer loans for nonresidential commercial property and multifamily housing. Since the crisis, many of the banks that did not modify their past CRE lending strategies and practices have failed.
Nevertheless, many banks with large CRE loan portfolios remain vulnerable, especially small and medium-sized banks where lending is likely to be geographically concentrated. CRE lending as a share of total assets among medium-sized banks has grown beyond pre-crisis levels. Consequently, as deregulation reduces scrutiny of these banks, they may become increasingly susceptible to risks stemming from the highly cyclical and relatively volatile CRE sector.
It is likely that harmful spillover effects from banks CRE lending exposures also are geographically concentrated. Localized risks may be greatest in places with relatively high dependence on local banks for funding—generally smaller towns— and among those banks where capital has not kept pace with the rapid growth in CRE lending.
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