ADC Exposures Under Capital Requirements Regulation (CRR)

On May 17, 2024 a consultation paper outlining prospective standards for acquisition, development, and construction (ADC) exposures to residential property was posted by the European Banking Authority (EBA). The purpose of this action is to make clear the circumstances under which financial institutions might give these kinds of loans a reduced risk weight. ADC exposures are classified as a new kind of credit risk under Article 126a of the Capital Requirements Regulation (CRR) that is connected to mortgages on real estate. These exposures often have a 150% high risk weight.

Institutions can, however, reduce this to 100% if they fulfill specific requirements that lessen the credit risk. According to Article 126a(2) of the CRR, these requirements include having a sizable percentage of pre-sale and pre-lease contracts, sizable cash deposits, or obligor-contributed equity to the property's worth at completion. The purpose of the EBA's proposed recommendations is to give these risk-reducing requirements precise language while taking into account the particulars of lending to non-profit and public housing organizations throughout the EU. The rules cover these organizations, which are governed by national laws and function as long-term housing providers and social service providers, in order to make sure their needs are sufficiently met.

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[1]

Capital Requirements Regulation (CRR): EBA Report

The EBA released a report on interdependent assets and liabilities under Article 428f of CRR, examining NSFR compliance. Such activities have no funding risk, potentially exempt from stable funding requirements if conditions are met. EBA monitors and suggests policy changes to the Commission.

GrandAlessandro Micagni

[2]

Capital Requirement Regulation (CRR): EBA RTS

EBA’s consultation on the Capital Requirements Regulation (CRR) is pivotal for banks, especially in the EU. It addresses changes in risk models under FRTB, impacting risk management and capital requirements.

GrandAlessandro Micagni

Comments Submission on the EBA's ADC Exposures Draft Guidelines

ADC exposures to residential property are the subject of a draft set of guidelines that the European Banking Authority (EBA) is requesting stakeholders to comment on. In order to improve the guidelines and make sure everyone is satisfied, this consultation procedure is essential. Clear and fact-based input is crucial, and the EBA has provided detailed instructions and important topics for comment submission.

• Procedure for Submission: By August 19, 2024, click the "send your comments" button on the consultation page to send in your thoughts. Please be aware that comments sent in after the deadline or through other channels might not be reviewed.

• Publication and Responses' Confidentiality: Kindly specify in the consultation form whether you want your feedback to be kept private or public. We may be asked to provide a private response in compliance with the EBA's guidelines regarding public document access. Should we get such a request, we might speak with you. The European Ombudsman and the EBA's Board of Appeal have the authority to review any decision we make not to reveal the response.

• Data Security: Regulation (EU) 1725/2018 of the European Parliament and of the Council of October 23, 2018, serves as the foundation for the protection of individuals with regard to the processing of personal data by the EBA. Additional details on data privacy are available on the EBA website under the Legal notice section.

With this methodical process, the EBA is guaranteed to receive constructive criticism that will improve the final ADC exposure recommendations.

EBA's Harmonized Framework for ADC Exposures Under Basel III

Article 4(1), point 79 of Regulation (EU) 575/2013 (CRR), which describes the EU's application of the Basel III framework, presents a new definition for exposures related to acquisition, development, and construction (ADC). Based on their increased risk, these exposures usually have a risk weight of 150%, as stated in CRR Article 126a. Institutions may, however, use a lower risk weight of 100% if certain risk-reduction requirements are satisfied.

Under Article 126a(3) of the CRR, the European Banking Authority (EBA) is responsible for defining certain risk-mitigating requirements. Important requirements include sizeable cash deposits, comparable financing, suitable equity given by the obligee, and a sizeable share of the total contracts. Significant cash deposits, for example, are subject to specified thresholds: ten percent minimum for pre-sale contracts and three times the monthly rent for pre-lease contracts.

Only installment payments and segregated funds are available as equivalent financing; these funds are forfeited upon contract termination. A minimum of 35% of the equity must come from the obligations. If 50% of pre-sale/sale or pre-lease/lease contracts satisfy certain requirements, the percentage of total contracts is deemed noteworthy. One of the EBA's mandates is to take non-profit organizations and public housing's particularities into account. These organizations may choose a particular framework with alterations such as lower cash deposit requirements and modified penalty terms. By guaranteeing a uniform approach throughout the EU, these standards create parity and transparency in own funds obligations.

Key Conditions for Applying Reduced Risk Weights to ADC Exposures Under CRR

Acquisition, Development, and Construction (ADC) exposures are a new class of credit exposures defined by Article 126a of the Capital Requirements Regulation (CRR). These exposures are high-risk by nature and usually have a risk weight of 150%. However, if certain credit risk-reducing requirements are met, institutions may apply a 100% reduced risk weight to ADC exposures to residential property. These recommendations address the particular requirements of public housing and non-profit organizations while providing comprehensive standards for these conditions, guaranteeing a uniform approach throughout the EU.

• Large Cash Deposit: If pre-sale or pre-lease contracts include a sizeable cash deposit, ADC exposures can benefit from a reduced risk weight, encouraging contract fulfillment and reducing default risks. The deposit must be large enough to guarantee the agreement or cover any potential drops in market value in the event that the agreement is terminated.

• Guaranteed Funding in a Comparable Way: Equivalent financing methods, such as segregated cash accounts or installment payments, which are both forfeited in the event of a contract termination, are accepted in lieu of cash deposits. Similar risk reduction as direct cash deposits is ensured by doing this.

• Considerable Share of All Contracts: A sizeable percentage of contracts must be pre-sale or pre-lease with sizeable deposits or similar finance in order to be eligible for the 100% risk weight. This ensures the project's marketability and lowers the risk of lower-than-expected cash flows.

• Sufficient Amount of Equity Contributed by Obligors: A significant portion of the obligor's equity must go toward the ADC project. This equity sustains the property's worth following completion and helps offset unforeseen losses, including upgrades made at the obligor's expense.

• Lending to Non-Profit Organizations or Public Housing: The guidelines provide a specialized framework with modified standards, such as lower cash deposit levels and broader financial equivalency definitions, in recognition of the special role played by public housing and non-profit organizations. This guarantees that, in meeting the demands for social housing, these companies can also profit from lower risk weights.

Financial institutions can routinely apply lower risk weights to eligible ADC exposures by adhering to these rules, which will help to create a stable and uniform financial environment throughout the European Union.

Compliance and Reporting Obligations for EBA Guidelines

This document's guidelines are in compliance with Article 16 of Regulation (EU) No 1093/2010, which requires financial institutions and competent authorities to make an effort to follow them. The European Bank's (EBA) perspective on appropriate supervisory procedures and the implementation of Union law in the European System of Financial Supervision is reflected in these guidelines. It is anticipated that competent authorities will incorporate these guidelines, where applicable, into their legal frameworks and supervision procedures.

In terms of reporting, Article 16(3) mandates that competent authorities provide the EBA with a status report on their compliance by a given date. Notifications must be provided by authorized people and must state whether the authority complies with the criteria, aims to comply with them, or gives an explanation if it does not. To maintain transparency, these alerts will be posted on the EBA website.

Criteria for Appropriate Amount of Obligor-Contributed Equity

In order for the residential property to satisfy the requirements outlined in Article 126a(2)(b) of the CRR, the equity contribution made by the obligee to the property's final value must be no less than 35%. This contribution can take the form of money, grants, subsidies, unencumbered marketable assets, cash outlays for development or construction, as well as land or upgrades that are specifically related to the project. To ensure that the obligor has a major stake in the project's success and risk mitigation, these investments must provide the obligor a residual claim that is subordinated to any claims from the financing institution.