The Federal Deposit Insurance Corporation (FDIC) recently released new guidance which allows for more scrutiny of banks' commercial real estate loans. Effective July 5, 2022, the new guidelines emphasize that banks should monitor their risk management practices and ensure that their loans align with their overall capitalization.
While this may seem minor, its impact on the banking industry is significant. Increasing the scrutiny regarding commercial real estate loans will help ensure that banks manage their loans properly and they don’t pose a significant risk to the their overall financial stability.
Read on to learn more about the FDIC's new rules and the possible implications for you or your organization.
The FDIC And Its Concerns With Commercial Real Estate Loans
The FDIC has broad authority to examine and regulate the operations of U.S. banks, including their commercial real estate loans.
In March 2016, the FDIC announced that it would begin allowing examiners to consider a bank's overall credit quality when evaluating its commercial real estate loans. This change applies to all banks, not just those deemed "systemically important" by the Federal Reserve.
The FDIC stated that this new policy is intended to help protect consumers by ensuring that banks have adequate financing for high-risk transactions.
This new FDIC policy came after years of criticism regarding banks’ heavy reliance on commercial real estate lending. In 2013, the Federal Reserve issued a report that callig for tighter restrictions and warning banks about the risks posed by too much debt.
Since then, several large banks have been criticized for frequently taking on high risk real estate lending.
Section 46 of the Federal Deposit Insurance Act allows the FDIC to take corrective measures if it determines there is a sufficient risk to the soundness of an insured institution. The FDIC has recently made use of this authority by:
- Taking possession of an insolvent bank's commercial real estate assets to sell them at auction
- Requiring that banks' commercial real estate loans be securitized by third parties
- Withholding earnings from businesses owned by financially troubled banks until they regain solvency
The FDIC has also restricted the activities of banks with poor underwriting standards, including requiring at least two independent officers approve any new commercial real estate loans, and prohibiting them from issuing loans that are secured by property located within a single development project.
Overview Of The FDIC's Policy Advocating For More Scrutiny For Banks' CRE Loans
The Federal Deposit Insurance Corp. (FDIC) recently voted to adopt a rule that significantly expands the agency's supervisory authority over risk-management practices at commercial banks and savings institutions.
These new rules will allow the FDIC to require banks to take specific actions when deciding whether to lend money for real estate projects.
The changes also require that banks respond within 30 days after receiving a notice of an issue with a loan before they report possible losses from those not performing as expected. It’s 90 days under the current provisions.
The FDIC's create the new rules to strengthen its ability to protect banks from bad real estate loans and other risks that could threaten the financial system. The changes are also designed to give regulators more time to act before a bank fails, partly by giving them a better understanding of how much money they could be lose on each loan.
The rules are part of the FDIC's ongoing efforts to ensure that institutions have appropriate systems and processes to assess risks so they don’t fail, as many did during the financial crisi.
The new rules require banks to have written policies about how much capital they need for commercial real estate financing, specifically, what types of assets they should measure, how update and the measurements, who makes those decisions, who has access to information about them (such as lenders), and what happens if someone complains about violations or errors during this process.
"The ability to take a look at all operations as necessary should be seen as an enhancement of examiners' capabilities … and not as any indication that the FDIC has concerns about anything in particular,"
How This Impacts Individuals And Organizations
As a result of this scrutiny will likely result in some banks getting rid of their commercial real estate loan portfolios, while others may take on fewer of these loans.
One major impact is that it could limit the amount banks can lend to borrowers, which means fewer loans may be available for purchasing or constructing commercial real estate projects.
Another potential impact is that lenders will require larger down payments from borrowers as well as significant collateral against default. If borrowers can’t provide the necessary down payments, they may need to seek financing from private investors or other sources. In addition, borrowers who qualify for loans will have to pay higher interest rates because of the additional risk associated with commercial real estate lending.
On the bright side, if these rules are implemented effectively, it could lower loan default rates, which will translate to fewer bank losses. Hopefully, consumers seeking mortgages or other loans from better rates and fees.
Banks and customers need to understand the implications of this change, they will be able to make informed decisions about their financial security.
Expanding the FDIC's supervisory authority is an important step toward ensuring that banks — particularly smaller banks — can manage their commercial real estate portfolios effectively and safely.
The agency's new rule will help protect the banking system by providing more effective supervisory tools to address problems with risk management at smaller banks. Requiring banks to use a risk-based approach will ensure they make sound decisions about which loans they should issue and to whom. This will help minimize problem loans and protect consumers who rely on these financial institutions for their banking needs.
Contact us to learn more about this and more.