Banking watchdog increases scrutiny on commercial real estate lending
Canada’s top banking regulator is increasing scrutiny on how the country’s largest financial institutions are managing their commercial real estate portfolios amid rising interest rates that are creating vulnerabilities in the sector.
“Commercial real estate (CRE) is highly cyclical with the potential for significant losses, especially when risks are not effectively managed,” the Office of the Superintendent of Financial Institutions said in a Sept. 29 notice.
“In the current rapidly evolving risk environment, high inflation and rising interest rates have increased the potential for a rise in the number of borrower defaults.”
OSFI said the notice is in response to the regulator’s ongoing supervisory work in the heightened risk environment and is intended to provide “interim” regulatory guidance to make sure lenders are adequately managing the risks in commercial real estate lending including underwriting, account management, and portfolio management.
This includes establishing limits on the level and type of risk a financial institution is willing to accept when it comes to commercial real estate loans, a broad asset class that includes loans secured by income-producing real estate used for business purposes such as shopping malls and office buildings and loans extended to build or acquire them, loans for residential real estate with five or more units such as apartment buildings where repayment depends on sale or rental income, and real estate held for lease to third parties.
The assessment of the risks related to these loans “should be forward-looking and consider both normal and stressed scenarios,” OSFI said.
Financial institutions should be conducting annual borrower review processes, but OSFI said these should be
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