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What is changing with Basel III?

AUTHOR

Manuel Inauen

DATUM

January 30, 2025

What is changing with Basel III?

From January 1, 2025, the final Basel III standards will come into force in Switzerland. These international guidelines are intended to make the financial system more stable and secure. The aim is to ensure that banks have more equity in high-risk transactions to cover potential losses. This set of rules applies to loans in general and therefore also to mortgages. In Switzerland, this is specifically changing the Own Resources Ordinance (ERV).

What does that mean specifically for mortgages?

In order to be able to take into account the different risks of the various types of real estate when setting up their own funds, banks must make a new distinction as to whether the loan was granted for owner-occupied residential properties, residential investment properties (other residential properties), owner-occupied commercial properties or commercial investment properties (other commercial properties). We analyse the regulations for residential properties below.

Standardised approach to credit risks

Depending on the creditworthiness of the debtor, loans must be backed by different risk weights (see Art. 72c ff Own Resources Ordinance (ERV)). The risk weighting represents the ratio of own funds, which the bank must prove, to the loan volume. A sample calculation can be found below the table.

Source: Explanatory notes on the amendment to the Own Resources Regulation

Loan level and risk weight:

The risk weightings for real estate can be found in Appendix 3 the ERV and show the differences between owner-occupied and non-owner-occupied real estate:

example:

To calculate how much own funds a bank has at a owner-occupied residential property with a loan level of 80% If you have to deposit, proceed as follows:

  1. Loan amount:
    • Loan ratio: 80% of the property value.
    • Property value: CHF 1,000,000.
    • Loan amount: 80% × CHF 1,000,000 = CHF 800,000.
  2. Risk weight:
    • According to current rules (see table): 35% risk weighting with a loan level of 80%.
  3. Risk-weighted assets (RWA):
    • RWA = loan amount × risk weight.
    • CHF 800,000 × 35% = CHF 280,000.
  4. Own funds requirement:
    • Equity ratio in accordance with Basel III: 8% of RWA.
    • 8% × CHF 280,000 = CHF 22,400.

Outcome:

The bank must CHF 22,400 Own funds deposit in order to meet the requirements for owner-occupied property with an 80% loan ratio.

Factors of the debtor and the bank also influence own funds. We are therefore looking at an abstract example here!

Comparison of owner-occupied and non-owner-occupied residential properties:In the case of a residential property that is not owner-occupied, the risk weight with the same loan is 80% according to the table 60%, provided that all requirements for the debtor and bank are met. This means that for the same loan amount of CHF 800,000, the bank has risk-weighted assets (RWA) of CHF 480,000 must start. With an equity ratio of 8%, there is an own funds requirement of CHF 38,400 compared to CHF 22,400 in the case of owner-occupied property.

Special rules for construction loans (Art. 72e, paragraph 3)

Important information for real estate investors: Construction loans and building land financing for unoccupied real estate usually receive a risk weight of 100% up to a loan ratio of 70%, provided that the requirements are met.

Compare owner-occupied and non-owner-occupied residential properties to a construction loan with 70% loan:As mentioned, a construction loan with a loan ratio of 70% has a risk weight of 100%, provided that the requirements are met. For a loan amount of CHF 800,000, the bank sets risk-weighted assets (RWA) of CHF 800,000 on. With an equity ratio of 8%, the own funds requirement is CHF 64,000, which is significantly higher than owner-occupied (CHF 22,400) or non-owner-occupied (CHF 38,400) property with the stated loan levels.

These regulations can therefore result in interest rates on development projects in particular becoming more expensive, which means that construction costs continue to rise. No change is expected for owner-occupied residential properties owned by solvent debtors.

Pros and cons of Basel III

benefits

  • Stronger financial system: Banks hold more capital to manage losses in crises and avoid insolvencies.
  • Risk transparency: Less dependence on banks' internal models promotes internationally comparable standards and facilitates control by legislators.
  • Protecting the national economy: Reduced likelihood of bank bailouts through tax money.

drawbacks

  • Higher credit costs: Banks could pass on stricter requirements to customers through higher interest rates, which is likely to affect development projects in particular.
  • Competitive disadvantage: Swiss banks could fall behind banks from countries that implement Basel III more slowly.
  • Less access to credit: Stricter credit regulations could further hamper the already low level of construction activity in Switzerland.

Basel III will make the Swiss banking system more resilient, but may make certain loans more expensive.

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