This is due to the fact that many smaller banks rely heavily on CRE lending as a source of revenue, and these loans can be especially hard hit by situations such as the economic downturn caused by the current crisis.
CRE loans are typically subject to higher default rates than residential loans, even during economic downturns. During periods of economic distress, such as what we are currently experiencing, interest rates tend to rise, making it more difficult for borrowers to keep up with payments. This can lead to higher delinquency and foreclosure rates as borrowers struggle to make payments on the loans they have taken out.
Smaller banks are also more exposed to potential losses from CRE loans due to their lack of diversification. While large banks often have multiple sources of revenue, smaller banks rely primarily on CRE lending to stay afloat. This absence of other income streams, combined with their reliance on CRE loans, means that any losses from defaulted loans can be especially damaging to smaller banks.
Moreover, the current economic slowdown has caused further distress to CRE loans, resulting in increased defaults and delinquencies. Since many smaller lenders are exposed to higher levels of risk due to their CRE lending focus, they are particularly vulnerable to potential losses from this type of loan.
In order to protect themselves from potential losses related to CRE lending, smaller banks should consider diversifying their sources of revenue. By expanding into other forms of lending, such as residential mortgages or consumer loans, smaller banks can reduce their exposure to CRE loans and limit their potential losses. Additionally, banks should consider increasing their reserve requirements, so that they have additional funds available in the event of a default. Finally, they should regularly review their portfolio of CRE loans and take steps to ensure that they are not overexposed to any particular sector or property type.
The coronavirus pandemic has had an unprecedented effect on the economy and is posing unique risk to smaller banks with a concentration of commercial real estate loans. Leverage ratios for CRE loans are typically higher than those for residential loans, leading to increased default and delinquency rates in times of economic distress. Furthermore, smaller banks that rely heavily on CRE lending as their primary source of income are particularly exposed to potential losses from loan defaults. In order to minimize their risk, smaller banks should look for ways to diversify their sources of revenue and consider increasing their reserve requirements. Additionally, they should regularly review their loan portfolios to ensure they are not overexposed to any particular sector or property type. With these measures in place, small bank lenders can better manage their risk and remain resilient despite the economic uncertainty brought on by the pandemic.
This article was contributed on Jul 26, 2023
