Probability & Partners: Competition for Dutch Residential Mortgages and CRR3

11 februari 2025

By Pim Poppe and Yusi Wang, respectively Managing Partner and Service line lead Capital Regulation at Probability & Partners

Capital requirements, along with risk and return, are important drivers for the attractiveness of investments. If the regulator of a subset of financial institutions is more prudent than others, asset classes will move to financial institutions with lighter capital requirements. In this light, it might be interesting to take a closer look at what CRR3 might entail regarding residential mortgages.

Dutch mortgages have long been an attractive asset class due to their stable and predictable income streams, combined with historically low default rates. For pension funds and insurance companies, in particular, Dutch mortgages align well with their long-term liabilities, as the duration of mortgage loans often matches the long term horizons of their obligations.

In recent years, Dutch mortgages have also gained additional appeal as they offer an effective way to integrate ESG ambitions. By adjusting mortgage pricing and shaping the composition of their mortgage portfolios, investors have been able to align their investments with sustainability goals, making this asset class even more relevant in the context of green finance.

Impact of CRR3 on the mortgage market

The competition for Dutch mortgages as an asset class has always been intense, driven by strong demand from banks, pension funds, and other institutional investors. However, regulatory changes are increasingly shaping this competitive landscape. In particular, differences in regulation across institutions and jurisdictions are becoming a critical factor.

The introduction of the Capital Requirements Regulation III (CRR3) raises important questions about how these changes will influence the mortgage market. The CRR3 will be implemented in phases starting on January 1th 2025. CRR3 is expected to affect capital requirements for banks, potentially altering how Dutch mortgages are valued, funded, and managed. This evolving regulatory environment will likely have significant implications for the competitiveness and attractiveness of Dutch mortgages as an asset class for banks and might create additional opportunities for insurance companies, pension funds and other asset owners.

The CRR3 introduces new methodologies for calculating the capital charge on real estate properties, including residential and commercial real estate. The new methodology is more risk-sensitive and imposes stricter requirements for real estate assets to benefit from preferential capital treatment.

ECB Banking Supervision has been focusing on banks’ credit risk management in recent years, with particular emphasis on residential property risks, which are more sensitive to the current macro-financial situation and exposed to refinancing risk. Consequently, residential property will remain an ECB supervisory priority from 2025 to 2027, with a specific focus on provisioning, loan origination, and collateral valuation. Banks have been investing considerable efforts in meeting all the supervisory expectations. According to the press, large banks in the Netherlands had to ‘remediate’ their organizations to get to compliance. These have been large and expensive exercises.

Capital Impact and Competitiveness

The capital impact of the new CRR3 rulebook varies across different bank types and depends on portfolio quality. In general, EU banks will see an increase in capital requirements for residential mortgage portfolios due to the new rules. In particular, the capital impact is greater for banks currently using IRB models for capital calculation, as the introduction of the output floor limits the capital benefits of internal models. Additional capital requirements must be allocated to these products, even though the underlying risk has not increased.

This creates an additional disadvantage for banks regulated by EBA and supervised by ECB compared to insurance companies or banks supervised by UK or US supervisors.

The capital increase can lead to a lower return on risk-adjusted capital (RORAC). Banks may face upward pricing pressure and potentially stricter lending criteria for their mortgage products due to increased capital requirements. This makes the mortgages offered by banks less attractive to customers looking to finance a home. This further creates pressure for banks to remain commercially attractive in the mortgage market.

Mitigating the capital or business impact is not easy. While most banks take traditional approaches, such as adjusting their risk appetite and pricing strategies, some consider securitizing residential mortgages to free up capital that would otherwise need to be held against these loans.

There is also an increasingly unlevel playing field in capital regulations within the banking sector, particularly between European, US, and UK banks. While the EU and many other jurisdictions are committed to implementing the Basel IV agreement's capital requirements by January 2025, the UK regulator, PRA, has recently decided to postpone its Basel IV implementation to January 2027 to align with the US’s intended implementation in July 2025. This could potentially lead to weakened competitiveness of EU banks if UK lenders are able to attract EU mortgage borrowers, depending on cross-border lending rules.

Challenges for banks and the role of non-bank lenders

The growing popularity of non-bank lenders has already been a long-standing trend in the Dutch mortgage market. With slightly different business models, key players like Nationale-Nederlanden Group, ASR, Aegon Hypotheken, Munt Hypotheken, and Vista Hypotheken have established themselves as major competitors. Their competitive advantage lies in their reliance on institutional funding, such as investments from pension funds and insurance companies, as well as regulatory changes that have constrained banks’ ability to expand their mortgage portfolios.

Additionally, their specialization in providing efficient, competitive, and customer-centric mortgage solutions has allowed them to capture significant market share. This rise of non-bank lenders has increased competition, improved terms for borrowers, and diversified the market, thereby reducing dependence on traditional banks.

The pressing question now is what will happen once the new, even more restrictive regulatory framework for European banks - the Capital Requirements Regulation III (CRR3) - is fully embedded into client rates and business decisions. These stricter rules could further erode European banks’ competitiveness in the mortgage market, potentially amplifying the role of non-bank lenders or reshaping the market dynamics significantly.

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