UK Banks OK, But U.S. And China Property Woes Could Hit Market, BoE Says

Problems in the U.S. and Chinese banking systems created by struggling property markets in those countries pose a risk to UK financial stability, the Bank of England said in a report published this week. 

While UK banks do not have significant exposure to U.S. office loans or the Chinese residential development sector, fallout from those markets could be felt globally, the BoE warned in its latest financial policy summary.

“Some risks have already started to crystallise, most notably in commercial real estate markets globally and in the mainland China property sector,” the Bank said in its summary. 

“CRE prices have fallen sharply in many advanced economies and could fall further, leading to losses for creditors,” it added.

“A number of smaller banks with significant exposures to CRE, in jurisdictions such as the U.S., the EU and Japan, have seen large reductions in their equity prices. Stresses in exposed banks could affect UK financial stability through a number of channels, including macroeconomic and financial market spillovers, contagion to funding conditions for UK banks, and a reduction in overseas finance for the UK CRE sector leading to further downward pressure on UK valuations.”

Financial stability spillovers from the adjustment to the mainland China property market have largely been limited so far, but significant downside risks remain, the Bank said.

“The Chinese authorities have provided support but the adjustment in the property sector, alongside broader structural trends, is likely to weigh on growth in China for some time,” it wrote in its summary. “More widespread crystallisation of risks in mainland China could lead to more pronounced spillovers in Hong Kong. Spillovers could also affect the UK and other countries.”

The two largest domestic lenders to UK CRE, Lloyds Banking Group and NatWest, do not have any significant exposure to U.S. commercial real estate, unlike German peers like Aareal and Deutsche Pfandbriefbank, which took significant write-downs on U.S. office loans in their full-year results. 

UK CRE loans in default rose from 3% to 4% in the first half of 2023, the most recent period for which data is available, according to research from Bayes Business School. That represents an increase of 33% but falls well short of the 25% of loans that were in default during the 2008-2009 financial crisis.