How well are Swiss banks prepared for a real-estate mortgage crisis?

Swiss Financial Market Authority FINMA is concerned about risks in the domestic real estate and mortgage market. In a recent guidance (20220522-finma-aufsichtsmitteilung-02-2025.pdf), FINMA warns that many banks in Switzerland tend to apply loose affordability criteria in their internal credit policies, and too often, grant loans which do not meet the standards that the banks have set themselves. In addition, FINMA provides insightful results from their mortgage stress tests. Our comparison of these results with the bank’s regulatory capital requirements shows that the Swiss banking sector is well capitalized to withstand a severe domestic real estate crisis.

High portion of Exception to Policy (ETP) loans

Loans that do not meet a bank’s internal credit criteria can be granted in justified cases. Decisions to lend in deviation of the bank’s credit standards (so called exceptions to policy – ETP) need to be comprehensible, verifiable and documented, and ETP loans need to be flagged accordingly. The proportion of ETP loans provides a natural indicator for a bank’s risk appetite. It should therefore be closely monitored by the board of directors.

FINMA observed that the portion of ETP-loans accounted for roughly 25% to 30% of the loan volume in the years 2018-2014, based on a sample of 29 banks. The practices vary though significantly across institutions, also including credit policies. A comparison based on the banks’ internal ETP standards is therefore of limited meaningfulness. FINMA applies instead a standardized ETP-criteria, using affordability criteria FINMA considers sustainable.

FINMA argues that for owner-occupied residential properties, borrowers should not spend more than 33% of their sustainable gross income for mortgage interest rate payments, calculated at a very conservative interest rate of 5% (current rates are below 2%), and building-related maintenance costs of 0.8% of the property value. If this standardized FINMA criteria is used as ETP-threshold, between 34% and 40% of new residential mortgage loans granted by the banks did not meet the affordability criteria.

Stress test results vs. capital requirements

Notably, FINMA publishes in the appendix also the results of their mortgage stress tests. These so far undisclosed numbers (Annex, Figure 6) suggest that banks could in a severe crisis suffer cumulative losses of around 1.5% on Self Occupied Real Estate (SORE), 5.5% on Income Producing Real Estate (IPRE), and 7.5% on Commercial Real Estate (IPCRE). The numbers reflect the average of FINMA’s stress loss estimates.

It is insightful to compare FINMA’s stress test results with the regulatory capital requirements for mortgage loans, including the Countercyclical Buffer (CCyB) requirement. Depending on the bank’s size (FINMA category), non-systemically relevant banks need to have Tier-1 capital ratios of at least 11% to 12.7% (in % of Risk-Weighted Assets (RWA), including the CCyB requirement of 2.5%). For domestically systemically important banks (D-SIBs), the Tier-1 capital requirement is 15.4% (base requirement) and for G-SIBs (UBS) 16.8% (18.2% from 2030). In addition, the systemically relevant banks are subject to a gone-concern capital requirement (bail-in bonds that can be used to orderly resolve a failed bank). These additional requirements range from around 5% (D-SIBs) to 11% (UBS). For Non-systemically relevant banks, an additional 2% – 2.6% of capital are required (to meet the minimum total capital ratio), for which the banks can use subordinated Tier-2 bonds. In Switzerland, small, liquid and well capitalized banks can apply for a simplified regulatory regime (“Kleinbankenregime”). For banks subject to this regime, the capital requirement is given by a simplified leverage ratio requirement of 8%.

For SORE-loans satisfying the minimum loan standards prescribed by the Swiss Bankers Association (SBA), the risk-weights under the Basel III Standardized Approach (SA) are between 20% (LTV <=50%) and 35% (LTV<=80%). Banks using the Internal Ratings Based (IRB) Approach are since January 1, 2025 subject to a capital floor of 72.5%. This means that the affected banks (UBS, ZKB, Raiffeisen) face effective risk-weights between 14.5% and 25.4%, correspondingly.

The above chart shows the capital requirements for SORE-loans with risk-weights of 20% (left bar) and 35% (right bar), or the IRB-Floor equivalents of 14.5 and 25.4% for D-SIBs/G-SIBs, respectively, providing the lower and upper boundaries of the capital requirements. The Tier-1 capital requirements (in blue, including CCyB in light blue) significantly exceed the FINMA mortgage stress scenario loss (dotted brown line) in all cases. This means that the Swiss banks are well capitalized to withstand even a severe mortgage crisis.

The above chart shows the capital requirements for IPRE-loans with risk-weights of 30% (left bar) and 60% (right bar), or the IRB-Floor equivalents of 21.8% and 42.9% for D-SIBs/G-SIBs, respectively, providing the lower and upper boundaries of the capital requirements. On average, the Tier-1 capital requirements (in blue, including CCyB in light blue) are in line with the mean FINMA mortgage stress scenario loss (dotted brown line). However, under FINMA’s most pessimistic stress scenario, the capital requirements might for some IPRE-exposures be calibrated too tightly. It is therefore important that the banks carefully assess their risk exposures, using their own stress testing methodologies.

Despite the banks’ overall strong capital positions, Orbit36 believes that sound credit assessment processes continue to be key for the success in the Swiss mortgage market. Digitalization provides great opportunities to streamline and automate processes, resulting in faster, more systematic and reliable credit decisions. Please approach us if you would like to learn more.