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Draft Guidelines on Classification of Exposures as Commercial Real Estate (CRE) Exposures

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Vincent

In terms of Basel-II Framework, CRE Exposures are of two types, (i) income producing real estates (IPRE) (ii) High volatility commercial real estate (HVCRE).These terms have been elaborated in the Framework in the context of advanced approaches for credit risk. It would be appropriate to follow the same approach for classification of exposures as CRE Exposures by banks which follow the Standardized Approach.

2. Basel-II Framework regarding CRE Exposures:-

2.1 Real Estate is generally defined as an immovable asset-land (earth space) and the permanently attached improvements to it. Under Basel-II, IPRE has been defined (para 226) of the Framework which is reproduced below:-

'Income-producing real estate (IPRE) refers to a method of providing funding to real estate (such as, office buildings to let, retail space, multifamily residential buildings, industrial or warehouse space, and hotels) where the prospects for repayment and recovery on the exposure depend primarily on the cash flows generated by the asset. The primary source of these cash flows would generally be lease or rental payments or the sale of the asset. The borrower may be, but is not required to be, an SPE, an operating company focused on real estate construction or holdings, or an operating company with sources of revenue other than real estate. The distinguishing characteristic of IPRE versus other corporate exposures that are collateralised by real estate is the strong positive correlation between the prospects for repayment of the exposure and the prospects for recovery in the event of default, with both depending primarily on the cash flows generated by a property'.

2.2 From the definition of IPRE given above it may be seen that for an exposure to be classified as IPRE/CRE, both repayment and recovery of the exposure should depend upon the real estate asset. In other words, if either the repayment (the identified source of repayment of principal and interest in normal course) or the recovery (the identified source of repayment of principal and interest in the event of default) does not depend upon the real estate, the exposure need not be defined as IPRE/CRE. However, in cases where the exposure is unsecured and the source of repayment is sensitive to change in real estate prices, the exposures would be classified as commercial real estate exposures.

2.3 Besides Basel II Framework, Federal Reserve System, USA have also defined Commercial Real Estate Lending as 'income...

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