* Medium-term risk from overvaluation or household debt
* No mention of Germany despite sharp rises in some cities
* ESRB warns of risks to bank sector if low rates persist (Adds Draghi quotes)
By Balazs Koranyi
FRANKFURT, Nov 28 (Reuters) - The residential property market risks overheating in eight European Union countries, including Britain, partly from unintended effects of ultra-low interest rates, the EU’s financial risk watchdog said on Monday.
The eight countries face a medium-term risk either from overvaluation or excessive household debt levels, a systemic risk to the bloc’s financial stability that requires regulatory attention, the European Systemic Risk Board said in a report.
The ESRB issued warnings to Austria, Belgium, Denmark, Finland, Luxembourg, the Netherlands, Sweden and Britain. It asked local authorities to devise appropriate measures and noted the vulnerabilities of banks in an environment of persistently low interest rates.
“Household indebtedness and the overvaluation of residential real estate develop over the course of years,” ESRB chair and European Central Bank head Mario Draghi said while presenting the report to an EU parliamentary committee.
“But, in the event of a shock, the related vulnerabilities can materialise quickly - for example, in the form of reduced household consumption, loan defaults and price falls.”
There was no mention of Germany, the bloc’s biggest economy with a booming housing market, suggesting that sharp price increases noted in several key cities have not created systemic worries.
Trying to kick-start growth and inflation, central banks across Europe have kept rates near or below zero, cutting borrowing costs to record lows.
Fuelling the boom, the ECB has promised to keep rates at current or lower levels for an extended period, suggesting that sub-zero rates may be around for years, potentially exacerbating asset price bubbles.
Cheap credit is a boon to consumers but has pushed property prices to record highs in some markets, also increasing the risk that households might struggle to pay back debt once rates return to normal levels.
This could eventually ricochet on the banks.
“As regards the banking system of the warned countries, the ESRB has not identified direct near-term risks arising from residential real estate exposures, although second-round effects are not excluded in the medium term,” Draghi said.
In Britain, property prices were at record highs before the June referendum on leaving the EU and a potential economic slowdown could leave some households vulnerable as rapid price increases have already stretched collateral, indicating that falling property prices could quickly reduce collateral levels.
“An economic slowdown could lead to the crystallisation of some risks - e.g. if unemployment rises and/or income growth falls, then some households may find it more difficult to service their debt,” the ESRB said in the report.
If the market’s slowdown is only temporary, Britain is still at risk of overvaluation and collateral stretch, the ESRB said.
Responding to the ESRB’s warning, decided in September but only published on Monday, UK Chancellor Philip Hammond said the Financial Policy Committee would continue to monitor the UK real estate market and would take action, if necessary.
In a separate report, the ESRB also warned of broader risks to the bloc’s banking sector from an extended period of low interest rates, as the environment forces lenders to take on more risk.
“Financial stability risks related to financial markets may increase in the low interest rate environment because of a search for yield, crowded position in some categories of assets, including real estate, and uncertainty about fundamental asset price values,” the ESRB said.
In such a scenario, there is a risk of asset price misalignments, which can lead to abrupt revaluations, potentially stretching bank balance sheets.
A possible response could be to limit the value of loans as a percentage of asset prices, improve loan affordability tests or better collateral valuation standards, the ESRB said, stressing that these were not warnings or recommendations.
The ESRB added that low profitability will also weaken banks’ resilience and low growth could worsen asset quality. In addition to lenders, low rates are also hurting insurance firms and pension funds.
A gradual increase in interest rates is less of a worry, however, as it would signal a rebound in growth, suggesting that prolonged low rates are a bigger concern. (Reporting by Balazs Koranyi; Additional reporting by Guy Faulconbridge and Francesco Canepa; Editing by Tom Heneghan)