* 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
By Balazs Koranyi
FRANKFURT, Nov 28 (Reuters) - The residential property market is at risk of overheating in eight European Union countries, including Britain, partly due to the 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 and requiring regulatory attention, the European Systemic Risk Board said in a report.
Headed by European Central Bank President Mario Draghi, the ESRB issued warnings to Austria, Belgium, Denmark, Finland, Luxembourg, the Netherlands, Sweden and Britain, asking local authorities to devise measures and noting the vulnerabilities of banks in an environment of persistently low interest rates.
Any mention of Germany, the bloc’s biggest economy with a booming housing market, was absent however, suggesting that sharp price increases noted in several key cities have not yet 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.
The cheap credit is a boon to consumers but has pushed property prices to record highs in some markets, also raising the risk that households might struggle to pay back debt once rates return to normal levels.
“The key vulnerabilities highlighted by the ESRB assessments are of a medium-term nature and relate to the rising indebtedness and ability of households to repay their mortgage debt or to the valuation or price dynamics of residential real estate,” said the ESRB, whose deputy head is Bank of England Governor Mark Carney.
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.
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; Editing by Alison Williams)