Pricing of risk and the cost of money: how banks are pricing property funding

Abstract

When the author was first asked to write for the Journal, the working title was ‘Creative property lending and how to maximise gearing’. As a member of the Association of Property Bankers, and having the honour of being a past president of that organisation, the author was not at all sure that he should accept the engagement! However, encouraged by the chance to get a point of view across – ie that sound property lending does not necessarily depend on low loan-to- value ratios (and the promise of payment in liquid measure), the author gave in. In this paper, he wants to look at techniques for understanding risk, avoiding unnecessary risk, and establishing ‘correct’ pricing for the risks which cannot be avoided. Of course, there is no such thing as ‘correct’ pricing, but in this context, the author means pricing at a level which, over the long term and after allowing for the occasional loss, still shows a profitable outcome. It was often said after the 1990 crash (mainly by insolvency practitioners), that for many property lending banks, it would have been cheaper to pay for their entire property lending teams to play golf for the previous ten years! At the risk of sounding condescending, this paper will start with something obvious but which nevertheless is fundamental. Copyright © 2001 Henry Stewart Publications