Should banks be taking more risks to fund housing?

The head of Canada Mortgage and Housing Corporation said recently what many housing ministers and developers already suspect - public housing agencies would welcome banks taking on more risk to fund residential construction. The suggestion is provocative because it cuts to the heart of a global bottleneck in housing delivery - financing the early stages of projects and standing behind builders when economics are tight. But the answer to whether banks can or should step up is complex and varies sharply by market. Political will, regulatory constraints, market structure, risk appetite and alternative capital all shape the reality, writes John Ridgeway.

Banks matter because they remain the largest, lowest-cost and most scalable source of development finance in many countries. When commercial banks reduce their appetite for construction and development lending, developers face higher costs or simply cannot start projects. That gap is increasingly being filled by non-bank lenders and specialist credit funds - solutions that can be effective, but usually carry higher pricing and shorter pay back times, which raises the ultimate cost of homes.

Public agencies can de-risk some projects, but they cannot and should not, finance the entire pipeline. If mainstream banks could re-engage more fully in pre-development and construction lending, the effect on housing starts could be material. Yet banks face real constraints. Capital and liquidity rules, tighter internal credit standards after recent shocks, the complex nature of construction risk, such as cost overruns, sales risk and macro uncertainty on rates and house prices – all go to make life difficult for the banking sector.

United Kingdom

In the UK, banks traditionally funded a large portion of development and housebuilding. However, since the post-2008 era, lenders largely retrenched from riskier smaller builders and higher-leverage schemes, preferring safer mortgage lending. In 2024–25 the Bank of England reported a rebound in gross mortgage lending and a competitive mortgage market, but also flagged prudential caution at banks more generally. While mortgage supply has grown, development and construction lending remain challenged by slower home sales in periods of higher rates and by individual housebuilders' balance sheet strains. High-profile lender exposure to housebuilders can become headline risk.

UK banks also face structural procurement and planning risks with long lead times and political sensitivity around planning consent making many projects less bankable in the eyes of risk managers. To make bank balance sheets work for housing again, lenders need clearer cashflows, stronger pre-sales or offtake agreements (for example build-to-rent) and public credit enhancement products that reduce downside exposure. Some institutional and private lenders (and even developer-owned lending arms) have stepped in to fill gaps - for example property groups creating lending arms to deploy capital into development - but these are complementary rather than systemic fixes.

United States - retreat by smaller banks, private capital fills the gap

The US presents a mixed picture. Large national banks still provide significant development finance, but regional and community banks, historically important lenders to local homebuilders, have pulled back from construction lending since the rate volatility and bank stresses of 2023–24. Data show that construction and land development loans outstanding have fallen compared with prior peaks, even while single-family construction loan volumes fluctuate with demand. At the same time, private credit funds and institutional lenders (pension capital, private real estate lenders) have dramatically increased their presence, offering tailored products to builders at higher spreads. Some private firms are now originating billions of dollars of homebuilder loans, illustrating how market demand is being satisfied outside the banking system.

The US experience highlights two dynamics. First, banks, especially smaller ones, may face capital, liquidity and risk-modelling constraints that make construction lending unattractive. Second, private credit can scale quickly, but at a higher cost. That trade-off feeds through into house prices and developer margins and may favour larger builders who can afford higher financing costs, potentially worsening market concentration.

Continental Europe - regulatory tightrope and divergent national responses

Across the euro area and wider Europe, bank lending surveys indicate modest easing or continued cautiousness depending on country and bank. European banks operate under strict capital and provisioning regimes and many are sensitive to macroeconomic and real-estate-specific risk. The ECB’s bank lending surveys show fluctuating credit standards and differing regional demand for housing loans. In some Northern European markets, well-capitalised banks continue to lend to development, often supported by conservative pre-sales and regulated rental markets, while in other jurisdictions lenders have tightened standards following economic uncertainty.

Europe’s opportunity lies in structured instruments and public-backed loan guarantees. Some countries have used public banks and guarantee schemes to bridge gaps, while others lean on long-term institutional investors to provide patient capital for build-to-rent and social housing. However, harmonising approaches across the EU is difficult because banking systems, housing markets and regulatory frameworks differ widely.

Australia — resilience, prudence and the role of policy

Australia’s banking system is large and resilient, with major banks deeply involved in mortgage markets and project finance. The Reserve Bank of Australia and APRA (the prudential regulator) have emphasised system resilience and careful credit standards. Construction lending occurs, but banks remain prudent on pre-sales, leverage and concentration risks. The Australian market benefits from relatively transparent development pipelines and strong institutional investors in private rental supply, but affordability pressures and climate-related risks (flood, bushfire zones) add new layers of caution for underwriters. Regulators have been actively monitoring exposures and banks are integrating climate risk into underwriting decisions, a direct example of lenders broadening the definition of “risk” beyond just price and sales.

What banks are doing and what they are not

Across markets, banks are doing the following:

• Tightening credit standards where uncertainty is greatest. After turbulence and higher-for-longer rates, many banks have raised lending standards, especially for smaller homebuilders and marginal projects. Central bank and regulator reports confirm cautiousness across jurisdictions.

• Preferring lower-risk structures. Lenders favour schemes with strong pre-sales, long-term rental contracts, or institutional off takers that reduce sales risk. Build-to-rent and social housing often attract cheaper debt than speculative for-sale developments.

• Collaborating with institutional capital. Banks are increasingly arranging or syndicating loans with pension funds, insurers and private credit, which share risk and bring longer tenors or different return profiles.

• Using specialist lending arms and non-bank partnerships. Where mainstream appetite is limited, alternative providers such as private debt funds and specialist lenders, step in to provide mezzanine or whole-loan financing at higher yields. This is visible in the US and growing in Europe and Australia.

What banks mostly have not done is dramatically increase unsecured willingness to finance speculative early-stage projects without mitigation. Pre-development risk (site acquisition, planning, viability testing) remains hard to finance at scale through traditional banks without guarantees, subsidies, or pre-sales. Many lenders are reluctant to underwrite projects where the debt-to-completion value or sales assumptions are marginal.

Challenges that restrain banks

Several structural and cyclical constraints explain the restraint:

1. Regulatory capital and stress testing. Banks are subject to capital adequacy rules and internal stress tests that penalise higher credit risk. Construction lending is volatile; under stressed house-price scenarios, loss rates can spike.
2. Construction-specific risk. Cost inflation, project delays, defects and customer pre-sale failure make forecasting cashflows risky. Banks require strong covenants, significant equity buffers, and experienced borrowers.
3. Interest rate uncertainty. Higher rates increase carrying costs for developers and reduce buyer affordability, raising default and sales risk.
4. Concentration and covenant risk. Lenders worry about exposure concentrations: too much lending to one sector, region or borrower group can create systemic risk for the bank.
5. Operational capacity. Underwriting construction loans requires specialised teams and local market knowledge - expertise that smaller banks may no longer have after years of retrenchment.

Opportunities to increase bank deployment of housing finance

If policymakers want banks to take more risk, there are practical levers that can combine public and private capital to unlock development finance without compromising financial stability:

Public credit enhancements and loan guarantees. Targeted guarantee schemes (partial credit guarantees, first-loss facilities) can lower capital charges and make projects bankable while keeping lenders incentivised to underwrite carefully.

Standardised underwriting and data. Better project-standardisation, digital reporting and transparency on costs and timelines would reduce information asymmetry and make underwriting more predictable.

Pre-development finance lines. Dedicated, cheap pre-development facilities (perhaps provided by national housing agencies or development banks) can advance planning and de-risk projects to the point where commercial banks will provide construction finance.

Blended finance and syndication. Structures that layer concessional public capital beneath commercial bank debt can reduce loss severity and attract private lending at scale.

Encouraging long-term offtake markets. Scaling institutional demand for rental housing (through pension funds and insurers) creates predictable revenue streams, making bank lending safer.

Support for smaller builders. Technical assistance, mandatory escrow accounts and staged drawdown mechanisms can reduce lender exposure to delivery risk with SME builders.

Where alternative capital is already changing the game

We are already seeing market-based responses. Large private lenders and specialist funds (for example in the US and UK) are lending to homebuilders at scale, accepting higher spread for the risk and filling the gap created by conservative bank underwriting. Developer-owned lending arms and institutional funding for build-to-rent are also growing. These models prove that capital is available, but often at a price that alters project economics and favours larger players.

A balanced conclusion: risk, but with mitigation

So yes - banks can take more risk in housing finance and in some markets they are already doing so in measured ways. But asking banks to simply “take more risk” without structural reforms is naïve. Regulators rightly prioritise system stability where lenders must manage capital, concentration and liquidity. The practical path to more bank-backed housing lies in smart risk-sharing such as calibrated public guarantees, blended finance, better data and more predictable revenue streams (offtake, rental, subsidy). When banks see lower downside and clearer cashflows, their risk appetites can and will shift.

The alternative - leaving the field to higher-cost private credit - will deliver housing, but more expensively and likely in a more concentrated industry. That outcome risks worsening affordability and reducing viable competition among builders.

Policymakers and housing agencies should therefore focus on designing mechanisms that make housing projects both bankable and socially valuable. Doing so means plumbing the gap between political ambition and financial reality where regulators can carve out well-supervised windows for project finance and where public agencies can stand behind early-stage risk with guarantees.

The Canadian Crown’s invitation for banks to take more risk is an important nudge. The real test for other markets will be whether governments and financiers work together to make doing so responsible, effective and durable.