Published by the CIPS Network of the National Association of REALTORS®
Second Quarter 2000
Evolving EU Property and Mortgage Markets - Excerpts from a report by Judith Hardt
By Judith Hardt
Property and mortgage markets within the European Union (EU), structurally very different for many reasons, are likely to be significantly changed by the increasing integration of the fifteen previously autonomous economies brought about by the advent of the euro. Speaking to a group of mortgage bankers and regulators from Eastern Europe in December1999 in Warsaw, Poland, Secretary General Judith Hardt of the European Mortgage Federation (EMF), said the new single currency would likely have major implications for European property markets and the financial systems that serve them. She went on to say that, although property and mortgage markets would remain intrinsically domestic, the driving force for change would come as a result of the creation of a deep and liquid single capital market. Her speech is excerpted here.
Housing Markets in the European Union
The 11 members of the European Economic and Monetary Union (EMU)-Austria, Belgium, Finland, France (the principality of Monaco is monetarily linked with France), Germany, Ireland, Italy, Luxembourg, Portugal, Spain, and the Netherlands-together with Denmark, Greece, Sweden, and the UK-make up the Member States of the EU. Substantial differences exist in the housing markets of the EU Member States because of their diverse economic circumstances, legal systems and property laws, taxation systems and social policies, and cultures and traditions.
According to Hardt, one of the most striking differences in those markets can be seen in the levels of owner-occupied households, which range from 80 percent in Ireland to 41 percent in Germany, where housing is very costly. In Germany, fiscal policies have favored the development of private rental dwellings. In Ireland, owner occupation has been historically favored-a counter-reaction to the power of private landlords has brought a strong tradition of own home ownership since independence.
The wide variance in the costs associated with the first property purchase strongly impact access to home ownership and the relative mobility of housing markets. Taxes, the largest share of these costs, run as high as 13% in Greece and as low as 1 to 2% in the United Kingdom.
The price of housing influences the appetite for home ownership. Pricing as well as the type and quality of housing varies widely across the EU. A comparison of trends reveals the extent to which markets remain structurally different. The greatest contrast is between those economies where prices remain relatively stable, and those that display greater volatility. The UK is an example of a relatively volatile market, where prices peaked in the late 1980s, followed by a prolonged period of stagnation. By contrast, the Netherlands has experienced a sustained housing price appreciation because a shortage of available housing and generous tax treatment.
Mortgage Markets in the European Union
The structures of the mortgage markets serving residential property markets are very different across the EU Member States. Mortgage credit plays a very important role in the overall EU economy, representing over 30% of GDP in the European Union and amounting to around EUR 3 trillion.
Levels of mortgage debt range from 69% of GDP in Denmark to just 7% in Greece. (See Graph 2) This is not correlated to levels of owner occupation. The extent to which households take on mortgage debt is linked to such factors as the stability of the economy, the efficiency of the mortgage lending system, the cost of housing, and fiscal incentives. In Denmark, high taxation levels combined with generous relief linked to mortgage credit have stimulated high levels of mortgage debt. In contrast, until recently mortgage rates in Greece were at 23% while inflation rates were 15%. In Italy mortgage rates have come down dramatically, but the legal process for repossession by mortgage lenders typically takes 6 years.
These diverse circumstances have created very different mortgage products in the various EU markets. The typical term of a mortgage loan can vary from as short as 10 years in some Southern countries to as long as 30 years in Denmark or Germany. Differing approaches to consumer protection regulations can result in only a handful of products being offered in some countries, compared to more than 4,000 products currently being offered in the UK. In certain countries, there is a predominance of fixed rate mortgage products. In others, the variable rate approach is more common.
In certain countries, the introduction of tight consumer protection rules has resulted in mortgage credit becoming increasingly separated from its sources of funding. For example, complex rules on the variation of mortgage interest in Belgium, which require the change in interest rate to be linked to government bond indices rather than to the true cost of funds for mortgage lending, introduce an interest rate risk. Rules that limit prepayment penalties charged to consumers by borrowers will also complicate the funding process, and may create dangerous mismatching.
The housing finance systems that operate on European markets have also evolved independently, resulting in a wide variety of institutions offering mortgage loans. (see Graph 3) In some countries, mortgage loans are offered by specialist institutions such as mortgage banks, building societies, and dedicated savings institutions. Elsewhere non-specialized lenders such as commercial banks, savings banks and insurance companies play an important role.
The type of institution offering mortgage credit has important consequences for the way in which mortgage credit is funded. In recent years, the trend has been towards despecialization. Nevertheless, the combined weight of the various types of specialist institution is significant. The funding of mortgage credit is split between retail markets and the wholesale capital markets. The bulk of mortgage funding is still through various. types of savings deposits, although there is increasingly recourse to the capital markets, in particular through the issue of mortgage bonds, which are on-balance sheet funding instruments. In terms of outstandings, mortgage-backed securities continue to play a relatively minor role, although institutions in many EU Member States are increasingly looking to this instrument to fund their mortgage assets.
In Germany and Austria, the Bausparkassen (dedicated savings institutions) attract savings at below market rates. After a contractually agreed-upon period, and with the help of a government subsidy, the borrower is entitled to benefit from below market rate mortgage loans. This is a system that performs in isolation from wider movements on the capital market.
In France, a system has evolved in which a government subsidy on certain forms of savings deposits ensures a steady flow of capital for housing purposes. More recently, the French government has been trying to move away from such systems, which can result in mismatching-interest rates on dedicated savings accounts that are higher than interest rates on mortgage loans.
The mortgage bond is, by contrast, typically a long-term, fixed interest rate product. Mortgage bonds are generally issued by the specialist mortgage banks, and are regulated by law. These are financial securities collateralized by a corresponding bundle of mortgage loans, and representing guaranteed claims against what are considered to be particularly secure types of credit institutions. There are limits to the loan-to-value ratios of the mortgages included in the pools (typically a 60% loan-to value ratio). In some cases, the valuation techniques are also strictly defined. In terms of volume, this form of funding instrument represents the largest category of securities in European capital markets after government issues. Mortgage bonds provide almost 20% of the funding of all mortgage credit in Europe and, at the end of 1998, amounted to some EUR 500 bln .
At present, three countries in the EU share more than 4/5ths of the overall mortgage bond market: Germany is in the lead with 45% of the issues, followed by Denmark ( 29%) and Sweden (14%). The remainder of the market is shared between Spain, France, Finland, Austria, and the Netherlands.
How Developments At EU Level Will Shape European Mortgage Markets
The current situation of fragmented mortgage and property markets is increasingly subject to external factors of change that should, in the long run, lead to a greater degree of homogeneity. Among the catalysts for change are the initiatives adopted by the EU, including the creation of the single market (See Sidebar) and the introduction of the single currency, which will determine the future of the mortgage lending industry.
The 1992 EU internal market program was aimed at liberalizing financial services markets. At that time, a number of directives were adopted, including the Second Banking Directive, which was based on the principle of home country control. This gave mortgage lenders the freedom to provide services across EU borders subject to supervision from the home supervisors. When the directive was adopted, many experts believed that this directive would help liberalize mortgage markets. To date, however, few mortgage institutions have used the possibilities provided by the Second Banking Directive. According to a survey carried out by the EMF, one of the fundamental problems in cross-border mortgage lending is the uncertainty presented by the current legal framework and the difficulty in exporting national products.
The EMF believes that if the EU wishes to favor cross-border business, it needs to clarify the legal framework for cross-border mortgage lending. The present legal framework is inadequate and gives rise to legal uncertainties. These uncertainties benefit neither the mortgage borrower nor the mortgage lender.
Consumer protection
The Maastricht treaty (the Treaty on European Union) moved consumer policy higher up the European agenda. In 1996, the European Commission (EC) commissioned a study that examined whether the 1987 consumer credit directive could be applied to mortgage credit. The study concluded that in most Member States, consumer protection standards for mortgage lending "meet or exceed the minimal requirements of the Consumer Credit Directive". There remains some doubt about whether the introduction of higher consumer protection standards would favor cross-border mortgage lending.
Almost all Member States have gone beyond these minimum requirements, introducing new rules that vary greatly from one country to another. France, Spain, Belgium, Ireland, and Sweden have enacted strict consumer protection regulations. Germany, Denmark, Sweden, Austria, and the UK have adopted regulations concerning specialized lenders. Germany and Austria have strict product regulations. Denmark and the Netherlands have adopted mortgage codes.
Many experts agree that it would be extremely difficult to find agreement on how to harmonize mortgage credit, and also that minimum harmonization would not help create a single mortgage market.
The euro increases the need for transparency
Without doubt, the advent of the euro will have an important impact on EU mortgage markets. A stable economic environment will promote low, stable mortgage rates, and longer-term loans. This will encourage the acquisition of owner-occupied housing. Mortgage interest rates in most EU Member States have decreased significantly with the adoption of the convergence program set out in the Maastricht treaty.
The decrease of mortgage interest rates has had a positive impact in most mortgage markets in Europe and outstanding mortgage loans have increased significantly in practically all EU Member States. Total outstanding mortgage debt in the European Union has, in nominal terms, more than doubled during the past 11 years, while GDP has developed at a slower rate.
Mortgage borrowers will benefit from keener competition, reduction in costs, diversification in mortgage products and savings products intended for households and greater transparency in prices. Greater price transparency will allow borrowers to compare the prices of houses and loans more easily and encourage them to conclude contracts with credit institutions from other Member States.
In cross-border situations, it is essential that potential borrowers are informed properly about the proposed mortgage loans and that they are able to compare them. This has triggered discussions at EU level on the need to improve the transparency and comparability of information on mortgage products. Since mortgage credit is among the most important financial transactions from the consumer point of view, the EC will continue to press the mortgage lending industry to improve information standards.
Furthermore, in the case of cross-border shopping, borrowers need to be made aware that there are major differences that exist between the different mortgage markets and products, including taxation systems, transaction costs, forced sale procedures and in some cases the role of the notary.
Taxation-a stumbling block?
The EMF did a survey to find tax and subsidy related obstacles to shopping across borders for better value mortgage products. The findings showed that a borrower in Austria, for instance, who wishes to deduct his foreign insurance premiums from his annual tax bill, might face problems. In several countries-among them Greece, Italy and Portugal-it isn't possible to obtain direct mortgage subsidies in the form of interest rate reductions unless the contract has been concluded with a domestic institution. Some countries require the lending institution to have already entered into a special agreement. In Greece, the borrower is subject to an additional stamp duty of 3.6% of the contract value if the loan is with a foreign credit institution. In Italy, Austria, and Portugal, the mere signing a loan contract is considered as a taxable event.
The Future
Until now, primary mortgage markets have been surprisingly resistant to change. Both mortgage and property markets are tightly enshrined in national law. Differences in tax and subsidy regulations, consumer protection rules and the fact that mortgage lending has always been considered as a local Business, mean that the achievement of a single European market in the field of mortgage credit can only take place in the longer term. These structural differences, however, are increasingly subject to the forces of change striving to impose a certain level of homogeneity.
The extent to which these pressures will change mortgage and property markets is not known, although it is likely that change on the capital markets will be the precursor for change on the primary markets. Common economic circumstances, particularly if the euro creates a stable low inflation environment within the EU, will likely cause further change. Consumer protection is likely to continue to shape the EU legislative agenda. Mortgage lenders will face continuing pressure from consumers and the Commission to improve the transparency and comparability of mortgage offers. Finally, the Internet will undoubtedly play a decisive role in opening European mortgage markets as it allows EU-wide market penetration at relatively little cost. Already there is some evidence that housing finance may become globalized and a number of American mortgage banks and mortgage insurers are currently evaluating possible strategies to enter into the European market.
If the single European mortgage market has proved an elusive goal in the past, it must be considered to be a realistic possibility in a single currency area.
The Second Banking Directive
The single market has been a reality in banking since January 1993, when the Second Banking Directive was adopted. The Directive established the principle of the single license allowing banks and other credit institutions to set up branches and offer services throughout the EU. It contains a list of banking services that can be provided in all the Member States with such licensing. In addition to the requirements already laid down in the First Directive of 1977, this Directive requires banks to have a minimum level of capital, and lays down prudential rules covering, for example, qualifying holdings, sound administrative and accounting procedure, and adequate internal controls.
The three pillars of the single market in banking are:
1. Essential harmonization in all Member States of the laws and practices governing
- access to banking activity,
- the capital required to cover both credit and market risks,
- the limitation of large exposures to a single borrower or a single group of associated clients, and
- the form, content and valuation rules of the annual and consolidated accounts published by banks.
2. Home-country control reinforced through cooperation between national supervisory authorities.
- A bank operating in other Member States will be supervised by the authorities in the country of origin; i.e. the country which has issued the single license and in which its registered office is located.
- The subsidiaries of credit institutions are supervised on a consolidated basis.
3. Mutual recognition by the national supervisory authorities of the rules and regulations in the countries of origin of the banks operating on their territory.
- The granting of licenses for subsidiaries of banks with registered offices outside the EU is, in principle, governed by the same rules, subject to the international agreements entered into by the EU.
- Member States may be required to suspend authorization for those subsidiaries where the third countries in question do not grant national treatment or effective market access to EU banks wishing to establish themselves on their territory.
- Once authorized, a subsidiary of a bank with its registered office in a third country will enjoy the same rights within the EU as have been granted to EU banks.
These rules will not be applied to countries that are signatories to the 1997 World Trade Organization agreement on financial services.
To ensure that all banks and other credit institutions in the Community can compete on an equal footing and to prevent registered offices being transferred to countries where supervision is less strict, the following measures supplementing the Second Banking Directive have been adopted:
- Rules on the preparation and publication of annual and consolidated accounts
- Rules designed to harmonize the concept of "own funds"
- Definition of a solvency ratio
- Rules on the monitoring of market risks incurred by credit institutions
- Rules aimed at preventing use of the banking system for the purpose of money laundering
- Rules on the supervision of credit institutions on a consolidated basis
- Rules on the limitation of large exposures incurred by credit institutions
- Rules on deposit-guarantee schemes
All but three of these measures have been in force since January 1993. The Directive on large exposures came into force in January 1994. The Directive on deposit-guarantee schemes came into force in July 1995. The Directive on the supervision of market risks came into force in January 1996.
For details on this and other EU economic policies affecting mortgage and property markets, visit Europa, the European Union's Internet server at www.europa.eu.int, enter the site by language, select the Policies link. |
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