Duebel_IFC_Bauspar_Subsidies

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					Contract Savings for Housing
              (Bausparen)

          - Subsidies and
       System Performance -
  IFC & Russian Banking Association Workshop
                  March 12, 2008
                     Moscow


            Hans-Joachim Dübel
             Finpolconsult.de, Berlin

                                               1
List of Contents

    Rationale for savings subsidies in general and CSH in particular

    Mechanics of CSH subsidies & fiscal costs, comparison to
     Russian Law Proposal

    Case study Czech Republic vs. Slovakia – impact of subsidies
     and system performance

    Discussion



                                                                    2
1. Rationale for Savings Subsidies




                                     3
Rationale for Savings Subsidies in General

 Reduce leverage and risk of overindebtedness (US crisis)
 Level playing field with mortgage subsidies (e.g. interest deduction)
 Reduce default incentives
 Reduce loss given default for the debt investor
 Create access to finance for low-income households
 Improve ‘ownership’ of the financing, incentives for borrower to
  behave financially responsible

Milton Friedman:
“There are only two types of money: my money and your money”



                                                                          4
 A Specific Rationale for Supporting CSH?
Pro:
 CSH is an access to credit mechanism like mortgage insurance (protecting
  first mortgage holder), which often are publicly provided/subsidized.
 CSH creates unique long-term prepayable fixed rate mortgage (comparable to
  main US product), which private sector otherwise doesn’t deliver.
 Subsidy may be the only means to reduce mismatch risk (CSH daily callable).
Con:
 CSH often primarily used for non-access purposes (e.g. modernization).
 Capital markets may offer long-term fixed-rate mortgages.
 CSH may lead to fragmentation of the financial market (esp. if special bank)
 Actual lending and access performance very difficult to monitor.
  Principle should be to treat access/high-LTV mechanisms alike – esp. CSH and
  mortgage insurance and high-LTV bank lending. Problem: mismatch risk.

                                                                            5
2. Mechanics of CSH Subsidies




                                6
Main types of CSH subsidies
 Tax exemption on savings interest
 CSH premium subsidy
 CSH loan interest tax deduction
 Subsidies on the institution level


  Often cumulations without consideration to distortions,
  total fiscal costs, targeting




                                                            7
CSH Premium Subsidies – Key Questions
 Where are subsidy rules laid down? CSH enabling act or annual
    budget? Defines ability of policymaker to change economics.
   Minimum savings period? Decisive about ‘subsidy yield’.
   Basis of subsidy payments? New savings vs. savings plus accrued
    interest.
   Subsidy ratio, max premium level?
   Income limits, age limits for children?
   Shall good brothers (savers-only) be entitled to subsidies?

Devil lies in the details, as will be shown shortly..

                                                                      8
Slovakia: Subsidies in the Annual Budget Law
   20.0                                                                        20.0

                                              Depressed returns
   18.0                                                                        18.0
                                             ex-post, as premiums
                                                                                      Bauspar
                                                 were reduced
                                                                                      Premium
   16.0                                                                        16.0


   14.0                                                                        14.0
                                                                                      Tax Exemption

   12.0                                                                        12.0


   10.0                                                                        10.0   5/6 Yr. Savings
                                                                                      Rate
    8.0                                                                        8.0


    6.0                                                                        6.0    Average Bank
                                                                                      Deposit Yield
                                                                                      after Tax
    4.0                                                                        4.0


    2.0                                                                        2.0


    0.0                                                                        0.0
          1997   1998   1999   2000   2001    2002      2003        2004 (e)




 Allowed for downward adjustment as rates declined from the late
 1990s on.

                                                                                                        9
Czech Republic: Subsidies in the Enabling Law
     16.0                                                               16.0


     14.0                                                               14.0
                                                                               Bauspar
                                                                               Premium
     12.0                                                               12.0

                                                                               Tax Exemption
     10.0                                                               10.0
                                                                                                 SAME Enabling
      8.0                                                               8.0
                                                                               5/6 Yr. Savings
                                                                                                 Law as Slovakia
      6.0                                                               6.0
                                                                               Rate
                                                                                                 *1992
                                                                               1 Year Deposit
      4.0                                                               4.0    Yield after Tax



      2.0                                                               2.0


      0.0                                                               0.0
            1997   1998   1999   2000   2001   2002   2003   2004 (e)




Created huge excess subsidies as market interest rates declined.

                                                                                                                   10
Fiscal Costs Compared
                Slovakia subsidies initially
                 huge, then much reduced
                   Started with 40%
                    premium level, reduced
                    already around 98 to
                    15%.
                Czech Republic
                 continued moderately
                 high subsidy, which
                 became large as market
                 interest rates declined.
                  Started with 25% premium
                   level, reduced in 2004 to 15%

                                                   11
Minimum Savings Period is a Crucial Parameter
– a Simulation




 Subsidy is given only ONCE per savings cohort , i.e. the last is always the most profitable
 The longer the savings must be held in the account, the lower is
 their return.
                                                                                               12
Minimum Savings Period – 2 Years is too
Short
                                                In CZ tied to takeout of an
 Return per savings cohort by holding period
                                                 interim/advance loan, i.e.
                                                 dual excess subsidy:
                                                   CSH institution can invest
                                                    CSH deposits at market rates
                                                   Borrower receives large
                                                    subsidy for short savings
                                                    period.
                                                 Solution is to allow for
                                                 interim/advance loans but
                                                 force savers to continue to
                                                 save, later prepay (Germany),
                                                 OR reduce subsidies for
                                                 shorter savings periods.

                                                                                 13
 Subsidy Structures Compared




Premiums often lead to returns exceeding market deposit rates.
Fairly generous premium levels – esp. considering income levels.
No income targeting outside Germany.

                                                                   14
Czech Republic: Growth without Limits
                              At peak time, numerically
                              63% of Czech inhabitants had
                              CSH contracts.

                              Children, elderly enrolled to
                              maximize subsidies per
                              household.

                              In 2004 reform, despite
                              changes in subsidies,
                              government was unable to
                              impose minimum age for
                              children.

                              Means also limited screening
                              function of pre-savings for
                              mortgage lenders.

                                                              15
Limit Subsidies to Loan Takers only?
 2006 French Epargne Logement reforms tied savings premia to actual loan
  takeout.
 In open systems rational, as savings premia are mere subsidies distorting
  competition of deposits with capital market funding further. In France EL
  funds were channeled to non-EL mortgage uses, at some point supported
  30% of mortgage lending.
 In closed systems, good brothers (savers-only) are needed to stabilize
  liquidity and minimize waiting periods. System would require much higher
  reserves without. Subsidy also reduces mismatch risk.

  Government should tie support to global loan-deposit ratio, generate
  incentives to keep good brother ratio low (e.g. min savings period).


                                                                              16
3. CSH System Impact:
Case Study Czech Republic vs. Slovakia




                                         17
Dimensions of CSH System Impact
 Profitability impact
 Financial sector structure impact
 Housing sector structure impact
 Fiscal impact




                                      18
Profits of CSH Institutions Compared
Return on equity


                             Czech CSH
                             institutions ran into
                             market rate decline
                             2000/01 with too
                             high deposit rates.

                             PSS quasi-
                             monopoly.




                                                     19
                                           Slovakia: MOF Opposed
                                            Repatriation of Profits
              10.0%


              8.0%                                                                                                          P.S.S. CSH institution
              6.0%                                                                                                          with RoE of 40-60%
                                                                                                   EBTD

              4.0%
                                                                                                                            initially.
% of Assets




                                                                                                                            Reason: ‘Austrian’
              2.0%
                                                                                                   Additions to
                                                                                                   Reserves
              0.0%
                                                                                                                            subsidy model - up to
              -2.0%                                                                                Disclosed                market deposit rate. No
                                                                                                   Profit
              -4.0%                                                                                                         CSH borrowing
              -6.0%
                                                                                                                            initially.
              -8.0%
                      1992   1993   1994   1995   1996   1997   1998   1999   2000   2001   2002



                                                                                                               Source: P.S.S., author’s calculations.
                                                                                                               Notes: EBTD – Earnings before Taxes and
                                                                                                               Depreciation.



                                                                                                                                                         20
Czech Republic Created Strong Financial
Market Distortions
        Czech Republic                                                                                                                                   Slovakia
                          12%                                                                  25%                                                                                  20%                                                                  16%


                                                                                                                                                                                                                                                         14%
                          10%
                                                                                                                                                                                    15%
                                                                                               20%                                                                                                                                                                                               Interest rates,
                                                                                                                                                                                                                                                         12%                                     l.h.s.




                                                                                                                                                                                                                                                               CSH Deposits.% of Term Deposits
                                                                                                                                       Interest rates,




                                                                                                     CSH Deposits % of Time Deposits




                                                                                                                                                          Interest rates/Premiums
                                                                                                                                       l.h.s.
                          8%                                                                                                                                                                                                                             10%
Interest rates/Premiums




                                                                                                                                                                                    10%
                                                                                               15%                                                                                                                                                                                               Bauspar
                                                                                                                                                                                                                                                                                                 Premium
                                                                                                                                                                                                                                                         8%
                                                                                                                                                                                                                                                                                                 Yield
                          6%                                                                                                           Bauspar                                                                                                                                                   Advantage,
                                                                                                                                       Premium                                                                                                                                                   l.h.s.
                                                                                                                                                                                    5%
                                                                                                                                       Yield                                                                                                             6%
                                                                                               10%                                     Advantage,                                                                                                                                                CSH Deposits
                                                                                                                                       l.h.s.                                                                                                                                                    as % of Time
                          4%                                                                                                                                                                                                                                                                     Deposits
                                                                                                                                                                                                                                                         4%
                                                                                                                                       CSH Deposits
                                                                                                                                       as % of CZK                                  0%
                                                                                                                                       Time
                                                                                               5%                                                                                                                                                        2%
                                                                                                                                       Deposits,
                          2%
                                                                                                                                       r.h.s.

                                                                                                                                                                                    -5%                                                                  0%
                                                                                                                                                                                          1994   1995   1996   1997   1998   1999   2000   2001   2002
                          0%                                                                   0%
                                1994   1995   1996   1997   1998   1999   2000   2001   2002




                            CSH deposits in excess of demand leads to reinvestment into other eligible asset, esp. covered
                            bonds. CZ as a result has some of the lowest covered bond interest rates.

                                                                                                                                                                                                                                                                                                     21
When CZ Was Forced to Reform, new Contract
Originations Collapsed
                                 Demand stop-and-go
                                 not healthy for
                                 liquidity
                                 management.

                                 Wider distortions for
                                 financial system and
                                 savings ratio.




                                                         22
Reducing Subsidies Takes Time due Lag Effects

                                   Still under new
                                   subsidy formula
                                   (2004) considerable
                                   subsidies, as these are
                                   paid over 5 years per
                                   cohort




                                                             23
Incentive and Performance Problems of Czech CSH
Institutions                     Extremely low loan-to-deposit
                                        ratio due to excessive subsidies,
                                        absence of second mortgage
                                        concept, no pressure on
                                        institutions to lend directly
                                        (securities).
                                       PSS Slovakia, German
                                        Bausparkassen run almost 100%
                                        loan-to-deposit ratio.
                                       Government indirectly
                                        stimulated interim loans.
                                       System cannibalized itself by
                                        depressing market rates
                                        indirectly – interim loans per 07
                                        almost same rate as CSH loans.

                                                                     24
As before, in total CZK million




                                  25
  Portfolio Composition of CSH Lenders
Table 10 CSH Loan Portfolio Composition, Slovak Republic
                                                                    Primary business is modernization
2001                             P.S.S.         VUB-Wuestenrot
                                                                    and small real estate transactions
Modernization                        37.0                    35.1   (old housing, land). 100,000s of
Transaction (housing and land)       39.9                    33.1   small loans.
New construction                     23.0                    16.2
Other                                 0.1                    15.3
Sources: Annual reports of P.S.S.and VUB-Wuestenrot.                Per 2007 relevance also in rental
                                                                    housing modernization.
 Table 21 CSH Loan Portfolio Composition, Czech Republic
 June 30, 2002                            Entire industry
                                                                    Reason for low new construction
                                                                    relevance is absence of option to
 Modernization                                    39                finance ‘senior-sub’ with a first
 Transaction (housing and land)                   39                mortgage lender.
 New construction                                 17
 Other                                            10
 Source: Roy (2003).                                                Possible in Russia?



                                                                                                         26
Czech Republic: Dynamics of CSH and Mortgage
Lending has Diverged
     Outstanding loan volumes in billion CZK




                                               27
Positive Spillover Effects for Stability of the
Mortgage Market?
 Czech market more stable than neighbours (related also to use of covered
     bonds, fixed-rate system), but also more subsidized.
    CSH savers receive “ca 50bp” margin discount from mortgage lenders
     (lender).
    Distribution system is enhanced(Slovakia better than Czech Republic)
    Modernization lending important in ageing economies.
    Small loans support lower-income households without access to credit.
    House price income ratio in Czech Rep   House price income ratio in Poland




                                                                                 28
Russia Considerations
Pro                                  Con

 Banks require partly large          High house price inflation
    downpayments – CSH facilitates     makes high LTVs and pre-
   In some corners, unsound           savings attractive
    practices (high LTV, CHF/JPY         .. This may lead to risky CSH
    lending)                               practices (high multipliers, low
                                           ISFERs)
   Foreign bond markets volatile,
    accessible only to few banks      Recent banking crisis (2004), i.e.
                                       how many banks can credibly
   Deposit funding share too low
                                       handle scheme?
   High RUR interest rates, CSH
                                      Small branch networks, high
    can isolate for a part of the
                                       distribution costs of deposits
    financing

                                                                              29
Russia Mortgage Funding Structure




                                    30
System has Value, But the Costs must be
Contained
 Avoid new banking and insurance sector fragmentation
    Integration into universal banking framework
    Capital, investor regulation delicate (high-LTV market)
 Sound regulatory structure to contain crisis costs
    Special regulation needed
 Create legal preconditions
    CSH needs possibility for senior-sub legal structure, stand
     alone problematic
 Limit and target subsidies

                                                                   31
           END

Hans-Joachim (Achim) Dübel

    Finpolconsult.de

 aduebel@finpolconsult.de

   www.finpolconsult.de


                             32

				
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