Contract Savings for Housing
- Subsidies and
System Performance -
IFC & Russian Banking Association Workshop
March 12, 2008
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
1. Rationale for Savings Subsidies
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
“There are only two types of money: my money and your money”
A Specific Rationale for Supporting CSH?
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).
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.
2. Mechanics of CSH Subsidies
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
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
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..
Slovakia: Subsidies in the Annual Budget Law
ex-post, as premiums
10.0 10.0 5/6 Yr. Savings
6.0 6.0 Average Bank
1997 1998 1999 2000 2001 2002 2003 2004 (e)
Allowed for downward adjustment as rates declined from the late
Czech Republic: Subsidies in the Enabling Law
5/6 Yr. Savings
Law as Slovakia
1 Year Deposit
4.0 4.0 Yield after Tax
1997 1998 1999 2000 2001 2002 2003 2004 (e)
Created huge excess subsidies as market interest rates declined.
Fiscal Costs Compared
Slovakia subsidies initially
huge, then much reduced
Started with 40%
premium level, reduced
already around 98 to
high subsidy, which
became large as market
interest rates declined.
Started with 25% premium
level, reduced in 2004 to 15%
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
Minimum Savings Period – 2 Years is too
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
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.
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.
Czech Republic: Growth without Limits
At peak time, numerically
63% of Czech inhabitants had
Children, elderly enrolled to
maximize subsidies per
In 2004 reform, despite
changes in subsidies,
government was unable to
impose minimum age for
Means also limited screening
function of pre-savings for
Limit Subsidies to Loan Takers only?
2006 French Epargne Logement reforms tied savings premia to actual loan
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).
3. CSH System Impact:
Case Study Czech Republic vs. Slovakia
Dimensions of CSH System Impact
Financial sector structure impact
Housing sector structure impact
Profits of CSH Institutions Compared
Return on equity
institutions ran into
market rate decline
2000/01 with too
high deposit rates.
Slovakia: MOF Opposed
Repatriation of Profits
8.0% P.S.S. CSH institution
6.0% with RoE of 40-60%
% of Assets
subsidy model - up to
-2.0% Disclosed market deposit rate. No
-4.0% CSH borrowing
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Source: P.S.S., author’s calculations.
Notes: EBTD – Earnings before Taxes and
Czech Republic Created Strong Financial
Czech Republic Slovakia
12% 25% 20% 16%
20% Interest rates,
CSH Deposits.% of Term Deposits
CSH Deposits % of Time Deposits
6% Bauspar Advantage,
10% Advantage, CSH Deposits
l.h.s. as % of Time
as % of CZK 0%
1994 1995 1996 1997 1998 1999 2000 2001 2002
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.
When CZ Was Forced to Reform, new Contract
not healthy for
Wider distortions for
financial system and
Reducing Subsidies Takes Time due Lag Effects
Still under new
subsidies, as these are
paid over 5 years per
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
PSS Slovakia, German
Bausparkassen run almost 100%
stimulated interim loans.
System cannibalized itself by
depressing market rates
indirectly – interim loans per 07
almost same rate as CSH loans.
As before, in total CZK million
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
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
Source: Roy (2003). Possible in Russia?
Czech Republic: Dynamics of CSH and Mortgage
Lending has Diverged
Outstanding loan volumes in billion CZK
Positive Spillover Effects for Stability of the
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
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
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
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
High RUR interest rates, CSH
Small branch networks, high
can isolate for a part of the
distribution costs of deposits
Russia Mortgage Funding Structure
System has Value, But the Costs must be
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
Limit and target subsidies
Hans-Joachim (Achim) Dübel