HOUSING FINANCE SYSTEMS FOR COUNTRIES IN TRANSITION PRINCIPLES AND EXAMPLES

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1 BUNDESAMT FÜR WOHNUNGSWESEN OFFICE FEDERAL DU LOGEMENT UFFICIO FEDERALE DELLE ABITAZIONI UFFIZI FEDERAL PER L'ABITAR STORCHENGASSE GRENCHEN / GRANGES TELEFON 032 / TELEFAX 032 / HOUSING FINANCE SYSTEMS FOR COUNTRIES IN TRANSITION PRINCIPLES AND EXAMPLES International Conference on Housing Finance Systems, Bratislava, Dr. Peter Gurtner, Director of the Swiss Federal Housing Office Ladies and Gentlemen I As Chairman of the Steering Group directing an international study on housing finance systems I have been invited to give you a short overview on its content and I would like to thank the organizers of this meeting for giving me this opportunity. The study has been released a couple of weeks ago. It was elaborated under the auspices of the Committee on Human Settlements. This is an intergovernmental body within the United Nations Economic Commission for Europe. It meets once a year to provide a forum for the compilation, dissemination and exchange of information and experience on housing, urban development, land administration and national and local objectives and policies. Through various workshops, research on urban issues, analyses of the housing sector and related publications, the Committee advises member countries on human settlements policies and strategies and encourages their practical implementation. The Committee supports the economic and social stabilization of Central and Eastern Europe by suggesting innovative ways of cooperation between different levels of governments. The Committee also promotes partnership between the public, non governmental organizations and the business sector of the UNECE countries at regional, national and local levels. As a consequence the Housing and Urban Management Advisory Network (HUMAN) was established in It consists of experts from the private sector, including industry, private business, financial institutions, professional associations, research institutions and local authorities. And it was this advisory body which initially proposed to carry out a study on housing finance. The project was submitted to the Committee which approved it in the context of its programme of work. Moreover it was financed both by some member countries and by the private sector thus being the first experience for the Committee in establishing a partnership between the private and public sector both in financing the project and in managing it. II The goal of the study is to assist government of countries in transition in the design of working housing finance markets for their citizens. It is supposed to enable and simplify the decision making as regards the selection, implementation and composition of different financing schemes. It intends to show politicians, authorities, the banking community and other decision makers how housing finance policies could be developed and improved, what general housing finance systems could be applied, what the C:\Dokumente und Einstellungen\bwo-web\Lokale Einstellungen\Temporary Internet Files\OLK12\gt-o4 Warschau.doc Peter Gurtner/pul Seite 1/5

2 experiences with some specific solutions are and which criteria and information could be used to evaluate, prepare and select appropriate policy measures. On the outset of the project five objectives were formulated: III Provide an overview on the present state of housing finance and specific problems in countries of transition. Give a summary of the main ingredients of a functioning financing system stressing the different roles of lenders, borrowers and governments. Present a collection of the most important financing schemes presently applied throughout the ECE region. Describe the elements and features of three distinct financing techniques, namely of the contractual saving scheme as represented by the Bausparkassen, the Danish mortgage bond system and the US variety of mortgage backed securities. Presentation of a possible evaluation tool to be exemplified along the line of the three financing methods mentioned above. In accordance with these objectives the report contains five chapters. The first one describes the actual situation and conditions of housing finance in countries of transition. It comments on wide-spread problems and bottlenecks regarding the housing and capital markets such as inflation and slow economic growth, unemployment, strong tenant protection, illegal housing construction, crowding out effects, cash economy, low affordability, preferences for non housing goods, deficient law enforcement, cultural obstacles and a poor legal and institutional framework. It furthermore highlights the main features of the existing banking systems and summarizes some of the efforts made so far to improve their effectiveness. Chapter two recalls the basic elements, objectives and mechanisms of housing finance. It explains the interplay between the origination, ultimate holding and servicing of mortgage loans for timely payments of interest and principal. It indicates the various risks entailed in this particular business and the major sources and ways of providing the financial means be it through owner self finance, seller finance, private third partyfinance and bank third party-finance or through insurance companies, finance companies, government mortgage backed securities, subsidies, etc. The third chapter contains an overview of the main financing instruments used in the ECE-region, broken down in deposit based systems (universal and specialized banks) and in systems based on bond market institutions, securisation or loans provided by public agencies and other third party lending Chapter four depicts the three specific financing instruments mentioned above. For the presentation of each of them a standardized format is followed describing the historical background of the formula, its legal framework, its relative position within the national mortgage markets, the main characteristics as regards the assets and liabilities side, the role played by the state and a short outlook on possible further developments. The fifth chapter starts from the fact that national housing finance systems must prove themselves competitive by mobilising and allocating capital efficiently. For policy makers the question arises, therefore, how different systems can be evaluated and compared. How the various interests of lenders, borrowers and regulatory bodies can be structured, weighted and assessed and how from advantages and disadvantages of different finance instruments a conclusion can be drawn as to their suitability in par- C:\Dokumente und Einstellungen\bwo-web\Lokale Einstellungen\Temporary Internet Files\OLK12\gt-o4 Warschau.doc Peter Gurtner/pul Seite 2/5

3 ticular circumstances. To answer these questions a multitude of methods and assessment tools have been developed in the past. One of them is the Benefit Analyses which demands in a first step the definition of goals and requirements of the stakeholders involved in the process of financial intermediation. Second a set of indicators as illustrated in the following table must be compiled and applied for the measurement of the performance of given financing schemes in relation to the stated goals. Further steps include technical transformations and calculations in order to compute a total benefit for each policy alternative in question. Tab.:Checklist for sub-goals and criteria in the evaluation of housing finance systems EFFICIENT PRIVATE HOUSING FINANCE SYSTEM BORROWERS LENDERS GOVERNMENT Supply of credit Credit availability Credit affordability Investment attractiveness Security of funds Profitability for shareholders achievable indirect benefits (costs for) economic (costs for) institutional (costs for) sector-specific housing credit portfolio continuity of new lending market shares loan amounts + periods of redemption collateral requirements income ratios (PTI and LTI) number of customers third party lending mortgage rates and fees spreads and real interest rates liquidity risk interest rate risks maturity of investment share of institutional investors Yields spreads and real interest rates inflation and reinvestment risk Solvency credit risks capital adequacy cost efficiency net income and margins return of equity and assets cost-income ratios housing outcomes and national income financial depth macro-economic stability savings ability and willingness Legislation regulation and supervision degree of financial development quality of residential infrastructure, construction sector and rent level home ownership promotions Chapter five describes the elements of this particular method and illustrates its practical application on the basis of the three financing systems presented in chapter four, namely the Bausparkassen, the Danish mortgage bond system and the system of mortgage backed securities. This selection must not be interpreted as an official bias of the Human Settlements Committee towards any of these schemes. They serve as C:\Dokumente und Einstellungen\bwo-web\Lokale Einstellungen\Temporary Internet Files\OLK12\gt-o4 Warschau.doc Peter Gurtner/pul Seite 3/5

4 mere examples. As the study shows a host of other and often more widely applied finance systems exist throughout the region of the ECE. IV The report ends with general conclusions and recommendations. First of all it makes clear that there is no universally applicable model of a housing finance system. Over the years a great variety of distinct solutions has emerged, each reflecting the historical, societal and economic particularities of a given country. Every finance system is a result of specific circumstances, such as the macroeconomic conditions, banking regulations, the size of the banking system, taxation, subsidy programmes and the structure of the housing market. These factors shape the path between bank based and capital-market based mortgage loan delivery channels. For any particular country, it is advisable to have more than just one housing finance scheme in place. In order to mobilise a maximum amount of funds dedicated to housing, a combination of systems is preferred. Each system assumes a certain function within the market so that systems complement one another. Whereas in a mortgage bond system or mortgage backed security system mortgage loans are refinanced by institutional investors (such as insurance companies, pension funds, etc.), deposits usually refinance ordinary or special loans granted through contractual saving schemes. The introduction of an individual technique should take into consideration the stage of the transition process a particular country is in. If capital markets do not work, saving models may be the first step to promote long-term commitments of borrowers and lenders. Contractual savings schemes often appear in an early stage of transition when lending to the private sector is still restricted because of poor income, an ill-functioning legislation and a lack of long-term funds in the capital markets They improve access to credit, especially for low and middle income groups, because these groups prove to the lender their ability to budget and set aside a certain portion of their income. Mortgage bond systems (like the Danish mortgage bond system) provide to the borrowers long-term loans with fixed interest rates, which allow for a better calculation of the interest burden. The loan is usually funded by a bond issuance with the same maturity. Referring to this instrument, mortgage banks can attract considerable volumes of funds and channel them to the real estate markets. Buyers of mortgage bonds regard these bonds as a safe investment because of their underlying collateral. In addition, bonds are fungible and can be quickly sold in the market. In higher developed economies secondary markets appear as a tool in further reducing credit risk and transaction costs both for the borrower and the lender. Loans can be bundled according to their underlying risk structure and sold in the market to those investors who are prepared to bear these risks in return for a higher yield on their investments. By selling loans through the secondary markets, banks are able to relieve their balance sheet and attract financing volumes for housing. Secondary mortgage markets, however, will not work as long as the primary mortgage market is not able to produce a sufficient volume of high quality mortgages that meet the requirements of institutional investors. If for example corporate governance structures were not respected or companies do not pay attention to transparent reporting of their activities, mortgage banks would face serious difficulties in refinancing their loan through bond issues. From this follows that no system can be regarded as the best. Whether a particular technique is appropriate for serving a given purpose depends apart from the individual benefits for borrowers and lenders on the level of economic development, on the C:\Dokumente und Einstellungen\bwo-web\Lokale Einstellungen\Temporary Internet Files\OLK12\gt-o4 Warschau.doc Peter Gurtner/pul Seite 4/5

5 household s capacity and willingness to make savings, on the rate of inflation and the overall monetary and fiscal policy. Other decisive factors are the legal and administrative infrastructure, the lack or existence of primary markets for mortgages as well as the fact, that the financing of rental and homeownership units may require according to circumstances different approaches. Common to all systems is the need for stable economic conditions and for a legal and and fiscal environment conducive to an efficient allocation of capital. This requires first and most importantly a reliable legal system securing property rights and contractual freedom as well as rapid foreclosure procedures. Further are modern systems of supervision of banking soundness and safety and as little obstacles as possible concerning property transactions. Once these conditions are established the appropriate housing finance institutions will emerge more or less spontaneously. Whether additional interventions by the government are necessary and justified to push some types of them is a matter of endless debate. Put forward as a supportive argument is often a real or pretended public interest in the mending of market distortions, in the provision of low interest credits for disadvantaged households or in the protection of new branches against foreign competition etc. Some of them might be valid, others less. In any case, governments should be cautious and beware of unreflected steps leading to inefficient institutional arrangements and ongoing political haggling over privileges and subsidies. If, however, for one reason or the other subsidies are considered to be necessary in order to reach specific policy goals they should be designed to both support the development of the private market and seek to improve the nation s social objectives. The debate should not be focused solely on the amount of the subsidy but also on its effectiveness in meeting governments goals for housing. Hence, subsidy policies should be efficient gaining as much as possible from every coin spent, should be well targeted and supportive of private sector funds for housing. Ladies and Gentlemen, the study I was talking about draws on experiences from the most advanced economies. Therefore, the systems and their application cannot simply be copied. Properly adapted to local conditions, however, they may help lay the ground for good solutions and so deserve a closer look from all interested parties. From an expert s point of view the content of the report may not appear to be very revolutionary. Much has been dealt with before. The merit lies in the fact that the topic of housing finance is discussed directly within the context of the difficulties faced by many countries in transition. In addition the project allowed the UNECE to gather valuable expertise in the field of public-private partnership where improvements of administrative procedures are badly needed if this kind of cooperation is to become a successful enterprise. The study can be consulted over the website of the ECE (www.unece.org). I thank you for your attention. Grenchen, November 2005 C:\Dokumente und Einstellungen\bwo-web\Lokale Einstellungen\Temporary Internet Files\OLK12\gt-o4 Warschau.doc Peter Gurtner/pul Seite 5/5

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