Comments of the European Federation of Building Societies. on the Green Paper on Long-Term Financing of the European Economy

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1 European Federation of Building Societies Fédération Européenne d Epargne et de Crédit pour le Logement Europäische Bausparkassenvereinigung Organisation: Name: European Federation of Building Societies Contact: Andreas J. Zehnder Details: Rue Jacques de Lalaing 28, 1040 Brussels Main activity: Promoting and supporting housing finance Transparency register ID No: Brussels, 25 June 2013 Comments of the European Federation of Building Societies on the Green Paper on Long-Term Financing of the European Economy The European Federation of Building Societies (EFBS) welcomes the opportunity to participate in the consultation on the Green Paper on Long-term financing of the European economy. The EFBS is an association of credit institutions and organizations that assist in and support the financing of home ownership. Its purpose is to encourage the concept of solid financing in the process of acquiring home ownership in a Europe that is converging, both politically and economically. The concept of savings for Bauspar loans, as represented by the EFBS, is based on the principle of bundling the savings of a group of savers to provide the funds required to finance home ownership within a shorter period of time than this would be possible for savers acting on their own, with fixed rates which have already been determined from the start. To this end, Bausparkassen customers conclude a contract with their Bausparkassen in which the amount which they would like to save is specified. They agree to make savings on a regular basis. In addition to this Bausparkassen business in the stricter sense, Bausparkasen are also allowed as specialised credit institutions to make investments in the EU Member States, however only in particularly safe investment vehicles. The European Federation of Building Societies would like to expressly acknowledge the European Commission s decision to devote more attention to long-term investments and savings vehicles. In the past, the European Commission had focused on promoting financial instruments which had only been geared to the capital market. Additional harmonisation measures adopted in the field of European mortgage loans in 2005 were justified on the basis of studies which had exclusively considered favoured mortgage loans that were refinanced in the capital market with a LTV of more than 100 % as sustainable. In their Report on the Costs and Benefits of Integration of EU Mortgage Markets, London Economics proposed securitisation techniques, high loan-to-value ratios, as well as fostering a subprime lending market etc. to generate internal market growth. The fact that such financing practices, which are common in the Anglo-Saxon countries, were not sustainable has been demonstrated by recent events in the context of the financial market crisis. For this reason, we very much welcome the discussion on the promotion of long-term investments and savings vehicles with regard to the three factors low interest rate, inflation and taxation of savings, which has been initiated by the European Commission with this consultation document. European Federation of Building Societies, Rue Jacques de Lalaing 28, 1040 Brussels Phone: +32 (0) , Fax: +32 (0) , info@efbs.org

2 With reference to the questions proposed by the European Commission, we would like to submit the following comments: (1) Do you agree with the analysis set out above regarding the supply and characteristics of long-term financing? The analysis and assessment of long-term financing emphasise correctly that savings are an important prerequisite. We also agree that long-term savings need to be synchronised with longterm investments. Private households are described as the main source of funds to finance investments; however, the analysis states that households tend to prefer short-term savings. It is therefore emphasised that there is a need to mobilise more long-term savings. As specified in Chapter 3.3 of the Green Paper, a number of schemes that provide incentives for long-term savings are already in place in the European Union. In the past, Bauspar contracts have proven to be a particularly effective vehicle for building up equity within the framework of housing finance because Bauspar contracts create additional stability due to their focus on home ownership. Saving money to purchase or build a home enables individuals to build up equity initially which they will use later to finance residential property. The loan which customers will be granted after the savings phase is earmarked for home building. The collectively managed savings are used by the Bausparkassen as an intermediary to extend loans to other Bausparkassen customers. This means that Bauspar contracts constitute a link between long-term savings and long-term financing. This may serve as a model for achieving the Commission s objectives. Traditionally, households start saving within the framework of a Bauspar contract very early on. This strengthens the long-term approach and educates covertly people to save. However, it must be stated unfortunately that, due to the artificial low-interest-rate policy pursued by the European Central Bank, consumers are currently being re-educated to consume, instead of saving. The European Central Bank s low-interest-phase, which has persisted for a fairly long period of time and whose only purpose, ultimately, is to reduce the sovereign debt of the EU Member States, has had an increasingly adverse effect on consumers. The low-interest phase attenuates progressively the incentive for consumers to save. Savers who hold long-term savings vehicles such as e.g. life assurance contracts or pay contributions to pension schemes are subject to cold expropriation, especially in view of the three factors low interest rate, inflation and taxation of savings. Within the framework of the upcoming discussions on the promotion of long-term investments and long-term savings vehicles, we would like to see the European Union exert a positive influence on the ECB to bring about a change in the current interestrate policy. (2) Do you have a view on the most appropriate definition of long-term financing? With reference to home ownership financing, we would like to draw attention to the fact that, for most people, building or buying a house and concluding the necessary loan agreement is the biggest investment of their lives. Long-term financing entails a very long commitment to the bank providing the loan and involves certain rights and obligations. Such investments in home ownership by means of long-term loans require long-term and sustainable refinancing on the part of the credit institutions. This must always be taken into consideration whenever regulatory action is taken. 2

3 Not only public investments but also private credit commitments account for a considerable share of the gross national product. In any definition, a distinction should therefore always be made between long-term equity financing and long-term debt financing. The time dimension associated with longterm financing should depend on the life-cycles of the capital goods to be financed, or a lower time limit should be defined. (3) Given the evolving nature of the banking sector, going forward, what role do you see for banks in the channelling of financing to long-term investments? As financial intermediaries which reduce information asymmetries, diversify risks and meet customer needs more effectively by means of financial innovations, banks will continue to play an important role in channelling financing to long-term investments going forward. In this context, the diversity of the European banking landscape will help to achieve an optimum allocation of supply and demand. More so than other banks, Bausparkassen which are low-risk banks governed by specific legislation proved to be a beacon of stability during the financial crisis, due to their sustainable business model and their specific safety architecture. In view of more than 30 million Bauspar contracts in Germany alone, for instance, it would not be possible to meet savings and financing needs in terms of time, money and risk without Bausparkassen as intermediaries. In addition, Bauspar contracts as a specific vehicle for financing home ownership in Europe provide more diversity in the banking sector and increase the range of products available for customers. Hence, the Commission s approach should not be to reduce the importance of financial intermediaries but to promote diversity, thereby intensifying competition. In the context of the regulation of the European financial market, we therefore ask that due consideration should be given to the diversity within the European banking sector, and we request that not only a traditional universal bank should serve as a model. Public banks, savings banks, co-operative banks, Bausparkassen, special mortgage banks etc. are subject to different national legal frameworks, and some of these institutions operate at regional level or only in a specific segment of the banking sector. European legislation should give due consideration to the diversity and the differences prevailing in the banking sector within the European Union. We therefore support all current proposals pointing in this direction. That is the case also for the own-initiative report of the European Parliament s Committee on Economic and Monetary Affairs (ECON) for the implementation of the Liikanen recommendations. In this context, it should also be stressed that, due to their national regulation, Bausparkassen and Building societies as specialised credit institutions already practice the system of separating commercial banking from investment banking. Bausparkassen are not allowed to perform high-risk transactions. The business model of Bausparkassen is based by law on collecting customer deposits and concluding savings agreements for building homes, which are usually occupied by the owners themselves. Bausparkassen are not allowed to provide other banking services such as investment transactions, payment services, credit card transactions or consumer credit. Furthermore, Bausparkassen are allowed to invest surplus capital only in eligible securities. With reference to the terminology used in the model of separating commercial banking from investment banking, Bausparkassen are already ring-fenced because of their risk-averse business model. 3

4 (4) How could the role of national and multilateral development banks best support the financing of long-term investment? Is there scope for greater coordination between these banks in the pursuit of EU policy goals? How could financial instruments under the EU budget better support the financing of long-term investment in sustainable growth? (5) Are there other public policy tools and frameworks that can support the financing of long-term investment? Whenever the private sector cannot become active in a given market, i.e. whenever there is evidence of market failure, public development banks can by all means become active in the market concerned. Yet, we would like to point out that lower regulatory standards apply to some development banks within the framework of guarantor liability ( Gewährträgerhaftung default guarantee provided by public owners to creditors). This may ultimately lead to market distortion because, aside from the state guarantee, these institutions also benefit from lower refinancing costs, compared with private-sector banks. However, at European and national level, development banks have always made important contributions toward building up cross-border infrastructure. Going forward, infrastructure financing is likely to pose the greatest challenges and to be the most important field of activity for development banks. In accordance with the principles of federalism and subsidiarity, multilateral development banks should become involved in projects that affect the entire European Union, such as transportation and power grids. At national level, development banks should only become active if they do not distort competition with private players. Otherwise, private-sector initiatives would be crowded out. This development can already be observed in some Member States of the European Union. In Germany, for instance, the government-owned Reconstruction and Loan Corporation (KfW - Kreditanstalt für Wiederaufbau) is assuming more and more tasks which were also performed and still are performed by private players. In the financing of measures designed to improve the energy efficiency of buildings, KfW can offer terms and conditions because of its public mission which can often not be matched by private-sector lenders. Competition is distorted and, in the final analysis, eliminated when players withdraw from the market. The range of products provided by KfW goes far beyond what could not have been achieved by market coordination in response to the socalled market failure. For this reason, the provision of such products by development banks can only be justified by reasons relating to the welfare economy in certain areas. (7) How can prudential objectives and the desire to support long-term financing best be balanced in the design and implementation of the respective prudential rules for insurers, reinsurers and pension funds such as IORPs? By analogy with the regulation in some product laws such as the German Mortgage Bank Act, we suggest that lenders who provide long-term financing should have to prove to the regulatory authority that they have the necessary skills and knowledge. (10) Are there any cumulative impacts of current and planned prudential reforms on the level and cyclicality of aggregate long-term investment and how significant are they? How could any impact be best addressed? 4

5 As is well known, the implementation of Basel III requires credit institutions, first and foremost, to increase their capital base. The Basel Committee has considered the possibility that this may adversely affect lending, and in order to prevent this, the Committee has allowed credit institutions to extend the increase in their capital base over a period of several years. However, the Committee has not taken into account that, at the same time, the ability of credit institutions in Europe to build up capital is considerably compromised by other factors. Their earnings will be burdened, in particular, by planned rules at European level (most of which will far surpass the burdens imposed on credit institutions in some Member States by national rules) in the fields of: - the protection of deposits, - the establishment of restructuring funds, - and the financial transaction tax. As a result, it can be expected that lending by European credit institutions will be significantly reduced. Bausparkassen may be subject to additional restrictions in the event that too severe limitations on leverage ratios are introduced in the EU. It is well known that the leverage ratio does not reflect the risks that are inherent in the businesses. Should the leverage ratio be limited to at least 3 percent, for instance, the credit institutions low-risk businesses would be severely restricted. Bausparkassen would have to cut down on long-term housing loans secured by residential property. Although mortgage loans were particularly affected during the financial crisis, the business model of Bausparkassen has proven to be stable and robust. The business model should be taken into account by the European institutions to ensure that it will not be jeopardised by introducing a general limit for the leverage ratio. (12) How can capital markets help fill the equity gap in Europe? What should change in the way market-based intermediation operates to ensure that the financing can better flow to long-term investments, better support the financing of long-term investment in economically, socially and environmentally sustainable growth and ensuring adequate protection for investors and consumers? An equity gap can be observed, not least in the financing of home ownership by private households. In this context, the European Commission has rightly drawn attention to dedicated saving instruments such as saving to finance the construction or purchase of a home. A sufficient equity ratio is crucial for sound housing finance. However, the conditions which currently prevail in the capital markets significantly hinder the efforts made to close the equity gap. The ECB s current policy of cheap money is heading in the wrong direction because - on the one hand, low interest rates do not provide much of an incentive for saving and providing for old age, - and on the other hand, low interest rates encourage private households to make investments which are not cost-effective in the long term and which are not sufficiently hedged against rising interest rates. 5

6 (13) What are the pros and cons of developing a more harmonised framework for covered bonds? What elements could compose this framework? Should the European Commission consider regulating covered bonds, if at all, this should be done at a high level in order to do justice to the high quality standards of the requirements that already apply in some countries. Otherwise, the disadvantages of regulation would outweigh the advantages, and the general standard of the legal framework for covered bonds in the EU would be lowered. (14) How could the securitisation market in the EU be revived in order to achieve the right balance between financial stability and the need to improve maturity transformation by the financial system? The members of the European Federation of Building Societies take the view that it is not the job of the European Union to revive the securitisation market in the EU. It was precisely the consequences of refinancing mortgage loans through securitisation which undermined sustainability in some EU Member States and the United States. A revival of such a refinancing instrument should be, with more stringent regulation, left to the market, and policymakers should refrain from unilaterally supporting this financing vehicle. (15) What are the merits of the various models for a specific savings account available within the EU level? Could an EU model be designed? For private households which do not have any direct access to the financial market, financial intermediaries are indispensable. They cover the long-term financing requirements for long-term private investments. Bausparkassen more than other credit institutions have close ties with their customers which have grown over many years. The savings phase marks the beginning of a longterm customer relationship. The relationship continues during the loan phase. Due to the fact that savings are made over a longer period of time, Bausparkassen know that their customers (and subsequent borrowers) are reliable, so that they can accurately determine their creditworthiness. Since the interest rate to be paid during the saving and loan phases is fixed and guaranteed in advance, the customers of Bausparkassen benefit from a high degree of planning reliability for their investment projects. Since saving for housing finance is a project designed for a long period of time, it fosters the concept of long-term savings and disciplines customers to repay their loans rapidly during the loan phase because customers of Bausparkassen can choose to make higher repayments than initially agreed without sanctions. The extremely low default rates on Bauspar loans show that the mutual trust that extends over many years pays off for both partners. Savings for housing finance therefore make an important contribution to the long-term stability of financing systems. Bauspar contracts are a particularly suitable instrument for accumulating capital. Bauspar contracts provide certainty due to the fact that the amounts to be paid are fixed and the terms and conditions are defined in advance. The interest rate payable on the Bausparkassen loan is fixed for the entire period of the contract, and it is extremely low. The objective of obtaining a low-interest loan fosters the concept of saving. The fixed interest rate on the loans provides a reliable source of finance for home building; such loans go into default in only very rare cases. In addition, however, we would like to draw attention to the fact that, in accordance with private international law and in particular in view of Article 6(2) of the Rome I Regulation, it is not possible 6

7 to export loan agreements to another Member State because the agreements will always have to be adjusted to reflect the interest of the general public, especially of the consumer protection law of the Member State in which the consumer has his or her permanent residence. This hampers the cross-border business. One solution in this context would be to create an optional legal framework which, ultimately, could apply alongside national legal systems and which the parties to a contract could choose as applicable law. Such an optional regime would encourage competition between legal systems, and consumers would have a right to choose a legal regime across national borders. (17) What considerations should be taken into account for setting the right incentives at national level for long-term saving? In particular, how should tax incentives be used to encourage long-term saving in a balanced way? Saving up capital can be incentivised by governments easily. To ensure the success of saving efforts, governments can e.g. tie the incentives to a minimum saving period, a specific use of the incentivised savings or income limits. When tax concessions are granted, care must be taken to ensure that such concessions do not in a onesided mannor increase the indebtedness of high-income private households. Public expenditure on tax concessions is usually several times higher than expenditure designed to mobilise savings, e.g. of lower and medium income groups. The current crisis has shown that a price bubble developed in the real estate markets in all the countries in which high debt interest was tax-deductible. Ultimately, these countries therefore set incentives for over-indebtedness. The activities of mortgage insurance providers in some Member States of the European Union and in the United States also played a role. The fact that these mortgage insurance providers assumed the full financing in the case of borrowers who had no capital ultimately also created incentives for over-indebtedness. (30) In addition to the analysis and potential measures set out in this Green Paper, what else could contribute to the long-term financing of the European economy? The large number of regulatory proposals made by the European Commission for the financial sector during this legislative period will still have to be implemented at national level. It is not yet foreseeable what cumulative effects the extensive European rules will have on both the banking sector and the real economy, as well as on the costs for consumers. In view of the multitude of regulatory measures, there is also a risk that solid medium-sized and smaller credit institutions may not be able to cope with the amount of regulatory acts which have become necessary because of the misconduct of large institutions. It cannot be accepted that the originators of the crisis become its winners. We therefore strongly recommend that, in the next legislative period, attention should be focused on monitoring and reviewing the effects of the regulatory measures adopted during this legislative period, and that a regulatory moratorium should be introduced. This applies in particular in light of the fact that that the European Union s 27 Member States have developed in very different ways in the market for financing home ownership. While, in some 7

8 Member States, it is certainly advisable and necessary for governments to take action in support of debtors and consumers, there is certainly no need for such action in other EU Member States with sustainable housing finance systems. We therefore also suggest that, in future, the European Union should take practical action designed to deal with the specific problems of individual Member States instead of introducing general measures for all 27 Member States of the European Union. 8