
Affordability: the Department of Housing and Urban Development defines “affordable housing” as a home which cost less than 30 % of a family’s income, in either rent or a monthly mortgage. When households pay more than 30 % of a family income, they tend to skimp on other necessities, such as health care. Low affordability to housing loans is usually caused by:

High default ratios / foreclosures sales (if measurable in emerging economies). High ratio of non-performing loans.

Ill-functioning legal conditions: the reason for high credit risk is that housing loans are normally secured though mortgages. The highly formalised legal instrument usually requires a clear, registered title to the land and the registration of the mortgage in the land register. Additionally, the lending process requires the valuation of the property which is costly and excludes all those who do not have a clear title to the land.
Incomplete land registries made it therefore rather difficult to convert the mortgaged property into liquid funds in case of default by the borrower.
Especially for the poor the mortgage instrument does not work because of the need for an acceptable title deed as collateral and the costs involved in valuation and registration of the collateral. Moreover, lending policies of some lenders tend to have a minimum size of loan, which is usually not affordable to the poor. In conclusion, the lack of access to collateral by borrowers and lenders is a major impediment to expansion of housing finance.

Lending to private sector is restricted because banks face difficulties in assessing the creditworthiness of the borrower. As a consequence, interest spreads are high (which reflect increased operation costs in order to cover higher risks in lending). In addition terms are short. In case of volatile inflation rates, banks often prefer to grant loans in hard currency (USD, EUR).

Low official savings ratios (mobilisation of funds for the housing finance system): in emerging economies, confidence in the banking sector is often low and other institutional long-term investors (pension funds, insurance companies etc.) remain undeveloped.. As a consequence, people prefer to put their savings into shoe-boxes instead of channelling them into the banks, which could use the funds to finance medium/long-term housing investments. To give you one example, during the conversion of the former Deutschmark into the Euro in the Serbia, a total of € 4 billion to € 8 billion has been converted and deposited in Serbian banks. However, most of it was whipped out again soon after January 1 st
.
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
Difficulty to obtain a second lien mortgage: banks often accept LTV ratios up to 60 or
70 %. As a result, the loan amount would not cover the total financing costs for the house.
Conclusion: Access to credit is difficult, especially for low and middle income groups. A complementary tool may help to fill this gap and make housing affordable. With such a measure, we may also expect more stability for the whole financial system. Financing structures will be more balanced and less dependent on market fluctuations.
CSS models may fill the gap between the intention of the government to make housing affordable and the prospect for the people to have a mechanism where they are able to build up own funds. Surveys have shown that households tend to save more for housing if they can combine savings with housing loans. In this context, CSS may help to create a general climate of home loan availability because a special mechanism offers home loan commitments to the savers. How do CSS Models work?
In general, contracts of the CSS models are designed in a way that the accumulation of savings is linked to a loan offer. Thus, we can differentiate four elements:
1.
Conclusion of the contract with the following items:
 Specific contract sum (€ 100,000).

Savings rate, repayment rate

Interest rates for the savings and the loan.
2.
Savings period: up to 40 – 50 % of this amount will be saved (= € 40,000 - € 50,000) in monthly instalments. The use of the funds is restricted to housing purposes.
3.
Allocation period: in general, the customer saves for 5 or 6 years, before a loan offer will be made to him. Once the customer has completed the savings period, he is entitled to a loan. The size of the loan is usually the difference between the contract sum and the amount saved (e.g. in our case € 60,000 - € 40,000).
Since a CSS is usually managed as a closed system, banks can only allocate those funds in form of loans to the customers, which the banks have previously collected. Hence, customers are subject to a waiting period the length of which depends on the availability of funds. The challenge for the banks in managing such an “allocation pool” is to balance fluctuating inflow and outflow of funds in order to meet all the future loan demands of the customers within a reasonable time span. Short and continuous waiting periods are an important factor of the attractiveness of the system. Therefore, specific queuing rules determine the sequence of the loan disbursements to the customers.
4.
Loan period: the customer repays his loan on the basis of the agreed interest rate. The granting of the loan is not subject to normal credit underwriting.
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A sound financing structure for a home
As for the conclusion, I would like to refer to experiences in Germany: a combination of bauspar loan and mortgage loan has appeared as a solution of a balanced financing structure of a home. The bauspar-funds which accounts for roughly 30 % of the purchase price of home supplements the mortgage loan (50 % of purchase price) and the down-payment (20 % of purchase price). The bauspar system has a complementary function.
As a complementary system, the CSS allows the potential home owner to accumulate the necessary down-payment in order to obtain access to credit. This characteristic is important for low and middle income groups who can steadily built up their creditworthiness.
This approach also allows a good integration of the baupar system in the housing finance system of a country. In this context, it has also stabilising effects on the whole financial sector.
Conclusion: From a financial perspective, the CSS introduces an option component to the contract. The customer has the right, but not the obligation, to call a loan at pre-specified terms from the bank. This option may be very valuable to the customer for three reasons: the loan is typically at a below market rate, interest rates are fixed over the whole lifetime of the contract for the savings and the loan (safeness of interest rates) and the customer does not have to go through an underwriting process to receive the loan proceeds. This option may be perceived as very valuable in a market where mortgage loans are not yet generally available i.e. capital markets do not work and many households do not have experience with the formal financial sector.
What we have seen so far is that saving is beneficial to the customer and the economy and the general characteristics of CSS. The question we face now is: how can we motivate people to save? Second question arising from the first one: if people want to save, how can CSS models be implemented in face of the special economic condition in emerging economies i.e. which constraints do we have to overcome in an emerging markets context? The two questions should be answered through the points 3 and 4 of this presentation. In this case, policy recommendations are delivered for the introduction of CSS models. Point 5 of this presentation gives some examples how countries have successfully managed to implement
CSS systems.
The establishment of CSS in emerging economies is linked to some specific features thereof the most important one is the safety of the savings: long-term obligations require special protection so that customers are willing to entrust their savings to a bank because failures where depositors have lost money may have a lasting impact on the savings willingness and the viability of the institutions which administer them. Furthermore, the attractiveness also depends on the fact how people perceive the government’s conception of the CSS and how these institutions deliver the loan. Macroeconomic forecasts also play a substantial role.
Taking in consideration the emerging market context, we may identify the following additional or specific constraints:
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1.
Credit risk: losses due to default as result of lacking capacity or willingness to repay the loan.
2.
Agent risk as a result of divergent incentives between agents, which may lead to a misuse of funds: for example, if an ordinary bank manages the CSS-product, the funds collected may be used to fund other purposes than housing. As a result, there might be no funds left to refinance the housing loans of the borrowers.
3.
Attractiveness risk: what can be done in countries with a low propensity/willingness to save (e.g. Romania, Brazil in contrast to China). In this context, we must differentiate between willingness and capacity. It is important to note that low and middle income groups are able to save. However, the products offered to them do not often meet their demand.
4.
Legal conditions: the government has to tackle the following questions: Protection of private property and the safety of the deposits, introduction of suitable supervisory bodies to guarantee viable institutions, the integration of the CSS into the financial system (e.g. the CSS can be designed as a complementary system to ordinary mortgage loans). The danger is that the government may discourage savings by regulating interest rates and financial innovations.
5.
Sound liquidity management in view of volatile inflation rates i.e. interest rates: the key risk of the CSS is liquidity risk, or the risk that banks will have insufficient funds to meet future loan demands. The possibility of a cash shortfall arises when the cash from new deposits and existing loan payoffs is insufficient to fund loan commitments (i.e. loans to savers who have completed the savings period). In emerging economies, inflation rates have a major impact on the flow of funds into the CSS since the CSS banks offer savings with a below market interest rate. In order to manage liquidity risk, CSS must ensure continued attractiveness to new savers, which is a function of both the savings return and the availability of loans.
1 As a result, CSS must be regulated and supervised.
As a consequence, a CSS-bank will constantly adapt the CSS-product to the changing market conditions (inflation rate/interest rate) in which it operates. The concept of a CSS must allow the CSS-bank to modify the conditions of the contract in order to meet future demand. However, modifications should only be applied for the next “saver-generation”.
Otherwise, confidence into the system will deteriorate.
A general advise would be to avoid frequent changes in the design of the CSS because any
CSS depends on a constant flow of funds in order to maintain the liquidity. Moreover, public confidence in the CSS would then be jeopardised.
1 However, existing contractual obligations will always be met because the allocation fund is filled up by both the savings and redemption payments. This means, the CSS-bank can also use the proceeds from the allocation fund to pay back the savings.
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1.
Credit risk: Since the CSS-bank already knows the customer’s reliability from the savings period, default should be easier to manage. For example, surveys in Germany reveal that people with CSS-contracts show a lower number of foreclosures sales in comparison with borrowers without a CSS-contract (as per 1998 0,15 %). Moreover, the current default rate of the German CSS-banks is about 0.02 % of their entire loan portfolio (in 2001).
Therefore, in the early years of the existence of CSS, loans may be granted as personal loans if collateralisation of property does not function well.
2.
Agency risk: Agency risk may be reduced through the introduction of specialised institutions because they guarantee that the flow of funds collected by them will be dedicated to housing purposes (clear focus). Specialised institutions also underline the strict mutuality and transparency of the system: almost all funds come from savers
(mutuality) and can be used only for housing loans (transparency). On the other hand, this approach implies less diversification and reduced cross-selling opportunities. Liquidity is to be managed and monitored more carefully because of less possibilities to evade macroeconomic shocks. Furthermore they cause additional costs to the institutional participants because the banks must be separately capitalised and competent staff at the supervisory bodies is needed to ensure the functioning and the stability of the banks.
In any case, it is recommended to introduce specific banking regulations and a regulatory feature of the product in order to preserve the security of the savings and the liquidity of the contractual credits. They can also be embedded into the overall banking legislation of a country.
3.
Attractiveness risk is closely related to the macroeconomic and legal conditions. The first step is that people perceive the institutions managing their funds as stable and viable so that they do not risk loosing their money. Close government regulation and supervision should be the crucial measure. A further one may be the invitation of foreign investors to build up such a system. The confidence in such a foreign-owned entity may be higher (for example, successful establishment of Microfinance bank in Kosovo in January 2000 by
IFC, EBRD, KfW and Commerzbank. The bank has attracted more than 35,000 accounts and assets of about € 140 mio. (mid-year 2001).
4.
Point 4 (legal conditions) and 5 (liquidity risk) are closely intertwined will be therefore discussed together since the solvency of the bank depends to a great extent on the legal framework where it does its business.
In general, the introduction of CSS should only be considered in economies with an inflation rate < 10 %. Higher inflation rates are also acceptable providing that they will decrease in the following years. Otherwise, inflation will eat up the value of the savings.
As for the different elements of CSS, the following measures should be taken into consideration in order to better manage liquidity:

Maintain short and consistent waiting periods (= the time the customer has to wait until his loan will be allocated) in order to avoid big fluctuations in their lending activities. Especially in the beginning of their activities, start-up effects should not be transferred to the customer (i.e. all in-going funds should not transformed into loans), but retained in order to keep the waiting periods in the future in balance. If waiting periods are not stable, confidence in the CSS bank may be jeopardised.
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
Clearly define the waiting period: it should be made clear that the CSS banks cannot guarantee immediate funding of the loan upon completion of the savings contract because the waiting period is one of the few strong levers that exist to manage the liquidity of the bank. Savers should have the right to receive a loan which is conditional on the availability of funds (from other savers). In any case, the amount of loans should not exceed the volume of savings.

Duration of the savings period: the savings period should encompass a certain minimum amount, a minimum time span of saving activities and the fulfilment of an assessment figure (which takes into consideration the ratio of the whole volume of savings and loans of a CSS bank). A minimum savings period prevents “quick savers” from receiving a loan too early without long saving efforts, which would decrease the liquidity of the CSS-bank in the long run. Other savers might wait longer before receiving a loan. As a result, consistent waiting periods are especially beneficial to savers who save regularly.
In countries, where CSS have been introduced, customers have opted for savings periods between 5 and 7 years. A longer minimum savings period would increase the proportion of resources going to larger housing solutions (purchase or new construction).

Require a reserve fund to meet future loan demand: some portions of the savings should be required to be placed in a special fund which serves as a cash/investment security reserve. Furthermore, these reserves should be used to keep the waiting periods equal in length and as short as possible. The set-up of reserves is of special importance in the start-up period of the CSS.

Introduce regulatory body (e.g. within the Central Bank) to monitor the CSS and its executing banks as well as the terms of contract: the regulator should approve the terms of new contracts (e.g. saving term, allocation terms, loan terms, interest rates etc.). The regulator should verify whether the banks have sufficient capital.
Furthermore, monthly or quarterly reporting of activity and the liquidity position should be reported to the regulatory institution (in this context, a further requirement is the creation of a liquidity model of the CSS which should be run on at least a quarterly basis by the regulatory body).

Flexible contract management: CSS-banks should be allowed to modify the conditions of the contract for new entrants into the system. However, these modifications should not affect existing contracts. Otherwise, the confidence into the system and the institution will be severely damaged and a collapse may be difficult to avoid.
5.
The role of subsidies: the design of a state housing policy concept usually tackles two areas: social housing programmes (will not be covered by this presentation) and government support for housing construction financing.
In principle, subsidies schemes should therefore designed to both support the development of the private market and seek to improve the nation’s social goals. The housing subsidy debate should not be focused solely on the amount of the subsidy but also on its effectiveness in meeting a government’s goals for housing.
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Hence, subsidy policies should be efficient – gaining as much as possible from each dollar spent, should be well targeted and supportive of private sector funds for housing.
Governments which intend to mobilise saving activities may consider the introduction of subsidies to induce savings activities (start-up effect). CSS is one way of achieving this goal. It is evident that other possibilities also exist. However, subsidies should not be used to keep a system running (whatever it is). Otherwise, we may observe a substitution effect: people channelling their savings into it in order to receive the subsidy instead of using them for housing purposes. We may then observe rentseeking effects which lead to market distortions. The money once spent in order to serve a well-accepted goal will be wasted. Therefore, the system should be selfsustainable and the main incentive should be the below-market loan rate. On the design of a subsidy scheme, the following points should be taken into consideration:

Provide realistic estimate of housing demand: if large new subsidies are designed in a context of unrealistic estimates of housing shortage, the policies will be distorted and put unwarranted pressure on the budget.

Continue the focus on macroeconomic and housing reforms: Policies should be aimed at leading to a continuous decline in inflation. Reforms should also encompass legal, administrative and information systems adjustments, which will reduce real lending rates in mortgage finance.

Helping to overcome the liquidity constraint: home ownership is responsive to income, the costs of owning versus renting and household preferences which will determine the capacity and willingness to incur debts. The so-callled liquidity constraints usually include a borrowing constraint (lack of sufficient down payment) and an income constraint (not having enough income to service the loan). A lump sum subsidy may help to overcome these constraints. For example, in Australia, a subsidy programme offered to borrowers either an up-front lump sum or a cash-flow over five years (or a combination of both). The subsidy was designed to address either the down-payment constraint (the lump sum approach) or the cash-flow constraint (payment over time). 80 % of the persons eligible opted for the down payment.

Consider specified target groups to assist those in need of a subsidy: subsidy schemes should be adjusted downwards so that after the fulfilment of precise conditions, further segments of the society will be reached. The eligibility of the subsidy might be restricted to households meeting certain income and/or asset ceiling (if possible to measure). Otherwise, the location may determine the eligibility for a subsidy.

In any case, subsidies should be linked to the use of the funds for housing purposes. If real interest rates are expected to decline and the probability of macroeconomic shocks is judged to be low, a lowering of the subsidy should not be excluded.
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The following countries have adopted a CSS comparable to the German bausparkassen model: Czech Republic, Slovakia, Hungary and Croatia. It is soon expected in Romania.
Outside Europe, the bausparkassen have expanded to India. In China, activities will be launched by the middle of this year. The introduction of bauspar systems has also been discussed in the Baltic states, Russia and Kazakhstan.
In India, a home loan deposit scheme as a variant of the bauspar system has been tested in certain local markets. It is planned to extend it nationally. The Indian CSS is intended to bring housing within the reach of lower middle class population particularly of rural and semi urban areas. Savings activities should allow the customer to take up a loan at a cheaper interest rate in the future.
Central and eastern Europe: economic indicators
1.
Inflation
To start with inflation, the so-called Visegrád countries Hungary, Poland, Czech Republic and Slovakia are the frontrunners with stable to low inflation rates. In Poland, the inflation rate in 2002 is expected to fall further from 5.5 % to 2.7 % with only a modest rise to 4 % in 2003. In the Balkan Peninsula, we observe great difference between Romania (17.8 % in 2002), Bulgaria (3.8 %) and Croatia (3.0 %).
2.
Employment
Here the situation is quite different. Hungary is one of the countries which is better off. A great worry is Poland with 18.1 % out of work (as per December 2002). The Balkan
Peninsula also suffers from a high percentage of unemployment. The reason is that in these countries governments have recently started to privatise enterprises, looking for a strategic foreign investor, which usually means laying off people.
3.
Economic Development
With a growth rate of 3.5 % of GDP, economic growth of the whole region is twice as high as in the rest of the world. In 2003, GDP will rise by 4 % according to the latest survey of the EBRD. Problematic areas are budget discipline and agriculture. In this survey the EBRD notes that politicians concentrate rather on metropolitan areas than rural areas. Especially in Poland, the situation is very critical because the current government has delayed necessary reforms (privatisation – more than 2000 enterprises are still stateowned, reform of agriculture). The EBRD notices that the Polish government uses its influence on the still state-owned banks in order to help the struggling steel, dockyard and chemical industry. As a result, GDP in Poland will only grow by a meagre 1 %, which means that Poland is the laggard among the other 26 Eastern European transition countries.
4.
Governmental policy in relation to housing
In order to judge the governmental policy on housing in a transition economy, you have to take into consideration the different stages of a transition process: usually, the first area to be tackled concerns the liberalisation of prices and foreign trade, then privatisation and the restructuring of the industry. Housing remains one of the later issues of concern and
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spending on housing projects will therefore start at a later stage.
Therefore, it is quite obvious that the development in the Visegrád countries differs from that in the Balkan peninsula, because in the latter transition has started about 10 years later. Hungary for example has recently overhauled its housing policy strategy and has introduced interest rate subsidies to stimulate demand.
5.
Banking sector
The status of the banking sector is more problematical: Hungary and the other Visegrád-
Countries have successfully restructured their banking sectors, allowing foreign banks to own major stakes of the banks. Moreover, these countries have successfully accomplished the restructuring and consolidation of their banking-sectors. Foreign banks do not only deliver the necessary capital which was necessary to clean up the murky balance sheets, they also provide management know-how, IT, and supervision (because they expect their new daughters to flourish). For example, when Komercni Banka published its third quarter results it became evident that thanks to the participation of Société Générale
(France) in Komercni Banka in 2001 – one of the former sickest banks in the Czech
Republic – now records the highest profits among central European lenders. As for the
Balkan Peninsula, governments have recently started to let foreign banks in (Romania,
Bulgaria) or to close unprofitable banks (Serbia). In Russia and the CIS-Countries, the situation is still a mess. In these two regions loans are often disbursed in hard currency with short terms (maximum 1 to 2 years).
6.
Legal framework
A prerequisite for a sound financial sector is functioning legislation. The transition process means here to introduce the necessary rules and regulations to allow action according to free market principles. Usually, these are contractual freedom, title and foreclosure rights.
As soon as the legislation works, the banking sector is poised to ensure an efficient allocation of capital, which means competition, new services and products to attract customers. The reasons for an underdeveloped banking sector are usually found in a nonfunctioning legal environment.
As for housing finance, title is one of the biggest problems: in all countries, the land registry during communism had not been run properly. As a result, you can hardly identify the right owner of a house. Further problem is corruption.
Again, the Visegrád countries and the Balkan peninsula differ in their development because transition has started earlier in the Visegrád countries. These countries also have to prepare for membership in the EU which means in this context the adoption of EU law.
Conclusion: Inflation rates are not of major concern in central and eastern Europe (except in
Romania and Serbia and Montenegro; but there, they also decline). The crucial issue is the access to credit.
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Bausparen in the Czech Republic
Bausparen has existed since 1993. Currently, 6 bausparkassen operate in the Czech Republic.
Since its inception, the number of bauspar-loans has risen from 880 to 520,000 (1995 – 2001).
Bausparkassen deposits have risen to about CZK 133 billion which corresponds to a market share of 16 % of all deposits held in the Czech Republic (as per 2001).
Corresponding to the increasing savings volume, the government expenditures on the subsidies have risen, too. In 1999, the amount peaked at € 2.06 billion and decreased to € 1,72 billion. In the following year, a further decrease is expected to € 1.5 billion.
Albeit increasing demand for bauspar loans, people have often not taken them up because general affordability of housing has been very low. A further reason have been ill-functioning legal conditions and administrative constraints (e.g. to obtain a building permit). This example shows that besides the development of the financial sector, legal reforms are equally important so that housing finance is possible. However, since 1999, interest rates of mortgage loans have decreased and range today between 8 – 11 %. On average, total housing expenditures vary between 18 – and 20 %.
Since 1995, housing construction has substantially increased after a decline from 31,500 to
12,700 dwellings between 1993 and 1995. The structure of housing construction shows that privately-owned buildings (family houses and flats) account for the largest number of completed dwellings and dwellings whose construction has started. In 2001, completed flats accounted for 31.5 % of all dwellings built while the share of family houses was 55 %.
Bausparen in Slovakia: development of flats being started and finished (1994 – 2001)
The regression line shows a clear trend of rising construction activities in Slovakia since
1994. However, between 1999 and 2000, there was a slight attenuation of the housing construction as a result of the economic situation. This decline is reflected with a shift of two years in the decrease of finished flats in 2001. Since 2001, the dynamism of flats started and finished has revived again. The outlook for 2002 is positive. In the first half of 2002, 8,452 flats were started and 5,665 flats were finished.
The example of Slovakia shows that the introduction of subsidies is beneficial to make a housing finance system work: between 1994 and 1996 the amount paid by the government in form of subsidies exceeded the volume of bauspar loans by 33 %. In 1997, the volume of bauspar loans exceeded the volume of subsidies for the first time. Since 1997, the subsidy amount has been reduced by 34 %. However, the volume of bauspar loans has risen by 87 %.
These figures also show that the system has become self-sustainable. Its functionality does not depend on the subsidy payments.
At the beginning of my presentation, I pointed out that the provision of affordable housing is the crucial point a housing finance system has to deliver. In this context, own funds stabilise the whole financing structure of the borrowers. They will enjoy:
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
Better access to credit, especially for low and middle income groups because they have the ability of proving their financial discipline (through regular savings). In addition, they benefit from a better creditworthiness towards the bank (achievement of more favourable credit scores), particularly in countries with poorly functioning legal conditions.

Buffer in case of difficulties: if a property is 100 % financed through mortgages, no room for manoeuvre will be left in case of declining house prices. The situation may worsen if customers have not agreed on fixed interest rates or if the fixed interest-period expired and they faces higher interest rates for the next period.
 Enhances capacity and willingness to repay the loan: through the savings process, people have already learnt to restrict their consumption. Furthermore, if they have invested their own money in the house, they will be even more motivated to pay the rest of the purchase price in order to become a complete owner of his home.
What is good for the individual is also good for the economy:

Housing affordability will rise. Foreclosures sales will decrease. Savings will be channelled into the banking sector. Banks will use these funds to finance investments.

In this context, CSS helps to develop the overall housing finance systems by supplementing other models. A sound and well-functioning housing finance sector has also stabilising effects on the whole financial sector.
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