Housing Standards 2004/2005
Financing Housing and Refurbishing Housing Estates

4. The Effectiveness of the System of Financing Owner-Occupied Housing in the Czech Republic

4.1 Introduction

The introduction of this part of the study drew on data from the Housing Attitudes in the Czech Republic 2001 survey to address the question of whether the relatively low level of indebtedness of households from mortgage loans in the Czech Republic is, in addition to the unfavourable economic conditions in the 1990s, caused by factors other than economic ones, that is, by socio-cultural factors. We reached the conclusion that socio-cultural factors in the Czech Republic have some influence on decision-making relating to the use of mortgage loans. The level of Czech household indebtedness from mortgage loans was also compared with the situation in selected European countries (using ECB data) and some studies by the ČNB examining the effect of monetary policy on household consumer decision-making were cited. The main finding in this study was that the decisive factor influencing Czech household consumption is general disposable income. The influence of real interest rates and the mortgage supply (measured by the interest margin) on the consumption expenditures of households was very weak.

The chapter is focused on an evaluation of procurement efficiency, that is, questions about what factors on the institutional side, the management of interest, mortgage, liquidity and other risks, government subsidies and legislative conditions, make the costs of granting home loans higher in the Czech Republic. The purpose was to get an idea of how efficient the market in financial instruments for financing owner-occupied housing in the Czech Republic is on the whole, and using knowledge about the way home loan markets work in the countries of the EU, together with efficiency testing methods used in advanced EU countries, attempt to point out its potential weak points and shortcomings.

The research was based on a combination of quantitative and qualitative methods, including analyses of secondary data. The quantitative research was conducted as a questionnaire survey, and representatives from all general banks and savings banks (usually the board representatives of these institutions or at least members of top management) were approached with the request to complete the questionnaire, which contained questions that were primarily (though not exclusively) of a statistical nature about completed transactions, the amount of loans granted, average interest rates, and also about the financial resources used to cover credit operations, solvency requirements for granting various types of credit, the values (average and maximum) of the loan-to-value ratio (LTV), the operational costs of the bank, the method used to value and revaluate real estate serving as collateral for loans, etc.

The qualitative part of the research was conducted by means of a roughly one-hour interview, during which representatives of individual general banks and savings banks were asked to address in detail some more questions of relevance to how efficiently the mortgage market and building savings work at the general level and with respect to individual general banks and building savings. The interview was a semi-standardised interview with a pre-prepared list of questions. The research was carried out in June and July 2005. The analysis of secondary data mainly involved a study of annual reports from individual institutions, specialised domestic and foreign studies in this field, and articles on Web servers specialising in financial issues. The questions for the qualitative research were developed with the use of studies by Diamond and Lea (1992) and by the UNECE (2005).

The qualitative research also examined the following "problem" areas:

1. Financing - what are the main sources of financing home loans, why is the particular predominant type used, what are the costs of financing and what could contribute to reducing those costs, to what degree do the banks experience insufficient resources for financing or have problems acquiring these resources on the financial and capital markets. Generally, whether financial institutions granting home loans in the Czech Republic see any specific obstacles preventing the accumulation of cheap capital that can be used to finance home loans, or obstacles preventing the effective allocation of capital according as investors decide (the source of loan capital).
2. Credit risk generally refers to the non-fulfilment of the agreed terms of a financial transaction on the part of a bank's client. The focus of this research was to examining the mechanisms banks use in an effort to minimise this type of risk and secure themselves against it (e.g. by means of interest rates, insurance from specialised institutions, penalties for early redemption of loans, what is the difference in the level of interest rates for mortgage loans with various levels of LTV). According to foreign studies evidence of a high credit risk is poor access to home loans combined with a high LTV, a conservative approach to granting loans to only a relatively limited circle of clients, and excluding first-time buyers of owner-occupied housing from the market in connection with their lack of an adequate volume of resources of their own to obtain a home loan and acquire owner-occupied housing (down payment).
3. Interest risk, i.e. generally the risk stemming from unfavourable developments in market interest rates. The subject of research in this case was examining to what extent banks in the Czech Republic pass on the interest risk to their clients, to what extent they use various types of interest risk management (adjusting the structure of assets and liabilities from the perspective of sensitivity to shifts in interest rates, by means of forward transactions). Diamond and Lea (1992) cite as the efficiency criteria in this sphere in particular access to a wide range of mortgage products for clients from the perspective of the type of interest rate (variable, fixed), term of payment, various interest-rate fixing terms, and the possibility of early mortgage redemption without a penalties for the client.
4. Liquidity risk, i.e. generally the ability of the bank to obtain additional sources to finance loans in order to satisfy client demand. With regard to liquidity criteria the banks were asked how bound they are by the liquidity rules established by the central bank and whether a relaxation of those rules would in their opinion help make mortgage more widespread and less expensive. In addition, the research inquired about the existence on an option to sell of part of or an entire portfolio of loans granted, as there is in countries with an advanced home financing market.
5. Operation costs, i.e. the costs associated with obtaining resources and granting loans as a criterion of intermediary efficiency. The level of costs is usually indirectly affected by regulatory measures and market and institutional structures. Foreign studies have shown that potential sources of inefficiency in this sphere may be an oligopolistic market structure, the absence of behaviour designed at maximising profit, high costs connected with the process of loan procurement (e.g. the costs of assessing a client's solvency, the degree of consultancy necessary for granting a loan and the related qualification requirements for the relevant bank employee and the level of his/her salary, etc.), the low level of standardisation of products offered.
6. Government intervention (or generally any kind of external regulatory intervention, not necessarily just from the state) - in the sphere the question was examined of how much government subsidies serve to distort the market from the perspective of general and building savings banks, how much in their view they are beneficial, and what is the optimum form they could take.

The approach of the majority of banks granting mortgage loans was very operative, with the exception of two banks that have a relatively small share of the market (from the perspective of mortgage loans), and it was possible to contact representatives from all the banks and conduct interviews with them, and all the banks, except for the two, completed the questionnaire they were provided with.

In the case of buildings savings banks there was very limited willingness to take part in the survey, and we only managed to make successful contact with three of the buildings savings banks out of the total six such banks operating in the Czech Republic.

The main findings that we reached in reference to mortgage financing can be summarised into the points below. They mainly contain a list of potential failings in the Czech mortgage market, but the overall conclusion that emerges out of the analysis is a positive view of how the mortgage market works.