Eesti Pank is setting requirements for housing loans from March 2015
As of March 2015, Eesti Pank will be applying three requirements to commercial banks issuing housing loans as a precautionary step to decrease the risk of a credit boom in the future.
The central bank initially planned to apply the housing loan requirements from the start of next year, but given the feedback from commercial banks on the requirements, the central bank decided to postpone enforcing the requirements by two months to give the banks time to adjust and review their internal lending procedures, if necessary.
The first requirement for the issue of housing loans is that the loan amount can be up to 85% of the value of the underlying property. If the surety is provided by Kredex, then the loan can be up to 90% of the value of the collateral.
The second requirement is that all the loan and lease payments of the potential borrower combined cannot exceed 50% of his or her net income. Net income is regular income paid to the person's bank account after all taxes.
The third requirement states that a housing loan has to be paid back in 30 years.
Governor of Eesti Pank Ardo Hansson says that this precautionary step by the central bank will help to avoid the risk of a credit boom in the future. "The requirements for housing loans will protect the Estonian financial system from risks in a situation where competing banks would like to take too many risks in times of fast credit growth. The requirements will also protect the borrower, as in an overheating market they prevent transactions that – in a recession – would mean difficulties in paying back the loan."
The new housing loan requirements will be applied at a level close to the banks' current lending standards. Thus, these requirements will not have a major impact on the conditions currently in place on the Estonian housing loan market. In addition, banks will be permitted to make exceptions to the requirements. These exceptions can cover up to 15% of the volume of housing loans issued in a quarter, which gives the banks sufficient flexibility in their lending decisions. The exceptions are meant to be used in cases where the borrower has excellent solvency or excellent collateral.
The requirements set by Eesti Pank will be applied to all banks operating in Estonia, including the branches of foreign banks. Loans issued to private persons for purchasing, renovating or building a home will be affected by the requirements. The Financial Supervision Authority will be monitoring compliance with the requirements.
Eesti Pank sought advice on the housing loan requirements from the Ministry of Finance, the Financial Supervision Authority and commercial banks. After receiving feedback the central bank changed the wording of the draft regulation, and as a technical change, extended the period for considering exceptions. The initial plan was to allow exceptions to be considered by the month, but this period has now been extended to a quarter.
Which other countries have applied similar requirements to housing loans?
The loan-to-value (LTV) ratio of housing loans or the requirement that determines how much of the cost of a home can be financed from borrowed money is one of the most widespread measures around the world for decreasing the risk of credit growth. Among other countries in the region, a similar 85% LTV limit has been introduced in Sweden, Norway and Lithuania. The debt service-to-income (DSTI) ratio is somewhat less popular in Europe. However, it has been used in Lithuania since 2011 and in Hungary since September 2014. Over the past year the debt-to-income ratio has been enforced in the USA and in Great Britain and is planned to be introduced in Ireland.
Generally, the gain factor of requirements for lending conditions is considered quite high when it comes to managing a credit boom, as the impact of these measures on loan issue is more direct than increasing banks' capital requirements.
Will housing loan requirements limit the chances of young families of purchasing their own home?
Young families will still have the option of lowering the self-financing rate of a housing loan to 10% if they use Kredex's guarantee (in which case, the LTV ratio will be 90%). These requirements will apply to all borrowers and thus, young families are no exception. People should also bear in mind that the requirements will protect borrowers from taking excessive risks.
Why is Eesti Pank setting housing loan requirements? Have the commercial banks not mitigated these risks?
The banks have already set these requirements in place in their internal policies, and with a much higher degree of detail. The commercial banks will still be managing credit risks. Eesti Pank's requirements set additional limits to these rules for the entire market, although these limits may change with the credit and real estate market cycle. Changes in limits may be considered for times of fast credit growth when competing banks happen to take excessive risks to maintain their market share.
The last credit boom and the experience gained from the crisis thereafter showed that decisions made at the level of individual banks may mean a significant accumulation of risks for the system as a whole. That is why it is important to think about the risks from the point of view of the entire financial system and, if necessary, take steps to manage these risks. The role of a "macroprudential supervisor" is played in Estonia by Eesti Pank, who assesses and addresses the risks to the stability of the financial system as a whole. Financial stability means that the banking sector is strong and reliable and able to offer banking services to clients even when times are tough.
Why is it important to give additional flexibility to banks when enforcing these rules?
From the point of view of financial stability, the efficient and transparent functioning of the credit market and the prevention of risks are both important, and it may support the of the financial system if banks are allowed to exceed limits in exceptional cases.
Using exceptions on the basis of risk estimates is up to the bank itself to decide. This decision can be based on the strength and sustainability of the borrower's solvency, the quality of the collateral or other circumstances.
What kind of collateral is taken into account in LTV ratio calculations?
Mortgages on real estate are taken as housing loan collateral. Mostly, collateral for a housing loan is a mortgage on the real estate purchased with the loan, or some other mortgage on the property that belongs to the borrower.
On what kind of income are the DSTI ratio calculations based?
The borrower's monthly net income used for the DSTI ratio calculations has to be regular and proven. It is important that the income is received sustainably; one important criterion for assessing sustainability is income received earlier. Since each lending decision is different, banks are free to decide on the length of the period of required income and the ways of proving income using their internal policies. The existence and sufficiency of internal policies is assessed by the Financial Supervision Authority according to its guidelines on responsible lending requirements.