Not banking on anything: central bank surveys emerging risks on Czech market
After the worries and shakiness of the last decade or so in Europe’s banking and financial sector, financial stability is no longer seen as a given but as something that has to be constantly safeguarded and, where necessary, regulated for. The Czech Republic came out largely unscathed from Europe’s last financial crisis, no large banks were bailed out and the biggest institutions are regarded as significant cash cows for their foreign owners. But the national bank has identified risk areas where it would like to see tighter control to make sure that the conditions for crises do not develop.
The overall tone of the report is both upbeat and cautious. And that’s perhaps understandable, a booming economy last year, slowing down a bit this year, means many individuals and companies are keen to invest and if necessary take out loans. And in some cases the central bank is worried that their appetite to borrow and invest might outpace their ability to repay, especially if conditions start to get a bit more difficult down the line.
But let’s start at the beginning and the Czech National Bank’s overall assessment of financial stability in the country. Governor Miroslav Singer:
“The sector as such is a bit more robust than last year. Not in any significant way, the change is not that dramatic but it did not have to be dramatic. And as to the environment, it is a little bit risky which essentially reflects more optimism of investors and their willingness, and households and their willingness, to take on loans especially with respect to real estate loans.”
“Low interest rates may mask for some households that servicing of their real estate loans may not be in future as easy as it is now when they take on these loans.”
The biggest worry for the central bank is that a housing boom seems to be developing fueled by record low interest rates. Czechs are seeking to profit from those low rates, anticipate further property price rises, and are piling into a market where the offer of new flats and houses, particular in the biggest cities like Prague, is short. The clear concern is that many would be house or flat buyers are being tempted to get in over their heads as regards loans and that they will be the first to suffer if their conditions change, such as they lose their job, or if interest rates start to rise, which appears to be a near certainty given how low they are now. Miroslav Singer again:
“The riskiness in this sector increases since, first of all, there is a healthy optimism. However, there are also low interest rates that may mask for some households that servicing of their real estate loans may not be in future as easy as it is now when they take on these loans.”
The Czech National Bank has been closely following the Czech real estate market for signs of over heating and it has also been surveying the loan practices of banks. Property prices are now back and sometimes beyond where they were back in 2008 at the peak of the previous boom. And while most of the banks have been following the central bank’s guidelines on what sort of loans can be offered, some appear to have been a bit more lenient and open handed. The governor again:
Last year the central bank issued banks guidelines saying that in no more than 10 percent of home loan cases should banks be offering loans covering 90-100 percent of the value of the property. But it appears that while the guidelines have generally been kept there have been exceptions where it has often been flouted. And, in cases where fairly high loan levels are covering 80-90 percent of the value of property the risk profile of borrowers is far from reassuring. Many are on fairly low to average incomes. And there is also a trend for the repayment periods to be stretched out, sometimes now coming to more than 30 years although the Czech repayment average is 24 years. In the face of these worries, the central bank has decided to act.
“We are strengthening our recommendations and we will attempt to have a chance to have an opportunity to make these recommendations into a binding regulation for the sector.”
The bank is now looking to gradually lower the maximum loan to property value limits. They should fall from the 100 percent now to 95 percent from October and decrease once again to 90 percent from April 1, 2017.
“We enjoy a robust, solid, liquid financial sector. We do not want to take the risks of having a different situation within the short term.”
And the banks themselves should change their 10 percent upper ceiling on all new loans with a loan-to-value ratio of 90-100 percent to 10 percent at 85 to 95 percent by October. That ceiling should then apply from April next year to loans with a loan-to-value rate down to 80-90 percent of property values. Both moves have the same target of curbing banks’ willingness to offer high risk loans. And while governor Singer agree that higher interest rates in the short to mid-term might address the problem as well, he is not willing to take a risk and lay off the regulatory brake on high risk loans.
“We enjoy a robust, solid, liquid financial sector. We do not want to take the risks of having a different situation within the short term.”
And the central bank is concerned that another part of the real estate market, this time the commercial real estate market, might be facing similar problems. This is basically the office space market where buyers might be tempted by potential price rises to enter the market and then find that they cannot find the tenants to cover charges, interest rates, and loan repayments. Here, bank loans covering over 70 percent of the value of properties are being made in more than a third of Czech office space purchases. And the worries are exacerbated by the fact that in most cases there are often no other assets which could be used to cover debts if thing turn sour and that office vacancy rates in many Czech cities remain stubbornly high. Miroslav Singer:
“The easiness with which the loans could be obtained and especially financed with low interest rates is making part of especially office space related loans relatively riskier with no big buffer in relation to service of debt in relation to income from the real estate ratio meaning that if the cost of servicing that debt increases mildly then those who take on these loans may face problems servicing them without increasing their rents. At this moment, the total share of these loans is not that risky but we just recommend to the banks to take proper care about the value of the real estate and loans ratio.”
“The easiness with which the loans could be obtained and especially financed with low interest rates is making part of especially office space related loans relatively riskier.”
And the bank has also been looking cautiously at the so-called buy to rent phenomenon. With returns on other investments so low in recent years, that’s a phenomenon that has taken off in some countries, such as Britain. In some cases the social implications have been enormous with whole swatches of lower value flats and houses being bought up by the relatively wealthy. That means those on low incomes given little chance to own their own place and condemned to be perpetual property renters. But so far the buy to rent market has not taken off in the Czech Republic, though the central bank is calling for banks to be vigilant and has loan guidance for this case as well.
“It’s not that significant so far. Again. we recommend to banks to properly identify those transactions and not to provide loans to more than 60 percent of the value of such real estate units. But, honestly this is not so far a significant share of the market.”
