The European Commission wants to boost efficiency in the mortgage market by creating a single European market for the sector. But care needs to be taken in establishing such a market, which must be free and open.
Any industry that has experienced a doubling in the size of its market in the past decade while the cost of its products halved might feel aggrieved to be singled out as a sector in which efficiency improvements could be made. Yet this is the case for Europe’s mortgage industry, which the European Commission (EC) now sees as the key to unlocking integration in Europe’s retail financial services markets. Despite record low interest rates and booming markets, the EC believes there is scope for further efficiency improvements from the market by creating a single European mortgage market.
The EC looked to London Economics (LE) to provide it with evidence of the potential benefits for the European economy of creating a single European mortgage market. It commissioned a costs and benefits analysis, which points towards a substantial level of benefits (0.9% of EU GDP) arising from further integration in return for relatively modest costs.
The main drivers of the benefits are improvements in product ranges in many countries and through lower mortgage rates. According to LE’s report, The costs and benefits of integration of EU mortgage markets (August 2005), this would lead to an increased take-up of mortgage products, which would boost housing demand and lead to more construction activity. It is interesting that it is increased housing market activity that leads to the benefits rather than any improvement in efficiency in the mortgage sector. The report notes that Europe’s mortgage industry is already largely operating efficiently and in very competitive national markets.
Rationale for integration
Nevertheless, the European Mortgage Federation (EMF) indicates in its report with Mercer Oliver Wyman (MOW), The financial integration of European mortgage markets (October 2003), that there is room for efficiency improvements in the sector. Economies of scale in particular would be an important source of benefits, given that some very efficient lenders are currently constrained within the boundaries of their national markets. MOW recognised, as did LE, that filling product gaps in some markets and increasing the range of consumers with access to mortgage credit would also carry substantial benefits. A further source of improved efficiency, discussed below, is via lower funding costs arising from an integrated secondary mortgage market.
The LE analysis omits any discussion about the route by which integration would occur. This has major implications when considering the various policy choices open to the commission. Despite the high level of benefits indicated by the report, on its own the analysis does not constitute a basis for policy action. Any individual policy initiative would have to be thoroughly assessed and subjected to an impact assessment to avoid unnecessary and potentially costly legislation.
Lack of activity
As has widely been shown, pure cross-border retail lending (where a consumer buys a product directly from a bank in another country) is negligible at present. This has repeatedly been shown by the Eurobarometer surveys as well as in the European Central Bank’s (ECB) Indicators of financial integration, (September 2005), which show that even in the eurozone only 3.5% of all retail lending activity is conducted cross-border.
The major obstacles to integration via this route are the cultural and language barriers. The consumer survey carried out by LE in its report suggests that consumers prefer to buy products in their own country, where they understand the consumer protection regulations. Also the mortgage product by definition is tied to its physical collateral, which will normally be in the same country as the borrower. The collateral cannot move across borders, which again would make it difficult for lenders to provide a mortgage product to a borrower in another country with different laws and practices relating to property valuation or the ease with which properties can be repossessed. Collateral efficiency illustrates the wide divergences in Europe’s mortgage markets: Finnish lenders are able to repossess their collateral in a little over six weeks compared with a minimum of six years in Italy.
Despite the speculation about possible regulatory intervention, integration is quietly progressing via the free market route. Taking the LE definition of integration as being “all products available in all countries at the same price”, there has been progress in terms of pricing convergence. According to the ECB, mortgage rates throughout the eurozone show greater convergence than at any time since they started monitoring convergence indicators at the start of 2003. And the mortgage sector shows a much stronger level of convergence than that for consumer credit.
Crossing borders
A more likely route to integration, in EMF’s view, is cross-border selling of products in which the lender goes cross-border and provides consumers with products in their own country under local consumer protection rules. This can be achieved in various ways: through establishing a subsidiary in another country, through entering into a distribution agreement with a local provider, through the establishment of branches or by using the mergers and acquisitions route. In this sense, many new member states have fully integrated mortgage/banking markets, with providers from the original EU15 countries representing a substantial market share compared with the local providers. A Polish high street will feature banks such as Millennium (Portugal), Fortis (Belgium), Raiffeisen (Austria) and Nykredit (Denmark), as well as local institutions.
Following the logic that lenders do the travelling, the barriers to be tackled are those that prevent access to foreign markets on the same terms as local providers. These are what can be termed ‘infrastructure’ barriers, such as differences in access to credit registers and land registers, or differences in property valuation methods. At the moment, the costs involved for a new entrant in surmounting all these problems often wipe out what are already very thin margins. In addition, there is often political resistance to opening up banking markets to foreign players, as demonstrated by recent cases in Italy.
A second front on which integration of mortgage markets could be tackled is on the funding side of the balance sheet. MOW identified integration of secondary mortgage markets as a source of improved efficiency for the industry. This issue remains an area with much potential and where further work needs to take place. The emergence of covered bonds as a Europe-wide funding instrument and the continued growth in the residential mortgage-backed securities market, both point towards the move away from retail deposits to more diversified forms of funding. As such, this presents an opportunity to create a pan-European secondary market, which would be more liquid and offer a reduced cost of funding for European lenders, with possible benefits being passed on to the consumer.
The third area in which integration can be tackled is via consumer protection regulation. Very different rules have evolved around Europe, all with their roots in a mix of economic and cultural factors. Taken to its extreme, regulators could introduce rules limiting markets to a single European product that would be transferable and comparable across borders. However, the richness of Europe comes from the breadth of choices available to consumers in different countries and it is important to safeguard this. The major downside of any tightening of consumer protection rules is likely to be a reduction in product choice and availability. Given that both LE and MOW point towards plugging product gaps as the greatest source of benefits for the industry, harmonising consumer protection measures would seem to be counter-productive.
In terms of consumer protection, a more measured approach based on the existing Code of Conduct on Home Loans would seem a more productive route for policy makers. The code, together with the European Standardised Information Sheet, provides consumers with product information and a comparison of the terms and conditions of products throughout Europe in a transparent way. Implementation of the code in the EU15 has now reached a high level and the new member states are also implementing it.
Laudable objective
The EC’s objectives of creating a competitive and dynamic financial services market that is able to compete at a global level is laudable and it is clear that the mortgage industry would have a massive contribution to make in terms of European integration of retail financial services. However, the way in which integration takes place needs careful assessment.
Any measures clearly need to result in a more efficient industry that would bring benefits for consumers and lenders alike, as well as the wider European economy. Any measures taken by the EC should be aimed at removing obstacles that impede the free and open market for mortgage credit in Europe, leaving natural market forces to operate and work towards the creation of a single European market for mortgage credit.
Simon Walley is deputy secretary general at European Mortgage Federation.
