The Unassuming Economist

Speech by Governor Constantinos Herodotou, Central Bank of Cyprus:

“The fact that not all euro area countries receive relevant warnings and recommendations by the ESRB is an indication that the Residential Market in the euro area is characterised by heterogeneity. In the upper right quartile of the chart, we find a number of countries that registered an accumulated increase in residential property prices of at least 25% in the last three years.  Other countries have recorded accumulated growth as low as 5%. 

Using as a starting point the observed heterogeneity and by analysing the experiences of several countries, we can draw certain broad conclusions on the effectiveness of the macroprudential toolbox.

The design of Borrower and Capital Based Measures is a decision of authorities. For example, based on information from the ESRB, Belgium introduced a Loan-to-Value on both owner-occupied and buy-to-let properties. Cyprus, in order to deal with a specific sectoral exposure, further to the Loan-to-Value cap, recently introduced an even stricter Loan-to-Value for luxurious properties. However, by observing the real estate cycles registered in a number of countries, it is evident that even the idiosyncratic design of these measures does not always stop real estate cycles from materialising. The Netherlands and Slovenia are examples of countries that have recorded vulnerabilities despite the implementation of such measures.

Analysis performed at the Central Bank of Cyprus verifies this observation.

Using an econometric model, we explain the growth rates of housing loans and house prices considering the implementation of macroprudential measures.

The analysis indicates that the Loan-to-Value ratio seems to be effective in containing housing loans, for 10 out of 12 countries in our sample and effective in containing house prices in only in 3 out of the 12 cases. Income based measures (such as Debt-Service-to-Income) and Capital Based Measures were found to be effective in around half of the countries that use them.

We can therefore conclude, that there is no “one-size-fits-all” type of macroprudential tool.

One of the reasons why macroprudential tools are not always effective, could be that vulnerabilities are not necessarily driven by the credit cycles. In the cases examined, it is evident, that credit for house purchases is not always correlated with the trends in housing prices. For example, Slovenia and the Netherlands experienced a build-up in vulnerabilities in the residential real estate market without a corresponding excessive growth in housing loans.

Structural factors could explain the above observation as they affect both demand and supply of housing. More particularly,

*Net migration and population growth are factors that have continued to put pressure on house prices in countries such as Luxembourg, which experienced net population growth of 13,6% in 2020. Countries with low vulnerabilities in the housing market, such as Greece, experienced a negative population growth.

*Strong preference for home ownership could also be a driving factor for the observed vulnerabilities in Luxembourg and Slovakia. Homeowners represent 92,9% of the population of Slovakia whereas in France, a country with low identified real estate vulnerabilities,  homeowners represent 65,2%. 

From the above examples, we can conclude that in designing a macroprudential tool, idiosyncratic structural factors need to be identified and accounted for.”

Monetary policy also plays a role. Although macroprudential policy is the first line of defence, the ECB has recognised that Financial Stability is a precondition for price stability. It has also been acknowledged that monetary policy, can, in principle, influence asset prices such as real estate.

(…)

To sum up, the euro area residential real estate market is characterised by heterogeneity. Vulnerabilities in the real estate market are not necessarily cyclical in nature but structural factors also play a role. A single policy or measure cannot be enough to tackle the materialisation of risks from the residential market, although macroprudential authorities, as the first line of defence, have a significant toolbox in their hands, that can help in containing these risks.”