Source: Czech National Bank
Headline: CNB introduces new mortgage limits
- The domestic financial sector has remained stable and highly resilient to potential adverse shocks over the past twelve months.
- However, the risks associated with the continued expansion of bank loans and the potential underestimation of risks by both banks and clients have increased.
- The CNB is responding to these risks in a preventive manner and in time using its macroprudential tools – by increasing the countercyclical buffer and tightening the mortgage lending conditions.
- The CNB is increasing the countercyclical capital buffer rate to 1.5% with effect from 1 July 2019.
- From 1 October 2018, the CNB is to include income requirements in its mortgage lending recommendations. Applicants’ debt should not exceed nine times their net annual income (DTI ratio). At the same time, applicants should spend no more than 45% of their net monthly income on debt service (DSTI ratio).
- These levels can be exceeded in specific cases, but for no more than 5% of loans.
- The limits on the loan-to-value (LTV) ratio remain unchanged.
- The CNB is continuing to prepare an amendment to the Act on the CNB which would grant it the power to set binding LTV, DTI and DSTI limits.
Developments in the Czech financial sector have been favourable over the past year. Banks remain highly resilient even to potential negative shocks, including a deep recession. This is shown by the results of the CNB’s stress tests and assessments in Financial Stability Report 2017/2018. However, analyses simultaneously indicate growth in risks associated with the current “good times”, in which both banks and clients perceive the risks to be negligible.
The CNB, which is legally responsible for maintaining financial stability as well as price stability, is responding to this risk assessment in a preventive manner and in time using new macroprudential policy measures: it is tightening the conditions for providing mortgage loans and raising the countercyclical capital buffer rate for banks for the fourth time since the end of 2015.
“The non-performing loan ratio tends to be very low when economic growth is strongest. This is often misinterpreted as evidence that the risks associated with loans are also low. In such a situation, however, they usually increase unobserved – and all the more dangerously,” said Governor Jiří Rusnok, explaining the financial stability paradox in good times. “However, we must look ahead. We are therefore interested mainly in what will happen to loan servicing when the good times end. Although this may not come soon, it will happen one day. As soon as interest rates or unemployment start to rise, a large subset of households could run into loan service problems, which in turn would negatively affect the condition of banks”
The favourable economic developments, coupled with low loan interest rates, are encouraging the emergence of optimistic expectations and increasing households’ willingness to finance their expenditure using debt. Despite slight growth in interest rates, lending conditions remain very relaxed and the amounts of new loans provided to households are still high.
Property prices grew at the fastest pace in the entire European Union for most of 2017 – by 16% on average. According to the CNB’s estimates, the overvaluation of apartment prices is also increasing – it stood at around 14% at the end of 2017. Conditions for the development of a spiral between property prices and property purchase loans thus persist. Since 2016, the CNB has identified this as the most significant risk to domestic financial stability. Moreover, in the past year banks have provided a significant percentage of mortgage loans that the CNB considers highly risky in terms of borrowers’ ability to service them from their current income.
“Debtors are becoming more vulnerable as growth in housing prices outpaces growth in household income. The probability that riskier clients will increasing apply for loans is simultaneously rising,” said Governor Rusnok.
To mitigate these risks while not reducing the availability of loans, the CNB is setting an upper limit on the debt-to-income (DTI) ratio of 9 as from 1 October 2018. The upper limit on the debt service-to-income (DSTI) ratio is 45%.
At the same time, the CNB respects the fact that a small proportion of loan applications have specific characteristics and that strict insistence on the application of the caps could lead to excessive regulatory hardship. Banks may thus exceed the DTI and DSTI limits for 5% of loans. In combination with this 5% exemption, most previously provided loans would retrospectively meet the DTI and DSTI limits.
The CNB is leaving the current 90% limit on the loan-to-value (LTV) ratio unchanged. It still applies that loans with LTVs of 80%–90% may account for no more than 15% of all mortgage loans provided by banks.
The following example illustrates how the new recommendation will be applied in practice. Assuming an 80% LTV, an applicant for mortgage for an apartment in Brno with a floor area of 75 square metres and a price of CZK 3.4 million would obtain a loan of CZK 2.7 million. If the loan maturity were 30 years, the interest rate 3% and the applicant’s net monthly income CZK 31,000, the DTI would be 7.2 (annual income of 12 x CZK 31,000/loan amount of CZK 2.7 million) and the DSTI 37% (annual instalments of 12 x CZK 11,400/annual income of 12 x CZK 31,000). Such an applicant would meet both the DTI limit (7.2 versus 9) and the DSTI limit (37% versus 45%).
The decision to introduce DTI and DSTI limits is not inconsistent with the CNB’s continued efforts to obtain statutory powers to set upper LTV, DTI and DSTI limits. This is because of the greater enforceability of such powers compared to a recommendation and the ability to apply them to all market participants, including non-bank and foreign mortgage providers.
At the same time, the CNB decided to increase the countercyclical capital buffer (CCyB) rate to 1.50% with effect from 1 July 2019. This measure is motivated by banks’ increasing vulnerability to a deterioration in the economic situation and the need for them to create buffers for “worse times”. In the event of continued rapid credit growth, increasing risks associated with property purchase financing and rising vulnerability of the banking sector, the CNB stands ready to increase the rate further. Conversely, if these risks decrease, the CNB will immediately lower this rate or release it fully.
Director, CNB Communications Division
Notes for journalists:
Every year, the Financial Stability Report provides an assessment of past developments in the individual areas of the Czech financial sector and analyses the risks to the stability of the financial system as a whole. The resilience of the domestic financial sector is assessed by means of macro stress tests using alternative scenarios of economic developments.
Maintaining financial stability is defined in the Act on the CNB as one of the CNB’s primary objectives. The Act requires the CNB to set macroprudential policy by identifying, monitoring and assessing risks jeopardising the stability of the financial system and, in order to prevent or mitigate these risks, to contribute by means of its powers to the resilience of the financial system and the maintenance of financial stability.
The main macroprudential policy tools applied in the Czech Republic include the countercyclical capital buffer (CCyB) and the Recommendation on the management of risks associated with the provision of retail loans secured by residential property.
The CNB announces the setting of the CCyB rate about a year ahead of its application, so that banks can adequately prepare for the new rate. The CNB announced earlier that the buffer would be increased to 1.00% from the current 0.5% from 1 July 2018 and to 1.25% from 1 January 2019.