Czech Central Bank Tightens Mortgages Rules to Pop the Nascent Housing Bubble

13 June 2018

The Czech National Bank (CNB) took aggressive actions to burst a potential real estate bubble before it gets too big on June 12 by increasing the banks capital buffer rate to 1.5% effective from July 1, 2019 and tightening lending policies on mortgages effective from October 2018. The CNB introduced a raft of tough prudential rules to ensure that consumers don’t overload themselves with debt. The regulator recommended that banks set an overall recommended limit on indebtedness to nine-times the total yearly income of the mortgage applicant, and limit the debt repayment load to 45% of the applicant’s monthly net income.

These recommendations are non-binding, but banks usually follow the central bank’s recommendations. CNB warned earlier that loans exceeding eight-fold and 40%, respectively are risky. Current measures are a bit more relaxed, but still tough, critics say.It has sparked heated discussion about CNB policy in three main categories: impacts on the financial sector, society and the property market.“The Czech financial sector has developed highly favourably since spring 2017. According to the CNB’s aggregate assessment presented in the macro-prudential dashboard, it has maintained a high level of resilience to possible adverse shocks,” the CNB said in its Financial Stability Report 2017-2018, also published on June 12.

“This is being fostered mainly by the maintenance of sufficient capitalisation, stable funding sources and an extensive buffer in the form of quickly available liquidity.”The CNB has chosen to act as it sees tangible risks in excessive optimism that has driven house prices up on the back of the buoyant economy. The financial sector has peaked and created obvious cyclical risks, mainly related to a boom in property prices and the growing size of mortgage loans in proportion to wages. Czech housing prices expanded faster that anywhere else in the EU throughout most of 2017.“The average year-on-year growth rate of apartment prices was almost 16% in the individual quarters of 2017. The year-on-year growth started to slow slightly in the fourth quarter of 2017 but remained relatively high. At the same time, apartment prices considerably outpaced wages, so the affordability of apartments deteriorated,” CNB said.

Analysts have said a nascent real estate bubble is already receding and could soon burst. But the growth in prices is still a worry, especially in Prague, where AirBnB is driving out regular tenants and the rate of issuing construction permits for new apartments has long outstripped demand.In response, the CNB has slammed on the brakes and issued very conservative recommendations, in effect saying, “We won’t let the 2008 crisis happen again.”Both the CNB governor Jiri Rusnok and vice-governor Vladimir Tomsik have reiterated the point. “There is warning information considering the ability of an applicant to pay back loans from ordinary income. Almost one-tenth of provided loans were what we consider risky,” Tomsik wrote in a commentary for the Czech business daily Hospodarske noviny.“Debtors are getting more vulnerable. If the economy worsened, households would get into trouble with repayments. And there is a greater probability that riskier applicants will apply for mortgages,” Rusnok said.

Often-cited Cyrrus chief analyst Lukas Kovanda criticized CNB policy in a piece for Czech business daily E15. He argues that the central bank, obsessed with financial stability, is creating bigger problems by only tackling the superficial ones, which the free hand of the market would solve on its own.Czech banks were in good financial standing during the 2008 crisis, and there was no need for public money to come to their rescue, Kovanda said, yet their reward is greater CNB regulation, which will hurt business. Rusnok anticipated such criticism in an interview for Radio Plus on June 11. “It is our policy, and we have to do it. I know that financial institutions won’t be happy.”

Analyst Lukas Kovanda warns the CNB policy could lead to a black market in residential real estate and usurious practices. CNB governor Jiri Rusnok said that there has been a “fetishization” of home ownership. “It is a bit off the wall. And I understand it is reminiscent of the previous [communist] regime. But in Germany maybe 50%, even less, of the people own their homes. In Czechia, it is 70%-80% and there are notions it is almost a human right to have your own home and quite early on. It is not like that”, he told Radio Plus.