The Florence School of Banking and Finance (Robert Schuman Centre, EUI) together with the European Commission and the European Supervisory Authorities (ESAs) launched the new EU Supervisory Digital Finance Academy (EU-SDFA) during a conference...
On September 23, the Banca d’Italia organised a workshop on “An EU Legal Framework for Macroprudential Supervision through Borrower-Based Measures”, where I was invited to give the introductory presentation. The background for the workshop is the ongoing review of the macro-prudential toolkit in the EU by the European Commission. In this context, there have been calls to explicitly include borrower-based measures into EU legislation. This is also on the background that the counter-cyclical capital buffer might not be sufficient as macro-prudential tool and that ongoing shocks might further exacerbate real estate cycles across member states. And as different as residential mortgage systems are across countries, there seems to be an increasing degree of synchronisation between residential real estate cycles.
The workshop included presentation by experts from France, Italy and Slovakia on their experiences with borrower-based measures, DG FISMA on the European Commission’s plans, by the Head of the ESRB secretariat, Francesco Mazzaferro, and Anat Keller from King’s College.
Borrower-based measures include loan-to-value, loan-income, and debt service-income ratios as well as maturity and amortisation requirements. Interestingly, not every EU member state has a legal framework for borrower-based measures and in others it is not complete. Also, the governance structure might give rise to an inaction bias, something I will discuss further below. Another challenge seems to be the lack of good mortgage loan data in some countries as they are not included in the credit registry; this in turn makes it harder to properly calibrate such policy measures.
It is important to keep in mind that borrower-based measures (as other macro-prudential tools) might clash with other policy areas. Monetary policy might be very loose with the intention to increase aggregate demand; however, this might fuel an unsustainable credit and real estate boom – a situation in some euro area countries over the last years. Fiscal policy measures might also affect housing and thus credit demand – just think of the lowering in stamp duties in the UK last week. More generally, borrower-based measures focused on financial stability might clash with distributional objectives of the government.
This leads me to the big elephant in the room (and something that central banks and macro-prudential authorities understandably do not want to talk about directly): politics. Raising capital requirement to counter a credit boom can be easily justified in terms of financial resilience. In the case of tightening borrower-based measures, the impact is more directly observable. Households with less resources for a down payment, mostly families with lower income (and often younger households) can no longer take out a mortgage. This in turn can lead to political pressure, as illustrated by the situation in Ireland before the pandemic: When the Central Bank of Ireland wanted to tighten loan-value ratios in the years before the pandemic, there was strong resistance from media, ministry of finance and politicians.
This takes me to the governance question, on which Anat Keller had some very interesting insights. One important question is who the mandate has to impose borrower-based measures; it might be better to have committees taking these decisions to avoid groupthink but also to have broad-based consensus, which might protect decision makers against political pressure. There should be a publication requirement for the underlying cost-benefit analysis to thus guarantee a certain degree of transparency.
Another important question is that about leakage. Leakage effects of macro-prudential measures have been well documented, as for example by Aiyar, Calomiris and Wieladeck. One might think that such leakage effects are less strong in the case of borrower-based measures, given that (residential) real estate markets are mostly national; however, leakages can still exist, be they through institutions outside the regulatory perimeter (as documented by this fascinating paper by Fabio Braggion and co-authors on China), foreign branches or direct cross-border lending. And while all of this seems of less immediate concern, there is an interesting interaction with the ambition to create a truly European banking market. In such cases, leakage effects might become important and reciprocity arrangements as already exist in the case of counter-cyclical capital buffers become important.
In sum, it is easy to agree on the usefulness of borrower-based measures, but the devil is in the details. Three challenges loom large: tensions with other policy areas, leakage effects and political pressure.
If you are interested to learn more about borrower-based and other macro-prudential policy tools, please check out this on-line training course we are jointly organising with ESRB in November: https://fbf.eui.eu/course/macroprudential-policy-academy/