Are concerns about the mortgage market justified?

Switzerland’s banks are in sound shape. That’s the message from the SNB’s Financial Stability Report. Nevertheless, the National Bank is concerned – not about cyber risks or tech firms entering the market, but because the real estate market has come through the coronavirus crisis unscathed.
Article byMartin Hess

The SNB’s annual Financial Stability Report, published two weeks ago, gives Switzerland’s banks a good rating overall. It concludes that the two globally active big banks are well placed to face the challenges presented by the current environment and to support the real economy. The domestically focused banks have also further built up their capital bases. In most cases, they are adequate to cover the substantial loss potential simulated in a scenario analysis. A number of banks could nonetheless approach, or fall below, the regulatory minima in this simulation, but not to an extent that the SNB, under its remit, considers to be systemically important. 

The SNB’s view of the risk environment

In his introductory remarks at the news conference on 17 June 2021, Vice Chairman of the SNB’s Governing Board Fritz Zurbrügg outlined three risks that are relevant to stability: first, a deterioration in the quality of banks’ credit portfolios given a worsening of the pandemic situation; second, asset price overvaluation; and third, vulnerability of the credit markets owing to the historic level of global debt. This list of risks to economic stability mirrors the assessment of other forecasters, such as the IMF, and therefore comes as little surprise.

Much more unexpected is the fact that these purely monetary macro risks are still the only dangers to financial system stability that the SNB deals with in its report. Once again, the SNB appears wholly untroubled by other key factors influencing financial stability, such as cyber risks, energy supply, and disruptive changes to market structures brought about by the activities of tech firms and other non-banks that can also impact monetary policy. This focus on banks as supposedly the only source of systemic impacts on the financial system is questionable. One can only hope that none of the risks which the Stability Report has failed for years to address actually materialises.

Good reasons for the price trend on the real estate market

In the volatile environment Zurbrügg describes, the mortgage and residential property market is once again giving the SNB cause for concern. The improved economic outlook has, he argues, reduced the risk of a pandemic-triggered correction in residential property prices; but for the SNB the risk lies not so much in residential property prices and mortgage volumes falling, as in them rising more strongly than fundamental factors such as rents and income can explain.

Against the backdrop of a less severe recession than was feared, the growth in prices of single-family houses (+5.4%) and apartments (+5.1%) comes as little surprise. First, the coronavirus crisis has increased the certainty that mortgage interest rates will remain low for some time to come. Second, the lockdown has spurred a move away from the urban confines in search of green space, lending a hefty boost to demand. In the single-family house segment at least, the decline in construction activity over the last few years has also underpinned the rise in prices.

Marked decline in risks in the mortgage business

Even in this environment of rising prices, however, the banks have been cautious with their lending. Their mortgage volumes have grown by 3.2% – less than the rise in property prices. The SNB also confirms the restraining effect of last year’s revision of the SBA’s self-regulation regime for residential investment properties.

A look at loan-to-value (LTV) ratios also reveals that the banks have clamped down heavily on risks. The share of new mortgage loans with an LTV ratio of more than 75% (where the SBA’s new minimum requirement kicks in) decreased substantially from 40% in 2019 to 21% in 2020 for residential investment properties held by commercial borrowers, and from 27% to 16% for those held by private borrowers. The median values also declined in some cases (see chart). The reason these figures have not declined even more sharply is that “buy-to-lets” do not have to be classified as investment properties because they often lack the yield element. Furthermore, the banks have not observed any growth in speculative real estate transactions, which are usually a good indicator of a bubble.

The Stability Report does not address non-banks’ lending policies in this segment or the risks arising out of them. The SNB appears unconcerned by non-banks’ risk appetite and influence on the market. Instead, it once again points to the persistently high affordability risks, although these are becoming less of a factor as average LTV ratios decline.

However, it is unclear why, when gauging the stability of a bank or the financial centre as a whole, the SNB only considers loan-to-income (LTI) ratios for new business in 2020; nor does it make much sense from a system perspective. To assess whether the risk is of systemically important dimensions, it would be necessary to consider the entire stock of outstanding mortgages. This has much lower effective LTI ratios, owing to borrowers’ contractual obligation to pay down their loans. Coupled with the rise in market prices, the buffer for any corrections in current market values is substantially increased.

Reactivating the countercyclical buffer is a questionable move

Despite the recent reduction in risks at various levels and its own admitted uncertainty about the extent of the overvaluation, the SNB is not just raising a warning finger. Instead, it states that it is regularly assessing the need to reactivate the countercyclical capital buffer. This is not simply a casual aside. Rather, the SNB is probably trying to manage expectations. Wisely, it ensured it had the backing of the IMF, which in its country report published at the same time argues that last year’s deactivation of the buffer should be temporary.

What is troubling is not just the absence from the report of any reasonably comprehensible thresholds for triggering the buffer supported by facts and science, but also the surprising circumstance that the profound economic analysis found elsewhere in the report is not employed to adequately address the causes of growth in real estate prices. Instead, the SNB talks about low levels of global interest rates, COVID support measures, and a preference for residential property due to the pandemic. These, however, are temporary in nature and are therefore unlikely to support a sustained rise in prices going forward.

Targeting the causes rather than zero risks

Measures are typically most effective when they target causes. There are plenty of ways in which the SNB could do this. The SBA published a study two years ago that examined the effectiveness and consequences of negative interest rates, which lead to misallocation of resources amidst a dearth of investment options. Moreover, the stock-exchange boom partly attributable to interest rates has probably further expanded the range of options for potential buyers.

In its Stability Report, the SNB also notes that banks are increasingly passing on negative interest rates to their customers. Theoretically, this reduces the need for account holders to be cross-subsidised by mortgage holders, and means that banks can offer more favourable interest rates on mortgages where their situation allows.

Once again, the SNB virtually ignores the potential for house price rises fuelled by mortgage lending from non-banks. A study published recently by Moneypark calculates that pension funds’ mortgage business has grown by 75% over the last five years. By contrast, the statistic that mortgages granted by pension funds grew by 18% in 2019 is relegated to a footnote in the SNB report. It does mention that non-banks’ share of total mortgage volume is small, at 6%; but in terms of new business that is a substantial figure.

What matters when it comes to the pricing power of non-banks – which are less strictly regulated and hence more competitive on price – and the increasing intensity of competition, however, is non-banks’ market share of new business, which the SNB does not put a figure on. Unfortunately, the report’s focus on the banks means it does not adequately reflect the market mechanism, essentially ruling out any informed discussion of the effectiveness of alternative macroprudential measures.

Taking it out on the wrong culprit

The Stability Report makes no case for the economic necessity of reactivating the countercyclical buffer. The question therefore is why the report was chosen as a vehicle for this message in the first place.

If the SNB wants to report holistically on the systemic risks in the mortgage market, it cannot ignore the ongoing “doping” via negative interest rates and a playing field that is tilted in favour of pension funds. Using the buffer to punish banks for risks that have their origins elsewhere is highly unlikely to have the desired effect.


Martin Hess
Chief Economist
+41 58 330 62 50