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1. INTRODUCTION

The financial sector plays an important

role in a modern economy by ensuring financial intermediation, i.e. channelling of

funds from savers to investors. A sound and efficient financial sector encourages

accumulation of savings and enables their allocation to the most productive

investments, thus supporting innovation

and economic growth. In Europe, banks are the main financial intermediaries,

especially in less developed economies.

Banking credit is also used to finance the needs of consumers, in particular for

smoothening the consumption pattern

over time and investment in real estate. An excessive growth of credit for house

purchases may cause price bubbles in the real estate market. A subsequent bust

may be very destabilising for the financial sector and the economy as a whole.

Given the risk of credit-driven asset price bubbles, in particular in the real estate

segment, monitoring of both the soundness of the banking sector and the

housing market developments is crucial for the assessment of stability of national

financial systems. The Member States are pursuing various macro-prudential policies

to contain risks emerging at the current

juncture.

2. CHALLENGES

2.1. Banking sector soundness

In 2015, post-crisis adjustment of the banking sector still continued in the EU. In

most countries, the banking sector was downsizing, illustrated by shrinking total

bank assets relative to GDP. On the other hand, some economies in Northern and

Central Europe saw their banking sector

expanding on the back of strong credit growth, mainly to households. Liquidity

conditions remained benign for the banking sector in general. Across Europe,

banks were building up their capital buffers to comply with the new regulatory

requirements and many have made progress in resolving the stocks of non-

performing loans.

2.1.1. Asset quality and capital

The quality of bank assets can be

assessed through such indicators as the

ratio of non-performing loans to total loans (NPL ratio), the capital adequacy

ratio (CA ratio) and the average return on equity (RoE ratio). The NPL ratio relates

the nominal value of non-performing loans (according to the EU definition, typically

loans whose instalments are not paid for over 90 days) to all loans. It shows the

extent of deterioration of the quality of

loans granted by the banks. The higher this ratio is, the worse the quality of the

assets, and consequently the higher are the expected losses. The CA ratio relates

the value of regulatory capital, i.e. capital instruments recognised according to the

banking regulation, to risk-weighted assets of a bank. It is an indicator of

banks' capacity to absorb losses. The

higher the ratio, the more the banks can absorb losses without endangering their

solvency. The RoE ratio relates banks' net income (i.e. profits after tax) to its total

capital. It is an indicator of banks' overall profitability. A high profitability suggests

that banks are in a favourable position to

EUROPEAN SEMESTER THEMATIC FACTSHEET

BANKING SECTOR AND HOUSING

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increase their capital buffer in the immediate future, namely through

retained earnings.

Asset quality of the EU banks presented a

mixed picture in 2015. The countries with highest ratios of non-performing loan

(NPL) were Cyprus and Greece, followed

by a group of countries with NPL ratios in the range 10%-20%. By 2015, the

accumulation of NPLs was peaking in

Cyprus, Greece and Croatia. The NPL ratios continued their downward path in

Ireland, Spain, Romania, Hungary and Slovenia. Increasing trends were observed

in Italy and Portugal.

Figure 1 – Non-performing loans as % of total loans, 2015

Source: ECB

In 2015, the capital adequacy ratio in most EU countries further improved. All countries

had an average CAR of at least 13%, much above the regulatory minimum1.

1 Following the implementation of the CRDIV and CRR, the new definition of regulatory capital and new minima have to be observed. While the

basic requirement remains at 8% of total capital, the minimum share of Tier 1 capital increased from 4% to 5.5% in 2014 and to 6% in 2015, of which 4% in 2014 and 4.5% in 2015 has to be

constituted by Common Equity Tier 1 (CET1). In addition, the CRD has introduced additional CET1 buffers: mandatory ones (conservation buffer,

counter-cyclical buffer and a buffer for global

systemically important institutions (SII)) and optional ones (systemic risk buffer and a buffer

for other SII), which can raise the capital requirement much above the current 8%. Their introduction will be gradual until the full compliance required in 2019.

In half of Member States CAR was above 18%. The highest ratio was observed in

Estonia (35%). Several countries had CARs above 20%. The overall sufficient

capitalisation should not be taken at face value, because it does not reflect the fully-

loaded Common Equity Tier 1 (CET1) ratios

and other capital rules, such as the leverage ratio2 that needs to be achieved under Basel

III by end-2019. Anecdotal evidence shows that the capitalisation of banks is still sub-

optimal in certain countries and certain individual banks, hampering risk-taking as

regards new lending.

2 A non-risk weighted measure of bank capitalisation, relating bank total capital to

their total assets. It is lowest in the largest and most developed banking sectors, including Finland, Sweden, the Netherlands, Belgium, Luxembourg, Germany, France and Italy.

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Figure 2 – Capital adequacy ratio: regulatory capital as % of risk weighted assets, 2015

Source: ECB

Bank profitability presented a mixed

picture across the EU in connection with a challenging low interest rate environment,

a deterioration of asset quality legated by the crisis and low credit demand in the

majority of countries. Only Greek, Cypriot

and Croatian banks were loss making in

2015, whereas in 2014 it was the case for

banking sectors in seven countries. In 2015, half of Member States had return on

equity (RoE) at least at the level of 7%. Romanian, Swedish and Latvian banking

sectors were most profitable among their

European peers.

Figure 3 – Return on equity (%), 2015

Source: ECB

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2.1.2. Credit growth and deleveraging

Credit growth can be gauged by the year-on-year percentage increase in the stock

of bank loans to the private sector. The faster bank credit expands, the higher is

the risk of an asset bubble, especially regarding the stock of mortgage loans for

house purchases. On the other hand, negative credit growth is likely to be

correlated with difficulties for businesses'

access to credit, especially SMEs, entrepreneurship, and growth. Ideally,

loans to the private sector should grow enough to provide sufficient access to

capital, but not excessively so as to prevent emergence of asset price bubbles.

Lending for house purchase further stepped up in the majority of Member

States. The median credit growth rate

among MS increased from 1.5% in 2014 to 3.8% by August 2016. Mortgage credit

growth was particularly strong in Romania, Slovakia, Czech Republic and Sweden.

High lending to households, especially for house purchase, is driving up house prices

and private indebtedness in several countries. This creates concerns,

especially in countries where private debt is already high. The latter indicator must

be considered relative to the income level

in the economy, i.e. the expected capacity of economic agents to pay back their debt.

Figure 4 – Housing credit growth (% y-o-y), August 2016

Source: ECB

Lending to non-financial corporations

increased in more than half of Member States. The median credit growth rate

among MS increased to 2.3% in August 2016 from -0.2% in August 2015. High

discrepancy was observed between

countries with the strongest credit growth (19% in Luxembourg, 11% in Lithuania)

and those with the strongest credit

contraction (-11% in the United Kingdom,

-8% in Slovenia). The divergent credit growth trends in the EU indicate

differences in enterprises' investment opportunities in countries with different

growth rates (credit demand factor), as

well as differences in their access to finance (credit supply factor), including

different levels of debt overhang.

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Figure 5 – Corporate credit growth (% y-o-y), August 2016

Source: ECB

2.1.3. Liquidity and funding

The bank funding structure can be

assessed through their loan-to-deposit

ratio (LTD ratio), as well as the share of borrowing from the central bank in their

total liabilities. Typically, banks are funded either by depositors or creditors on the

wholesale capital markets.

The latter is considered a less stable

source, especially as far as short term instruments and / or foreign investors are

concerned. The LTD ratio relates total loans granted by the banks to total

deposits they received from their customers. In other words, it shows how

the share of the loan book that is covered by stable funding from depositors.

Therefore, the higher the LTD ratio, the less stable the funding structure is

regarded. Differently to that, the level of borrowing from the central bank indicates

the shortage of private funding and thus

also the degree of instability in the funding

structure. Central bank liquidity loans should only constitute a significant share

of commercial bank liabilities in exceptional, temporary circumstances.

Banks' funding structure remained broadly stable as deposits grew at the pace of

loans in the majority of countries. The median loan-to-deposit ratio (LTD) for 28

Member States declined slightly from about 99% in 2014 to 96% by August

2016 (Figure 6). It declined most in

Cyprus, Ireland and Slovenia on the back of the post-crisis deleveraging trends.

A new funding model relying on local

deposits gained hold in the "host" banking markets of Central, Eastern and South-

Eastern Europe. The high LTD levels for

Denmark and Sweden reflect the low share of deposits and the crucial role of

market funding in banks' balance sheets, implying specific refinancing risks.

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Figure 6 – Loan to deposit ratio (%), August 2016

Source: ECB

The better funding conditions allowed for reduction of dependency on central bank

financing, although several countries experienced the opposite trend. In the

course of 2015, the reduction of central bank credit in total liabilities of the

banking sector was achieved in Cyprus (from 13% to 10%), Ireland (from 4.7%

to 3.4%) and Italy (from 6.6% to 5.9%).

On the contrary, in Greece, as a consequence of the deposit flight,

dependence on central bank liquidity lines soared, increasing from 20% to 44% of

the balance sheet. It also increased somewhat in Spain, Slovenia and

Hungary. In most countries, the share of central bank financing in the banking

sector was marginal, staying below 2% of

total liabilities.

2.2. Housing market developments

Housing markets developments in the

years which preceded the financial crisis have resulted in macroeconomic imba-

lances build-up in a number of Member States. House price dynamics before 2008

were characterised by a long and unprecedentedly strong expansion in most

Member States. This expansion was accompanied by large increases in credit.

Since then, the correction experienced in the EU Member States has been very

uneven. As demand factors have picked up in a number of Member States in 2015,

house price dynamics, and the potential accelerating role that credit market

conditions can play, deserve careful

monitoring.

2.2.1. House price dynamics

A number of EU Member States are

experiencing high and/or rising housing market-related vulnerabilities. In a context

where interest rates reach an historical low and where growth recovers, though at

a still tepid pace, in most Member States, demand factors for houses seem to be

building up. Accordingly, house price growth picked up in most Member States

in 2015 and it was particularly strong in

Sweden, Hungary and Ireland. Conversely, in Greece, Italy and Croatia, house prices

have recorded negative growth in real terms every year since 2008 and have

continued to contract in 2015.

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Figure 7 – House price growth

The deviation of the price-to-income and the price-to-rent ratios from their long-term

average provide useful benchmark to gauge the sustainability of house price deve-

lopments. The price-to-income ratio provides

an indication of the efforts required by the average household to purchase a house.

Meanwhile, in equilibrium, and notably for a given cost of capital, agents should be

indifferent between owning and renting a house, meaning that rent and house prices

should move together. Deviation of the ratios from their long-term value can be interpreted

as deviations from the equilibrium on the

housing market. Such tensions may result in a mismatch between the supply and demand

of housing and exert pressure on house prices. Based on these ratios, and on a

statistical analysis of fundamental house prices, a valuation gap can be estimated

(Figure 10). Sweden, Luxemburg and Belgium, which experienced no or only

limited downward adjustment in house prices since 2008, are the Member States where

the price to income and the price to rent ratios are the highest compared to their long-

term average and where the valuation gap is

the largest. On the contrary, despite high house price growth in 2015, Hungary shows

limited sign of overvaluation with prices remaining relatively close to their long-term

average. Ireland offers a more mixed picture with a price-to-rent ratio now more than

20% above its long-term average. Finally, for countries which had negative price dynamics

in 2015, the affordability and price to rent

ratios are generally below their long-term average suggesting that price could pick up.

Finland is an exception in that group as ratios are very close to their fundamentals based

on affordability ratio and significantly above those based on the price-to-rent. This

suggests that further adjustment could be expected.

2015 2014 2013 2000-2008 2008-2015

BE 1.0 -1.1 0.1 5.1 0.4

BG 3.4 1.5 0.2 12.9 -6.6

CZ 3.9 1.8 -0.8 6.6 -1.0

DK 6.4 3.0 3.1 5.3 -1.5

DE 4.1 2.2 1.8 -1.7 1.7

EE 7.0 12.9 7.3 n.a. -1.7

IE 9.9 11.3 0.4 5.1 -4.8

EL -3.8 -4.8 -9.0 5.1 -7.2

ES 4.1 0.1 -10.0 8.1 -6.2

FR -1.3 -1.7 -2.6 7.5 -0.7

HR -2.4 -1.2 -5.5 4.6 -4.6

IT -2.7 -4.6 -6.9 3.6 -3.4

CY 3.2 0.3 -4.7 n.a. -3.8

LV -3.7 5.3 6.2 13.0 -5.7

LT 4.5 6.3 0.4 12.0 -5.4

LU 5.1 3.7 3.7 7.7 2.6

HU 11.6 3.1 -4.6 n.a. -3.2

MT 2.3 2.4 -1.6 11.6 -1.0

NL 3.6 0.1 -8.2 2.4 -3.3

AT 3.5 1.4 2.9 -0.2 3.3

PL 2.9 1.2 -4.9 n.a. -3.5

PT 2.4 3.6 -2.7 -1.1 -1.8

RO 1.6 -3.2 -2.2 n.a. -10.4

SI 1.9 -6.6 -6.0 n.a. -4.3

SK 5.5 1.5 -0.4 n.a. -3.3

FI -0.4 -1.8 -1.3 3.4 0.1

SE 11.9 8.6 4.7 6.5 4.8

UK 5.4 6.3 0.5 7.5 -0.2

Source : Eurostat

% y-o-y change in deflated

House Prices% CAGR

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Figure 8 – Price to disposable income ratio, 2008-2015

Source: Eurostat, Commission calculations.

Note: The long-term average is set as 100.

Figure 9 – Price to rent ratio, 2008-2015

Source: Eurostat, Commission calculations.

Note: The long-term average is set as 100.

0

20

40

60

80

100

120

140

160

180

LU SE

BE

FR

UK

AT

DK

NL

ES

CY

CZ IT FI

EL

EE IE SK SI

HU

MT

HR

PL

PT

DE

LT

LV

RO

BG

2015 2008 2012

0

20

40

60

80

100

120

140

160

180

200

SE

BE

LU

UK FI

FR IE

DK

MT

ES

AT

CY

SK

NL

HU

LV IT SI

EE

BG PL

CZ

DE

EL

RO PT

HR

LT

2015 2008 2012

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Volume indicators for housing markets are useful to quantify the developments of

construction activity, and should be seen as a

complement to house price developments. Residential construction is a volume indicator

that measures new residential buildings produced in a given period. It also offers

information on how housing supply reacts to price and demand pressures. In particular,

they provide an indication of the share of resources that are devoted to the housing

sector. In period of accelerated house prices, an inflated construction sector can become

part and parcel of the transformation of

potential house price adjustments into economic crises.

Residential investment remained at subdued

levels in 2015, particularly in Member States where corrections were still running their

course. Compared to 2008, residential in-

vestment is notably 8.5pp of GDP lower in Cyprus, 7.3pp lower in Greece and 6.3pp

lower in Ireland. In some cases this reflects the overinvestment of a few years ago (e.g.

Spain), in others, this is related to general economic uncertainty, impaired credit

supply and demand, and regulatory bottlenecks. Sweden and the UK stand as

exceptions as the level of residential

investment in these countries is close to or above pre-crisis levels.

2.2.2. Impact of credit developments

Besides the potential valuation gap, the

potential risks stemming from housing price developments are notably linked with

the level of banks' exposure to mortgage credit and the indebtedness of households.

Developments in the housing market can contribute substantially to vulnerabilities

in the financial sector. These include growing reliance on mortgage finance by

banks, persistently high leverage and

weak lending standards (e.g. elevated loan-to-value (LTV) ratios, long loan

amortisation maturities, low risk-weights on banks' balance sheets for real estate

exposures, etc.). Challenges linked to the financing capacity of households (in

Luxembourg, Sweden, Belgium, France, the UK) may also represent a risk for

banks. In recent years, particularly strong

vulnerabilities have been observed in that respect in Sweden, Ireland, the

Netherlands and the UK, where rapid house price increases were recorded

alongside high levels of household indebtedness and high average mortgage-

loan LTVs and maturities on banks' balance sheets raising questions about the

sustainability of such dynamics.

Figure 10 – Valuation gap and real growth in house prices, 2015-Q2

Source: Eurostat, Commission calculations.

Note: Valuation gap computed based on the price-to-rent, the price-to-income

ratio and a statistical model for fundamental drivers of house prices.

BE

BG

CZ DKDE

EE

IE

EL

ES

FRHR

IT

CY

LV

LT

LU

HU

MT

NL

AT

PL

PTRO

SI

SK

FI

SE

UK

-5%

0%

5%

10%

15%

20%

-20% -15% -10% -5% 0% 5% 10% 15% 20% 25% 30% 35% 40%De

flat

ed

ho

use

pri

ce g

row

th (

yoy

20

16

Q1

)

Valuation gap (in %)

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Figure 11 – Banks' exposures to mortgage credit vs. households' indebtedness

Source: ECB, ECB calculations.

Notes: Latest observation 2015Q2. Values on x-axis are computed as ratio between own domestic loans to real

estate (template Finrep 20.4), and mortgages, both carrying amount, over CET1. Values on y-axis represent a ratio

of household loans to the annual moving sum of gross domestic product.

3. POLICY RESPONSES IN THE

MEMBER STATES

As the EU financial sector is confronted with important challenges going forward,

Member States take policy action in relevant areas. They overarching policy

objectives are preserving financial stability

and improving financial intermediation with a view to support economic growth.

At the current juncture, policy measures

focus on enhancing access to finance through cleaning of bank balance sheets

from legacy non-performing loans and

removing barriers to development and integration of capital markets; addressing

deficiencies in national supervisory and regulatory frameworks and improving

corporate governance in some institutions, addressing specific risks related to credit

exposures in foreign currency and, last but not least, containing incipient imba-

lances in some housing markets fuelled by

private debt growing at excessive pace.

3.1. Increasing lending to the real

economy and resolving the NPL stocks

Bank deleveraging is subsiding but still

requires close monitoring. In 2015, credit growth was negative in eleven EU Member

States. On the corporate side and in fewer

countries on the household side, the large private debt overhang may explain the

lack of credit demand and may thus hamper growth. Similarly, from the banks'

perspective, high private debt levels and lack of solvent demand, i.e. viable invest-

ment opportunities in a protracted reco-very of the real economy, may hamper

granting new credit.

A boost to new lending requires further

progress in cleaning-up the balance sheet of banks and restoring adequate capital

buffers. The amount of NPLs is still large in many EU countries, i.e. it is still in the

double-digit range in Bulgaria, Croatia,

Cyprus, Greece, Hungary, Ireland, Italy,

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Portugal, Romania and Slovenia. The banks strive at achieving viable loan

restructurings or foreclosing of non-

performing assets. However, this behaviour needs to be supported by a

functioning legal framework as regards debt enforcement and asset foreclosure

and adequate provision and capital buffers that allow banks to absorb potential

losses. In some countries, improving the insolvency frameworks and the functioning

of the judiciary system could also lead to more rapid work-outs. In this respect,

the role of supervisors and regulators

becomes obvious in asking banks to regularly check the quality of their assets,

monitor arrears resolution, provision ade-quately doubtful exposures, strengthen

capital buffers.

3.2. Developing alternative sources

of funding for companies

In order to improve access to finance also through non-bank sources, Member States

are taking various actions to develop their capital markets, in particular the equity

and bond markets, private equity and

venture capital funds as well as modern ways of securitisation. At the EU level,

these initiatives are encouraged by the Action Plan on implementing the Capital

Markets Union adopted in September 2015. Targeted technical assistance is

offered to national authorities in this regard, focussing in the first stage on a

group of priority countries: Bulgaria,

Romania, Croatia and Slovenia.

3.3. Strengthening bank supervision,

regulation and corporate governance

The strong increase in NPLs during the crisis has shown some cases of inadequate

supervisory or regulatory practices as well

as credit risk assessment and corporate governance in financial institutions. The

recent example refers to the banking problems in Bulgaria, which triggered a

review of supervision, conducting of independent stress tests and tackling the

concentration risks and related party exposures. Some other countries launched

reforms of corporate governance in par-

ticular segments of their financial sector (e.g. the role of foundations in the ban-

king sector in Italy), addressed contingent

liability risks related to the state ownership of banks (e.g. Slovenia) or

shored up their regulatory framework (e.g.

for personal and corporate insolvency in Croatia). On the other hand, some of new

regulatory initiatives aimed at consumer protection may pose potential risks to

financial stability (e.g. the personal insolvency law in Romania).3

3.4. Tackling the risks related to

loans in foreign currency

The recent strengthening of the Swiss

franc emphasised again the risks of lending in foreign currency (FX lending).

The turbulences caused by the strong appreciation of the CHF were most

prominent in Croatia, and Poland. Also in

Romania, where most FX loans are in EUR, the impact was smaller. In recent years,

European institutions, in particular the European Commission and the ECB have

stressed such risks and the need to take action. As part of the efforts, a new

Directive regulating mortgage credit arrangements has been adopted with

provisions limiting the exchange rate risks

for consumers. The Directive is applicable as from 21 March 2016, covering

mortgage loans which are concluded after that date.

3.5. Addressing housing market-

related vulnerabilities through

macroprudential policies

Financial stability risks related to real estate markets in the EU could materialise

in a number of countries due to persistent or growing overvaluation in property

prices combined with high private sector

debt and banks' exposure to mortgage credit, and a potential loosening in lending

standards amid persistently low interest rates and continued competition between

banks for new loans (Figure 10, Figure 11).

Public policies can mitigate, or encourage, the build-up of vulnerabilities in the hou-

sing sector. In a number of Member States,

3 See Tables 3 and 5 in "Key Aspects of Macro-prudential Policy — Background Paper", IMF, June 2013, available at: http://www.imf.org/external/np/pp/eng/2013/061013c.pdf

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fiscal measures (e.g. deductibility of mortgage interest payments) reduce the

marginal cost of acquiring housing, which

– together with low interest rates and expectations of future house price

increases – can increase the potential for speculative property investments by

households and increases in household leverage. Such incentives were recently

revised in Spain, Belgium and France. Furthermore, supply-side measures (e.g.

to boost construction of new properties amid high demand and rising property

prices) can help improve the respon-

siveness of house supply to potential price increase, thus limiting the risk of prices

spiralling up. Measures have been implemented in several jurisdictions (e.g.

Ireland, the Netherlands, Sweden, the United Kingdom, Luxemburg) to increase

supply and temper soaring house prices.

EU Member States have actively imple-

mented macro-prudential measures to address vulnerabilities stemming from the

real estate sector. Along with measures increasing the risk-weights, and therefore

capital requirements, on mortgage loans on banks' balance sheets, national

authorities have implemented lending

restrictions under national law, with limits to Loan-to-Value (LTV), Loan-to-Income

(LTI) and Debt-Service-to-Income (DSTI) ratios, as well as to loan maturity being

most frequently used (Figure 12). These instruments directly target credit

standards at origination and have been empirically proven as very effective in

restricting risky lending practices across a wide number of jurisdictions, while

reducing vulnerabilities on both banks' and

households' balance sheets to property-price related shocks.

In addition to these targeted measures

applied specifically to real-estate exposures (both stocks and flows),

Member States' authorities have also implemented other macro-prudential

measures, including capital buffers, to

address housing-related vulnerabilities in their banking sectors. For example, capital

buffers for systemic risk (e.g. SRB, O-SII buffer) and Pillar 2 add-ons, have been

introduced in a number of Member States (e.g. Austria, Belgium, Estonia, Finland,

Slovakia and Sweden) with the aim of increasing the resilience of the banking

sectors amid heightened real-estate

related vulnerabilities.

An in-depth comprehensive evaluation of these measures across the EU is currently

challenging due to considerable data gaps and also given that they have been

introduced relatively recently in many

countries. Nevertheless, early evidence suggests that while they have

strengthened financial sector resilience in a number of Member States, increased

capital requirements (e.g. via the use of Pillar 2, stricter risk-weights on mortgage

loans and macro-prudential buffers) have been insufficient to stem soaring housing

prices (e.g. Sweden, Ireland, Estonia,

Luxembourg).

Figure 12 – Macro-prudential measures targeting real estate risks on bank balance sheets

Measure EU Member State(s) using measure

Stricter risk-weights BE, FI, HR, IE, LU, MT, RO, SE, SI, UK

LTV limit DK, EE, IE, CY, CZ, LV, LT, LU, HU, MT, NL, PL, RO, SK, FI, SE

LTI/DTI limit IE, PL, UK

DSTI/PTI limit EE, CY, LT, HU, PL, RO, SK

Stress test/sensitivity test/other prudent lending standards requirements

BE, DK, IE, CY, CZ, LU, RO, SK, UK

Loan maturity EE, LT, NL, PL, RO, SK

Loan amortisation DK, NL, SK, SE

Source: ESRB

Page 13 |

The effectiveness of borrower-based measures targeting lending standards has

been widely documented in empirical

analyses4. Studies from some EU Member States which implemented such instruments

following the recent financial crisis also indicate their effectiveness in staving off

real-estate related financial stability crises5. Their complementarity with capital-based

macro-prudential instruments is particularly pertinent during the upswing of credit

cycles, when the latter could become less effective as capital ratios increase due to

high bank profitability and buoyant asset

prices (Shin, 2011). In such circumstances, measures targeting lending standards at

origination can reduce banks' incentives to engage in riskier (high-LTV/high-LTI)

lending.

However, in a number of Member States

exhibiting real estate risks, authorities have faced difficulties with implementing

these instruments in a timely manner, either due to constraints in their own

national legal orders or institutional and governance arrangements for macro-

prudential policy. For example, in Sweden, in November 2014 the FSA announced a

draft regulation on amortisation for new

loans. The Administrative Court of Appeal in Jönköping issued an opinion that the

FSA does not have the legal base to impose compulsory amortisation. The le-

gislative initiative was then transferred to the government and had to pass through

additional court reviews to assess poten-tial issues with the constitutionality of the

measures. In December 2015 the Council

on Legislation (Lagrådet) deemed the pro-posal to be constitutional paving the way

for its implementation by June 2016. In

4 See footnote 1; in addition, Akinci and Olmstead-Rumsey (2015) show that housing-market related instruments are more effective in containing house price and mortgage growth,

while non-mortgage related measures are more effective in slowing down overall credit growth. Cerutti et al. (2015) find that borrower-targeted

instruments are more effective than institutions-

based ones in containing household credit growth in advanced economies. 5 In November 2016, the Central Bank of Ireland published a report examining the impact and effectiveness of the loan-to-value and loan-to-income measures since their introduction.

Germany, in June 2015 the national macro-prudential authority (AFS) issued a

recommendation to make LTV and LTI limits

available as macro-prudential measures in German law by March 2016, which are yet

to be implemented, amid ongoing discussions on data protection issues and engagement

with industry. In Belgium, the national com-petent and macro-prudential authority (NBB)

has no power to activate LTV, LTI and DSTI limits, though they are available in national

law (only the Federal Government can implement them, on the basis notably of a

recommendation of the NBB), in view of

their potential distributional impacts6 7.

The European Systemic Risk Board (ESRB)8 has undertaken systematic and forward-

looking work analysing vulnerabilities in the EU residential real estate sector. Accor-

ding to its horizontal analysis conducted

since September 2015, which was based on a joint comprehensive framework

developed together with the ECB for cross-country risk identification covering all EU

Member States, the ESRB identified 11 coun-tries, where vulnerabilities were risen to an

extent that required deeper research. These countries are Austria, Belgium, Denmark,

Estonia, Finland, Luxembourg, Malta, the

Netherlands, Slovakia, Sweden, and the UK. These countries were subject to deeper

country-specific vertical analysis focusing on vulnerabilities in collateral, households

and banking stretches and policy measures addressing these vulnerabilities.

Date: 14.11.2016

6 See Collin M., Druant M. and Ferrari S.

(2014), "Macroprudential policy in the banking sector: framework and instruments", Financial Stability Review, National Bank of Belgium, pp.

85-97. 7 In the context of the review of the EU macro-prudential policy framework, the Commission is consulting on the scope for

including these instruments in the CRR/CRD IV, and providing for some harmonisation of definitions and standard requirements for the

mandatory exchange of relevant data between

authorities, while keeping discretion for their activation at the national level (to deal with

country-specific conditions across the Member States). 8 The EU body in charge of monitoring macro-financial risks.