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Eastern European regulators act to contain mortgage bubble

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Eastern European regulators act to contain mortgage bubble

Surging house prices and rapid credit growth in several key markets in central and eastern Europe have led regulators to tighten mortgage lending rules and bank capital requirements, in the hope of containing what many observers regard as a bubble.

The Czech Republic, Slovakia and Hungary, in particular, have seen rapid house price growth and an overall surge in credit. Czech and Slovakian home prices grew respectively by 8.4% and 11.6% at the end of 2017 compared to the end of 2016. In Hungary, house prices rose by 13.8% in nominal terms in 2017 and are projected to increase by 13.9% in 2018, according to the country's central bank.

Interest rates in local currencies across central and eastern Europe have been low for several years and the growing house prices, especially in countries such as Hungary and the Czech Republic, are a cause for concern, Ciprian Dascalu, chief economist at ING Bank Romania, said in an interview. "So, probably, the central banks are looking at prudential measures to curb lending and avoid the creation of a housing market bubble [in these two countries]," he said.

"Potential risks and downsides of rapid price increases in selected [central European] residential real estate markets are becoming more and more obvious," Raiffeisenbank International said in its CEE Banking Sector report 2018. The Czech and Slovak central banks have both already taken steps to prevent "excessive housing loan growth," RBI said.

The Czech National Bank said June 12 that it would raise the country's countercyclical buffer rate to 1.5%, as of July 1, 2019, along with several measures to tighten mortgage lending standards. "The countercyclical cushion on capital is not designed to stop lending today: It is — as its name suggests — [intended] to avoid it ending tomorrow during a turnaround in the economic cycle," the central bank's Governor Jirí Rusnok said at the time. "It is this excessive cycle of credit — the risk of go and stop experienced in financial crises — that a moderate capital buffer is intended to prevent." Banks are not likely to reduce credit production, Rusnok said.

The Czech Banking Association estimated that the market will see loan applications drop as much as a fifth and growth decline as much as a third following the dampening measures taken by regulators.

The measures make sense because the Czech Republic is "one of the fastest-growing mortgage markets in Europe," according to Gunter Deuber, head of economics, fixed-income and foreign exchange research at Raiffeisen Bank International. At 1.18 trillion Czech koruna, mortgage loans accounted for around 75% of total loans extended to Czech households, which stood at 1.57 trillion koruna in May 2018, according to central bank data.

'A certain bubblish tendency'

There is overvaluation in the Czech market similar to other smaller European peers with "a certain bubblish tendency" such as Sweden, Norway, and Denmark "where definitely you have spillover from this ultralow interest environment," Deuber said in an interview. "The mortgage bubble is even larger in the Slovak Republic," he added.

Liam Carson, an economist who covers the region for Capital Economics, a research firm in London, agreed that property price risks look greatest in the Czech Republic and Slovakia, but said he did not see a bubble forming just yet. However, he added there is perhaps cause for concern in Slovakia where "double-digit property growth is being accompanied by double-digit household credit growth."

The loans extended to households in Slovakia have doubled over the past six years and the country's household debt level currently stands at over 40%, almost double the EU median figure, according to the country's central bank.

"With the ECB set to keep policy very loose over the next year or so — and Slovakia adopting the monetary policy of the eurozone — there's clearly a risk that property price growth and household credit growth continues to grow at a worrying pace for a prolonged period. That could cause problems further down the road," Carson said.

Slovakia's central bank is also seeking to raise the countercyclical buffer to 1.5% as of Aug. 1, 2019, in an attempt "to increase the resilience of the banking sector at the time of continuing excessive credit growth," it said July 3. As further measures the central bank will seek to gradually cap the loan-to-value ratio for mortgage loans, it said in a financial stability presentation.

The Hungarian government confirmed it would not extend a 5% reduction in the value-added tax rate on new housing, which it introduced in 2016, Reuters reported July 4. The measure, expiring Dec. 31, 2019, has triggered a massive increase in housing prices and mortgage lending not seen since the financial crisis, Reuters said. The news agency cited a radio interview with Finance Minister Mihaly Varga told a local radio station the government did not want to continue fueling the "bubble" that had built up in the market.

The total value of new housing loans extended in Hungary in 2017 was 650 billion Hungarian forints, up nearly 40% year over year and accounting for three-quarters of housing loans extended in 2008, the Hungarian central bank said in its May housing market report.

As of July 12, US$1 was equivalent to 22.19 Czech koruna and 279.92 Hungarian forints.