The Swiss mortgage industry
Leo Schuster
The Swiss Mortgage Industry
Although renowed for its beautiful Alpine setting and its elite international banking clientele, Switzerland is less well known for its large and powerful domestic mortgage indurstry, which is the cornerstone of its superb banking system. This system has a number of striking features: the highest per capita mortgage indebtedness in the world, interest rates which almost never fluctuate more than two or three percent, and the highest withholding tax rate in any country. Although the mortgage industry in Switzerland functions in a different environment from its American counterpart, it is nonetheless parallel in many aspects and instructive in its idiosyncracies. This article will acquaint the reader with the basic structure and recent history of the Swiss mortgage industry and compare these with those of the American history.
General Background Information
Mortgages in Switzerland are collateralized with the land upon which the housing is located–the owner has the possibility of obtaining credit because of the value of the land. As such, there is a sharing of property rights pursuant to the mortgage agreement. The lender acquires the right to use the land if the borrower is unable to meet his/her mortgage payments.
On a bank’s balance sheet, the mortgage loans appear in three separate asset line items: (1) the current building credit account with mortgage collateral, (2) the fixed loan account with indirect mortgage collateral, and (3) the direct mortgage account.
The building credit is used for the period of construction and is eventually transformed into either a fixed indirect loan or direct mortgage. The difference between the latter two is the following: in the case of the fixed loan with indirect mortgage collateral, the borrower signs a letter of debt for the bank stating that, upon failure to pay, the borrower is obligated to sell the house and land and to hand over the receipts to the bank. With direct mortgage, the bank secures the right to directly seize the collateralized land and home in the event of default.
The most important mortgage lenders in Switzerland are the large banks [49 million Swiss Francs (Sfr) in 1982–one Sfr being approximately equal to 50 US cents] and the cantonal (state) banks (60 billion Sfr in 1982). To a smaller extent, regional, cooperative, and savings banks also provide mortgages. The total amount of mortgages held by banks, which are by far the largest source of mortgages, was 155.4 billion Sfr in 1982. At a far second are the Swiss insurance companies, which hold twelve billion Sfr in mortgages, followed by the pension funds, which hold another ten billion Sfr. In Switzerland, there is a full-service bank philosophy; consequently, all banks are generally allowed to grant mortgages. In the pre-World War II period, however, there was an historically based division of labor; the mortgage business, for example, was handled solely by local banks, savings banks, and cooperative banks. After World War II, and particularly in the 1960s, the big banks, which previously were more or less wholesale banks, began to introduce mortgages, as well as savings accounts into their pallette of services.
The transformation in market shares held by the various banking groups is depicted in Graphs 1 through 3. Graph 1 shows the percentage of the mortgage market held by each banking group and shows clearly how the big banks have greatly increased their market share since 1960. Graph 2 depicts the changes in the percentage of total savings accounts held by each group and reflects trends which are almost identical to those in Graph 1. The third graph shows the percentage of total bank balances which each group holds and demonstrates clearly in real absolute market terms how the cantonal banks, the regional banks, and the cooperative banks have lost ground to the big banks. This has been due both to the entrance of the large banks into the domestic mortgage market and to the general growth in the Euro-market business, which is handled primarily in Luxembourg, London, and the offshore banking centers.
The high level of foreign deposits in Switzerland, coupled with a high rate of domestic savings and its small size, results in a very high rate of per capita mortgage indebtedness–26,000 Sfr per citizen, in comparison with the US with 15,000 Sfr per capital, and West Germany with 7,000 Sfr.
Because of this high per capita mortgage indebtedness, the mortgage rate is a leading interest rate indicator in Switzerland. This rate is traditionally very low; currently, for example, it is only 5.5 percent annually while in 1981 it was only 4.0 percent. The reasons for these low rates are the huge capital inflows into Switzerland and interest rate cartels by banks. The mortgage interest rate also has a great impact on the inflation rate here. There is a direct link between the price of agriculture produce and rental rates on the one hand and mortgage rates on the other. For example, an increase of 0.25 percent in the mortgage rate results in a 3.5 percent increase in rental rates. Since both agricultural products and rental rates are major factors in the Consumer Price Index (CPI), the rate of inflation is thus accelerated markedly by minor mortgage rate increases. Rising interest rates push up rental rates, which then exert upward pressure on wages, since wages are tied to the CPI in Switzerland, leading to what is commonly referred to as the price-wage spiral. For this reason, the mortgage rate is not only a leading interest rate indicator in Switzerland, but is also a major political one.
Switzerland: A Land of Savers and Tenants
The political importance of the mortgage business is derived from the involvement of nearly all people as either savers or tenants. For both categories, the level of the mortgage rate is decisive for interest and rental rates, particularly because the Swiss are the biggest savers in the world. The total amount of savings deposits totalled nearly 100 billion Sfr in 1982. In addition, bank-issued, medium-term notes totalled more than 60 billion Sfr, and mortgage bond loans amounted to 10 billion Sfr. Statistically, every Swiss citizen has two savings accounts. That means 12.5 million savings accounts for 6.3 million inhabitants.
The per capita rate of savings is 24,000 Sfr, compared with only 10,000 Sfr in the US.
On the other hand, 72 percent of all living units are rented in Switzerland, compared with only 37 percent in the US, the remainder being owner-occupied. In addition to the political importance of the interest paid on savings accounts, there is another point to be mentioned. The savings deposits, together with bank-issued, medium-term notes and the mortgage bond loans, have to finance the mortgage credits. That is a very special situation since long-term mortgage assets must be funded by short-term liability deposits. It is very well known that this configuration circumvents the banker’s golden rule. This rule, of course, holds that short-term deposits should not be used to match long-term credits. Unitl four years ago, however, all went well. At that time, the high interest rate period initiated by America’s tight monetary policy came to Europe, especially to Switzerland, and Swiss savers began to withdraw funds from their lower-yielding savings deposits and placed them in the Euro-market in other currencies. To show this with figures, the total value of savings deposits was 93 billion Sfr in 1979, decreased nearly 3 billion in 1980, and fell by another 5 billion in 1981. This was the first time in post-World War II history that Swiss savers boycotted their usually beloved savings accounts.
During this period, it became more costly for the banks to finance their mortgage portfolios. For this reason, some banks had to sustain temporary losses as they were scissored between high costs of funds and relatively low loan yields. This was particularly true for specialized banks, such as savings institutions and cooperative banks, which were unable to offset a squeezed operating margin on mortgages with other more profitable operations. Yet the difficulties were minimized since Swiss banks can accrue legally sanctioned hidden reserves from which banks can profit in difficult periods.
The hidden reserves arise through the over-evaluation of liabilities and the under-evaluation of assets. The under-evaluation of assets is achieved by a low assessment of debts, securities, buildings, and physical inventories. The over-evaluation of liabilities are generally accrued by provisions for bad loans. The Swiss law, particularly the Stock Law and the special Bank Law, grants extensive limits for building such reserves. To cite an example, Credit Suisse had substantial trouble in 1977 with its Chiasso branch, from which losses totalling 1.2 billion Sfr were incurred. These considerable losses were entirely covered by hidden reserves so that no serious consequences arose.
In the sense that rates rose sharply in domestic terms over the past several years, the recent Swiss experience is much like that of the American mortgage industry. There are, however, a number of substantial differences. First, during the first phase of rising rates, American thrifts were unable to raise the savings account interest rates because of Regulation Q. Second, while short-term rates in the US climbed to well over 15 percent, rates in Switzerland rose to a height of only 4.5 percent. Another fundamental difference was that while interest rates in the US were positive in real terms, savers in Switzerland received negative real interest rates of up to minus three percent. Third, the greatest share of Swiss mortgages were floating rate loans. For these reasons, no bank in Switzerland actually experienced financial insolvency or provocated the interference of the overseeing federal bodies, whereas American thrifts suffered numerous defaults and mergers.
Special Characteristics of the Swiss Mortgage Industry
Having already discussed the asset/liability maturity imbalances experienced in the Swiss mortgage business, it is now appropriate to mention two more unique characteristics of this industry. First, the lending limit is up to 90 percent of property value or even more. The reason for this is that Swiss banks have a very high liquidity level.
Second, there is no mandatory amortization of the first mortgage, which normally covers two-thirds of the market value. The second mortgage, which covers the remainder, however, has a higher interest rate, because of its secondary claim to the collateral, and must be amortized. This situation is true for most of the Swiss cantons (these are the 22 small federal states), with the exception of some French- and Italian-speaking cantons.
Because of the difficulties some of the Swiss banks had in the aforementioned period, there are a number of suggestions for improvement currently under consideration. First of all, Swiss bankers would like to introduce fixed-rate mortgages which, as American thrifts can attest to, are ideal in periods with no interest fluctuations, but which are disadvantageous for savings institutions when interest rates increase, and vice versa for the borrowers. The reason that the banks are now offering fixed-rate mortgages is that their executives believe that rates are currently at a high point and, secondly, there is considerable political pressure to offer them. Nonetheless, the Swiss banks hesitate to change the whole mortgage philosophy and, instead, will probably use both techniques simultaneously, thus allowing the customers to exercise their preferences. There are still more alternatives being introduced, such as a semifloating rate mortgage in which a 1/2 percent change in the current mortgage rate results in a 1/4 percent change in the semi-floating rate. A customer who initially borrows at a base rate of five percent would then pay only 4.75 percent when the current mortgage rate falls to 4.5 percent. This provides somewhat of a cushion for the borrower. There is also a trend in some cantons towards requiring the amortization of first mortgages.
A further trend is to depoliticize the mortgage interest rate. A study group has recommended that floating rates on mortgages be indexed to the average yield on bond issues listed on the Zurich Stock Exchange. In this case, the interest rate would be fixed every six months and regularly published. The advantage of this philosophy is that mortgage rates would correspond to the market rates and the fixing would be automatically carried out by a neutral party, such as the Swiss National Bank. This solution is highly controversial–as one would expect–first, because mortgage rates have such an impact on rental rates and, secondly, because it would also indirectly control the payout on savings accounts, since savings are used to finance the mortgage.
Tax Treatment
For Americans, it may be difficult to believe that most Swiss borrowers take out a mortgage for almost the full value of their property. This is because taxes must be paid on the “opportunity’ rental value of owner-occupied homes. Government officials estimate the rental value of a home, and the homeowner must claim this rental value as personal income. The homeowner may, however, deduct his interest payments from his declarable income. Thus, it is standard practice to take out a large mortgage, even if not essential for personal cash flow reasons, solely in order to offset the additional income tax which a homeowner must pay. This is particularly true for homeowners in the higher tax brackets.
The depositors, on the other side of the balance sheet, must pay a withholding tax equal to 35 percent of the interest received, the highest withholding tax rate in the world. The banks thus act as the fiscal agents of the federal government, deducting the withholding tax and rendering it to the authorities. This withholding tax is a powerful tool for fighting domestic tax evasion.
The Swiss banking industry is a very good contributor to the national coffers. In 1978, the taxes totalled more than two billion Sfr. About 30 percent, or nearly 730 million Sfr, is derived from direct taxes on the corporate income of banks. Some 600 million Sfr had to be paid by employees as income tax, whereas stockholders of bank securities paid some 300 million Sfr in income tax on dividends. The indirect taxes and withholding taxes which banks had to surrender totalled three billion Sfr but, since bank customers can reclaim the undue amount of taxes withheld on their tax declaration, only 460 million remained for the state. Reimbursement of withholding taxes is often not possible for foreigners, however, since there are no bilateral tax treaties with all countries. Finally, Swiss banks pay another 370 million Sfr incurred through stamp taxes on the issuance of securities.
Cartels and Antitrust Laws in Switzerland
The continental European opinion about cartels is much more tolerant than the Anglo-Saxon view, and particularly the American view. In the Federal Republic of Germany (West Germany) and Switzerland, cartel laws only prohibit collusion under certain circumstances. In the Federal Republic of Germany, there is a prohibitory law, whereas in Switzerland there is a damages law. This means that cartels are essentially allowed but that abuses can be legally punished. Bank cartels, in particular, are viewed tolerantly because of the general opinion that financial intermediaries play a special role in the economy and have many other constraints, such as the policies of the National Bank and the other supervisory authorities. Therefore, bank cartels are generally allowed and are used to guide interest rates, fees, and practices in different banking districts. In Switzerland, there is a distinction between federal cartels, which are formed under the guidance of the Swiss Bank Association headquartered in Basel, and local cartels. The prime rate, for example, is subject to this federal association as are guidelines for marketing, credit rating, the issuance of bills, and the use of letters of credit, etc.
On the other hand, there are many bank cartels restricted to specific banking centers like Geneva, Bern, or Zurich, which is, of course, the most important one.
The philosophy of agreement in the banking industry has a long history in Switzerland not only in the realm of cartels, but also in many other aspects. For many years, at least until 1978, when the last central banking law was established, the relationship between the Swiss National Bank and the commercial banks was based on gentlement’s agreements, which regulated the credit ceilings, the volume of money flows into the country, and the issuance of international securities.
Summary
The Swiss mortgage industry has experienced a considerable degree of transformation during the past two decades, much like the American industry. The greatest difference, however, is that the changes have been the result of changes in practices and levels of competition which have not been initiated by federal actions. This stands in stark contrast to the transformations in the American industry which have resulted largely from federal monetary policies and from federal deregulation under the Banking Act of 1980. Moreover, the Swiss experience has been far less dramatic in the past several years because of conservative banking practices such as accruing hidden reserves for difficult times and issuing primarily floating rate mortgages. The major change in the Swiss industry has been in the relative market shares held by different groups, and, although this transformation may continue, it is likely that the Swiss mortgage industry will continue to remain one of the most stable ones in the world for years to come.
Table: Chart 1.–Aggregated Mortgage Volumes
Table: Chart 2.–Aggregated Deposits
Table: Chart 3.–Aggregated Balance Sheet
COPYRIGHT 1984 U.S. Government Printing Office
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