ADRIAN COLESADRIAN COLESSECRETARY GENERAL, IUHFSECRETARY GENERAL, IUHF

The WORLD BANK SEMINAR

Washington DCWashington DC11 March 200311 March 2003

THE DEPOSIT BASED MODEL

INTERNATIONAL UNIONINTERNATIONAL UNIONThe International Union -The International Union - Publishes a quarterly journal, Publishes a quarterly journal, Housing Finance InternationalHousing Finance International. . Publishes a newsletter two or three times a year.Publishes a newsletter two or three times a year. Maintains a website Maintains a website www.housingfinance.orgwww.housingfinance.org Facilitates a World Congress, which is normally held every two Facilitates a World Congress, which is normally held every two

years.years. Co-operates with the Wharton School of Management at the Co-operates with the Wharton School of Management at the

University of Pennsylvania, - international housing finance University of Pennsylvania, - international housing finance school each May/June.school each May/June.

Answers ad hoc queries from members and maintains a small Answers ad hoc queries from members and maintains a small library.library.

Has 160 members in 55 countriesHas 160 members in 55 countries

UK BUILDING SOCIETIES: UK BUILDING SOCIETIES: BASIC STATISTICSBASIC STATISTICS

65 societies – mutually “owned”, locally based

Assets of £190 ($300) billion, end 2002

15 million savers - 34% of all adults

2.5 million borrowers - 22% of all mortgage borrowers

20% of outstanding mortgages – 10%-30% of new business

15% of outstanding retail deposits - 35% of new business

2,100 branches

31,000 staff

Deposit Role in Mortgage FundingDeposit Role in Mortgage Funding %% USA USA EUEU

20002000 19981998Retail depositsRetail deposits 41 41 62 62MBS and CMOMBS and CMO 36 36 1 1Agency debtAgency debt 23 23Mortgage bondsMortgage bonds 19 19Dedicated savingsDedicated savings 5 5OtherOther 13 13TOTALTOTAL 100100 100100

Source: Achim Dubel and European Mortgage Federation

Typical Building Society Typical Building Society Balance SheetBalance Sheet

LiabilitiesLiabilities

Retail depositsRetail deposits 7575

Wholesale depositsWholesale deposits 2020

CapitalCapital 5 5

100100

Variable rate modelVariable rate model

AssetsAssets

Mortgages:Mortgages:

- residential- residential 70 70

- commercial- commercial 5 5

Liquid assetsLiquid assets 20 20

Other assetsOther assets 5 5

100100

Key Issues of System Key Issues of System DesignDesign

Institutional issues – Institutional issues – e.g. mutual, shareholder or governmente.g. mutual, shareholder or government

Operational issues – Operational issues – e.g. fund collection (product distribution)e.g. fund collection (product distribution)

Regulatory issues – Regulatory issues – e.g. disclosure of informatione.g. disclosure of information

Risk issues – Risk issues – e.g. variable rates gives interest rate risks to consumerse.g. variable rates gives interest rate risks to consumers

All overlapAll overlap

Institutional IssuesInstitutional Issues

Mutual, shareholder, government?Mutual, shareholder, government? Specialised or generalist?Specialised or generalist? Contractual or open?Contractual or open? Centralised, all or some functions, Centralised, all or some functions,

or local?or local? Competitive or services of local Competitive or services of local

non-competitors?non-competitors?

Institutional IInstitutional IMutual, Shareholder, Government?Mutual, Shareholder, Government?

MutualMutual customer focuscustomer focus no need for dividends – no need for dividends –

narrow marginsnarrow margins difficult for mutuals to difficult for mutuals to

acquireacquire weaker institutions can weaker institutions can

survivesurvive

Institutional IInstitutional IMutual, Shareholder, Government?Mutual, Shareholder, Government?

ShareholderShareholder lack of customer focus?lack of customer focus? dividend – wider margindividend – wider margin capital available quickly capital available quickly

from external sourcesfrom external sources can acquire weaker can acquire weaker

institutionsinstitutions can be acquired – incentive can be acquired – incentive

to efficiencyto efficiency

Institutional IInstitutional IMutual, Shareholder, Government?Mutual, Shareholder, Government?

GovernmenGovernmentt

securesecure no duplicationno duplication inefficient?inefficient? not customer-lednot customer-led monopoly?monopoly?

Institutional Issues IIInstitutional Issues IISpecialist or Generalist?Specialist or Generalist?

Current general shift from specialist deposit taking Current general shift from specialist deposit taking mortgage lenders to generalistmortgage lenders to generalist

SpecialistSpecialist- focus, knowledge, experiencefocus, knowledge, experience- high exposure to one product market – high risk?high exposure to one product market – high risk?

GeneralistGeneralist- economies of scope- economies of scope- deposits lead to money transmission, credit cards deposits lead to money transmission, credit cards

banking banking - mortgages lead to insurance, propertymortgages lead to insurance, property- wholesale market presence offers alternative source of - wholesale market presence offers alternative source of

fundsfunds- diversification – lower risk?- diversification – lower risk?

Institutional Issues IIIInstitutional Issues IIIContractual or Open?Contractual or Open?

ContractualContractual- customers save before obtaining mortgagecustomers save before obtaining mortgage- customers are committedcustomers are committed- institution knows customer before lendinginstitution knows customer before lending- interest rates can be divorced from general interest rates can be divorced from general

economy – closed circuiteconomy – closed circuit- wait for mortgage fundswait for mortgage funds- German Bausparkasse – also Austria, German Bausparkasse – also Austria,

Slovakia, SloveniaSlovakia, Slovenia

Institutional Issues IIIInstitutional Issues IIIContractual or Open?Contractual or Open?

OpenOpen

- immediate mortgage lending funds immediate mortgage lending funds availableavailable

- limited pre-lending knowledge of customerlimited pre-lending knowledge of customer

- UK building societies – competition moved UK building societies – competition moved institutions from closed to open systeminstitutions from closed to open system

Institutional Issues IVInstitutional Issues IVCentralised or Local?Centralised or Local?

France (Credit Agricole), Holland (Rabobank), France (Credit Agricole), Holland (Rabobank), Germany (DZ Bank), USA (Federal Home Loan Germany (DZ Bank), USA (Federal Home Loan Banks), Australia (Credit Union Services Australia Banks), Australia (Credit Union Services Australia Ltd) – local institutions, with strong centralised Ltd) – local institutions, with strong centralised banks (owned by local institutions) providing banks (owned by local institutions) providing treasury management, outsourced services, risk treasury management, outsourced services, risk management., management.,

UK – no similar institutions. Building societies, UK – no similar institutions. Building societies, locally based, but compete with each other, co-locally based, but compete with each other, co-operating more loosely.operating more loosely.

If local institutions – e.g. one for each town or region If local institutions – e.g. one for each town or region – do they compete with each other? In past, most – do they compete with each other? In past, most countries no.countries no.

Operational IssuesOperational Issues Deposit collection – branches, post, Deposit collection – branches, post,

internet, phone, ATM’s, intermediaries?internet, phone, ATM’s, intermediaries? Product design – instant access, fixed Product design – instant access, fixed

term, notice?term, notice? Savings before granting a loan?Savings before granting a loan? Outsource, or in-houseOutsource, or in-house Share services? E.g. branches, liquidity Share services? E.g. branches, liquidity

management, treasury management, management, treasury management, cheque clearingcheque clearing

Operational Issues IOperational Issues IDeposit CollectionDeposit Collection

BranchesBranches- builds trustbuilds trust- cash cash - face to face meeting of customers and staffface to face meeting of customers and staff- cross-selling opportunities cross-selling opportunities - ExpensiveExpensive

Post/internet/phonePost/internet/phone- needs trustneeds trust- no cashno cash- cheapcheap- Remote – encourages commoditisationRemote – encourages commoditisation

Operational Issues IOperational Issues IDeposit CollectionDeposit Collection

IntermediariesIntermediaries- deposit taker uses another business to deposit taker uses another business to

collect depositscollect deposits- cash basedcash based- needs trust of intermediary and deposit needs trust of intermediary and deposit

takertaker- intermediary has institution’s intermediary has institution’s

customers customers - deposit taker has responsibility for deposit taker has responsibility for

intermediaryintermediary

Operational Issues IIOperational Issues IIDeposit Product Design?Deposit Product Design?

Instant accessInstant access

Notice/fixed termNotice/fixed term

good for lower income groupsgood for lower income groups higher liquidity needed for institutionhigher liquidity needed for institution less stable?less stable? must follow interest rate cyclemust follow interest rate cycle lower rates, more transactions, ATM’slower rates, more transactions, ATM’s

more suitable for higher income groups more suitable for higher income groups less liquidity requiredless liquidity required more stable?more stable? needs more trustneeds more trust helps insulate institution from general helps insulate institution from general

interest ratesinterest rates higher rates, fewer transactions, no ATM’shigher rates, fewer transactions, no ATM’s

Operational Issues IIIOperational Issues III

Savings first/loan laterSavings first/loan later Outsource, or in-houseOutsource, or in-house Sharing servicesSharing services

All covered on institutional issues, but need All covered on institutional issues, but need not benot be

institutionally basedinstitutionally based

Regulatory IssuesRegulatory IssuesPrudential Prudential

regulation?regulation?

Conduct of business Conduct of business regulation?regulation?

Product regulation?Product regulation?

Ombudsman?Ombudsman?

capital, liquidity, large capital, liquidity, large exposureexposure

disclosure of informationdisclosure of information restrictions on rate changesrestrictions on rate changes

specify productsspecify products prohibit certain featuresprohibit certain features prescribe certain featuresprescribe certain features

to deal with complaintsto deal with complaints

Regulatory IssuesRegulatory Issues

Deposit protection?Deposit protection?

TaxationTaxation

GovernmentGovernmentcompetition in competition in

depositdepositmarketmarket

- industry or taxpayer?- industry or taxpayer?

- special status for deposit - special status for deposit takers with mortgage takers with mortgage presence?presence?

Regulatory Issues IRegulatory Issues IRegulationRegulation

PrudentialPrudential• Capital – Basel rules?Capital – Basel rules?• Liquidity – depends on Liquidity – depends on

deposit profiledeposit profile

Conduct of businessConduct of business• Disclosure of informationDisclosure of information

• Standards of serviceStandards of service

write on rate write on rate changes?changes?

write about new write about new products?products?

branch opening hoursbranch opening hours advice to customersadvice to customers

Regulatory Issues IRegulatory Issues IRegulationRegulation

Product Product regulationregulation

Regulator designRegulator design

products?products?

e.g. no penalties on e.g. no penalties on withdrawals, link to external withdrawals, link to external raterate

depends on levels of trustdepends on levels of trust linked to extent of conduct of linked to extent of conduct of

business regulationbusiness regulation

Regulatory Issues IIRegulatory Issues II

• Dealing with Dealing with complaintscomplaints

• Deposit Deposit protectionprotection

- institution and customer- institution and customer- courts- courts- regulator- regulator- ombudsman- ombudsman

- none, rely on prudential regulation- none, rely on prudential regulation- industry scheme- industry scheme

- Voluntary- Voluntary- State-sponsored- State-sponsored

- insurance- insurance- tax payer- tax payer

Regulatory Issues IIRegulatory Issues II

• Taxation/ subsidiesTaxation/ subsidies

• Government competitionGovernment competition

- tax benefits for mortgage - tax benefits for mortgage lenders?lenders?

- important to trace who - important to trace who ultimately benefitsultimately benefits

Who Bears the Risks?Who Bears the Risks? Deposit risk – Deposit risk –

can the institution repay deposits when can the institution repay deposits when due?due?

Interest rate risk – Interest rate risk – who wins/loses when interest rates change?who wins/loses when interest rates change?

Other risks – Other risks – operational, reputational.operational, reputational.

Who Bears the Risks?Who Bears the Risks?

Deposit risk borne Deposit risk borne byby

Interest rate riskInterest rate risk

- ManagementManagementshareholdersshareholdersother institutions (protection scheme)other institutions (protection scheme)tax payer (e.g. USA thrift crisis)tax payer (e.g. USA thrift crisis)insuranceinsurancedepositordepositor

- depositor and borrower in variable rate depositor and borrower in variable rate systemsystem

- but hedging overcomes this to offer shortbut hedging overcomes this to offer shortterm fixesterm fixes

- no deposit based system offers USA and no deposit based system offers USA and Danish advantage – fixed rate/adjustable Danish advantage – fixed rate/adjustable downward – although this has costsdownward – although this has costs

ConclusionsConclusions

Deposit based Deposit based systemsystem

- simplesimple- few intermediariesfew intermediaries- transparenttransparent- links borrowers and links borrowers and

saverssavers

ADRIAN COLESADRIAN COLESSECRETARY GENERAL, IUHFSECRETARY GENERAL, IUHF

The WORLD BANK SEMINAR

Washington DCWashington DC11 March 200311 March 2003

THE DEPOSIT BASED MODEL