Overview – efficiency

At the very top of the house, the mortgage markets studied appear broadly efficient There is a very narrow adjusted price range (45bp or approximately 10% of the total price) across 7 of the 8 countries, with prices in the 8th country (Italy) coming down sharply driven by foreign entry. Much of the price variation that exists across countries is driven by costs, which are in large part driven by structural factors, such as loan size, registration time, collections regulations etc. Lenders are not earning excessive returns and there is little scope currently for across the board price reduction, unless cost structures change.

Figure 5.1: Adjusted price by country

We should note that this situation is of low price differentials is not assured for the future. We note that markets operate separately and that product cross-subsidies and the involvement of government acts to keep returns (and prices) low in some geographies. The removal of these conditions could lead to a change in price levels within markets. During our interviews, some participants felt that price rises were possible although few thought that the practice of cross-subsidisation would cease in the medium term.

0.0% 0.5% 1.0% 1.5% IT UK ESP NL PT FR DK DE Interest rate (%) Adjusted price range 64bps

The most important driver of prices in the medium to long term is operating cost levels, which vary across markets. We have identified the main factors that drive operating cost efficiency at the national level.

„Processes. Here we mean both processes that are defined by

government or regulation (e.g. costly registration procedures, borrower- friendly collection standards that increase collateral collection costs) and over-manning induced by ownership or regulatory standards (e.g. union, government or cultural limitations on branch closure and staff reduction). These inefficiencies may be serving political purposes (e.g. giving a borrower every chance to cure before their house is sold, protecting access to branches in rural areas, preserving local jobs) but they do raise costs and these costs have to be passed on to borrowers through higher mortgage rates. As these inefficiencies are largely driven by national policy (largely consumer protection policy) it is within the gift of national government to remove them.

„Lack of national and lender scale. Clearly the level of impact of this factor depends on the size of the market, as a larger market will have room for more large-scale lenders. Lender scale is often driven by bank ownership structures and national competition policy. In some

countries the principal impediment to cost reduction is the fact that institutions are simply sub-scale. A solution to this issue lies in further domestic consolidation and outsourcing of sub-scale processes. One of the possible barriers to this is that many banks are not shareholder corporations but mutual or government owned companies.

Consolidation can be difficult for mutual firms as the owners (in most cases the customers) of these firms receive benefits from the bank beyond simple profits (e.g. local investment, lower prices) which may be lost in consolidation, particularly outside of the mutual sector20_.

Government owned institutions might also provide benefits to the government in addition to profits (e.g. subsidised lending, lower prices) that they may not continue to do under other ownership structures. In practice the big mutual/government groups (e.g. in France, Germany, Netherlands) do tend to pool some activities to achieve a level of cost efficiency but this is rarely as high as can be achieved with a single organisation.

„Loan size. Loan size is highly correlated to GDP per capita. There are

many fixed costs involved in mortgage lending and lending margins are typically lower for larger loans as the lenders can amortise the costs over a larger loan. While countries with lower GDP per capita tend to have lower labour costs, loan size tends to fall faster than labour costs so overall smaller loan size tends to result in higher costs (as a % of loan balance). In some markets, such as France, this is exacerbated by government lending schemes that tend to result in borrowers having multiple loans from different institutions, artificially depressing loan size and raising costs. Where the loan is broken into pieces, but all the loans are from the same institution, the cost inefficiencies are relatively minor as the mortgage can be distributed, disbursed and serviced in a single process.

57 Footnotes

20_{The UK is an exception here as there have been a large number of recent mergers between}

58

The second key factor influencing prices is the presence of product-cross subsidisation by commercial banks and the involvement of 'non-profit' mutual and state-owned lenders who are able to keep prices low as they do not need to pay dividends to shareholders. Both of these effects have the impact of lowering prices even in markets with high operating costs and so increase barriers to foreign or domestic entry from shareholder owned institutions.