Faststart

1
THE DEPOSIT BASED MODEL
ADRIAN COLES SECRETARY GENERAL, IUHF The WORLD
BANK SEMINAR Washington DC 11 March 2003
2
INTERNATIONAL UNION

• The International Union -
• Publishes a quarterly journal, Housing Finance
  International.
• Publishes a newsletter two or three times a year.
• Maintains a website www.housingfinance.org
• Facilitates a World Congress, which is normally
  held every two years.
• Co-operates with the Wharton School of Management
  at the University of Pennsylvania, -
  international housing finance school each
  May/June.
• Answers ad hoc queries from members and
  maintains a small library.
• Has 160 members in 55 countries

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UK BUILDING SOCIETIES BASIC 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

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Deposit Role in Mortgage Funding

• USA EU
• 2000 1998
• Retail deposits 41 62
• MBS and CMO 36 1
• Agency debt 23
• Mortgage bonds 19
• Dedicated savings 5
• Other 13
• TOTAL 100 100

Source Achim Dubel and European Mortgage
Federation
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Typical Building Society Balance Sheet

• Liabilities
• Retail deposits 75
• Wholesale deposits 20
• Capital 5
• 100
• Variable rate model

• Assets
• Mortgages
• - residential 70
• - commercial 5
• Liquid assets 20
• Other assets 5
• 100

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Key Issues of System Design

• Institutional issues
• e.g. mutual, shareholder or government
• Operational issues
• e.g. fund collection (product distribution)
• Regulatory issues
• e.g. disclosure of information
• Risk issues
• e.g. variable rates gives interest rate risks to
  consumers
• All overlap

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Institutional Issues

• Mutual, shareholder, government?
• Specialised or generalist?
• Contractual or open?
• Centralised, all or some functions, or local?
• Competitive or services of local
• non-competitors?

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Institutional IMutual, Shareholder, Government?

• Mutual

• customer focus
• no need for dividends narrow margins
• difficult for mutuals to acquire
• weaker institutions can survive

9
Institutional IMutual, Shareholder, Government?

• Shareholder

• lack of customer focus?
• dividend wider margin
• capital available quickly from external sources
• can acquire weaker institutions
• can be acquired incentive to efficiency

10
Institutional IMutual, Shareholder, Government?

• Government

• secure
• no duplication
• inefficient?
• not customer-led
• monopoly?

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Institutional Issues IISpecialist or Generalist?

• Current general shift from specialist deposit
  taking mortgage lenders to generalist
• Specialist
• focus, knowledge, experience
• high exposure to one product market high risk?
• Generalist
• - economies of scope
• deposits lead to money transmission, credit cards
  banking
• mortgages lead to insurance, property
• - wholesale market presence offers alternative
  source of funds
• - diversification lower risk?

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Institutional Issues IIIContractual or Open?

• Contractual
• customers save before obtaining mortgage
• customers are committed
• institution knows customer before lending
• interest rates can be divorced from general
  economy closed circuit
• wait for mortgage funds
• German Bausparkasse also Austria, Slovakia,
  Slovenia

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Institutional Issues IIIContractual or Open?

• Open
• immediate mortgage lending funds available
• limited pre-lending knowledge of customer
• UK building societies competition moved
  institutions from closed to open system

14
Institutional Issues IVCentralised or Local?

• France (Credit Agricole), Holland (Rabobank),
  Germany (DZ Bank), USA (Federal Home Loan Banks),
  Australia (Credit Union Services Australia Ltd)
  local institutions, with strong centralised banks
  (owned by local institutions) providing treasury
  management, outsourced services, risk
  management.,
• UK no similar institutions. Building
  societies, locally based, but compete with each
  other, co-operating more loosely.
• If local institutions e.g. one for each town or
  region do they compete with each other? In
  past, most countries no.

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Operational Issues

• Deposit collection branches, post, internet,
  phone, ATMs, intermediaries?
• Product design instant access, fixed term,
  notice?
• Savings before granting a loan?
• Outsource, or in-house
• Share services? E.g. branches, liquidity
  management, treasury management, cheque clearing

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Operational Issues IDeposit Collection

• Branches
• builds trust
• cash
• face to face meeting of customers and staff
• cross-selling opportunities
• Expensive
• Post/internet/phone
• needs trust
• no cash
• cheap
• Remote encourages commoditisation

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Operational Issues IDeposit Collection

• Intermediaries
• deposit taker uses another business to collect
  deposits
• cash based
• needs trust of intermediary and deposit taker
• intermediary has institutions customers
• deposit taker has responsibility for intermediary

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Operational Issues IIDeposit Product Design?

• Instant access
• Notice/fixed term

• good for lower income groups
• higher liquidity needed for institution
• less stable?
• must follow interest rate cycle
• lower rates, more transactions, ATMs
• more suitable for higher income groups
• less liquidity required
• more stable?
• needs more trust
• helps insulate institution from general interest
  rates
• higher rates, fewer transactions, no ATMs

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Operational Issues III

• Savings first/loan later
• Outsource, or in-house
• Sharing services
• All covered on institutional issues, but need not
  be
• institutionally based

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Regulatory Issues

• Prudential regulation?
• Conduct of business regulation?
• Product regulation?
• Ombudsman?

• capital, liquidity, large exposure
• disclosure of information
• restrictions on rate changes
• specify products
• prohibit certain features
• prescribe certain features
• to deal with complaints

21
Regulatory Issues

• - industry or taxpayer?
• - special status for deposit takers with mortgage
  presence?

• Deposit protection?
• Taxation
• Government
• competition in deposit
• market

22
Regulatory Issues IRegulation

• Prudential
• Capital Basel rules?
• Liquidity depends on deposit profile
• Conduct of business
• Disclosure of information
• Standards of service

• write on rate changes?
• write about new products?
• branch opening hours
• advice to customers

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Regulatory Issues IRegulation

• Product regulation
• Regulator design
• products?

• e.g. no penalties on withdrawals, link to
  external rate
• depends on levels of trust
• linked to extent of conduct of business regulation

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Regulatory Issues II

• - institution and customer
• - courts
• - regulator
• - ombudsman
• - none, rely on prudential regulation
• - industry scheme
• - Voluntary
• - State-sponsored
• - insurance
• - tax payer

• Dealing with complaints
• Deposit protection

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Regulatory Issues II

• - tax benefits for mortgage lenders?
• - important to trace who ultimately benefits

• Taxation/ subsidies
• Government competition

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Who Bears the Risks?

• Deposit risk
• can the institution repay deposits when due?
• Interest rate risk
• who wins/loses when interest rates change?
• Other risks
• operational, reputational.

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Who Bears the Risks?

• Deposit risk borne by
• Interest rate risk

• Management
• shareholders
• other institutions (protection scheme)
• tax payer (e.g. USA thrift crisis)
• insurance
• depositor
• depositor and borrower in variable rate system
• but hedging overcomes this to offer short
• term fixes
• no deposit based system offers USA and Danish
  advantage fixed rate/adjustable downward
  although this has costs

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Conclusions

• Deposit based system

• simple
• few intermediaries
• transparent
• links borrowers and savers

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THE DEPOSIT BASED MODEL
ADRIAN COLES SECRETARY GENERAL, IUHF The WORLD
BANK SEMINAR Washington DC 11 March 2003