The Swiss mortgage industry

Federal Home Loan Bank Board Journal, March, 1984 by Leo Schuster, Rod A. Beckstrom

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.