FINANCE AND HOUSING IN CENTRAL AND EASTERN EUROPE: A DEMAND-SIDE APPROACH Liviu Voinea, Deputy Governor, National Bank of Romania Finance and Housing Panel, Bruegel Annual Meetings 2017  In 2015, ESRB published the Report on residential real estate and financial stability in EU. In November 2016, a detailed assessment of countries with high vulnerabilities followed.  AT, BE, DK, FI, LU, NL, SE, UK were identified as having medium term vulnerabilities on the Residential Real Estate (RRE) market. No CEE country was singled out.  The ESRB methodology is based on the concept of “stretch”, applied to households, collateral, and banks.  Household stretch refers to vulnerabilities related to borrowers’ indebtedness and ability to repay debt, as well as their capacity to maintain their consumption pattern. Main indicators: household debt % GDP, financial assets to debt, debt service to income.  Collateral stretch refers to vulnerabilities relating to the property market. Main indicators: residential price index, house price to income.  Banking stretch refers to vulnerabilities related to direct losses by banks and due to their RRE exposures. Main indicators: loans for house purchases, loans’ growth rate and trend.  The report finds that the structural features of the RRE markets can be grouped into demand-side, supply-side and institutional factors. The demand side factors include: household income, credit availability and interest rates, home ownership rates, demographic factors. On the supply side: residential investment, housing construction and construction costs. Institutional factors: housing taxes and subsidies, mortgage contract features, foreclosure and insolvency procedures.

Household access to banks or financial markets which is typically limited for low- income households defines who will be directly and indirectly affected by changes in interest rates, and thus who will react more strongly to monetary policy impulses. More generally, household response to changes in monetary conditions depends on each household’s income and indebtedness profile; that is, on their disposable income profile. All these variables indicate that two different income distributions can potentially induce many different impacts on the economy for the same monetary policy1.  Access to credit has improved after the crisis, mainly due to lower interest rates (Figure 13), income growth (in particular for low-middle income households) and the introduction of a state-guaranteed “First House” program (Figure 14) (which mainly compensated for the lack of savings by allowing for a very low advance payment). When “First House” program was changed to allow only local currency guarantees, the share of local currency mortgages skyrocketed (Figure 15), reducing the vulnerability of foreign exchange evolution, but increasing the risk of a future interest rate shock on low-middle income households.  National Bank of Romania introduced a series of macroprudential measures starting from 2004 (Figure 16). Yet, macroprudential rules put in place to foster financial stability can affect households unequally. For example, relaxing or tightening access to mortgages through caps on debt-to-value ratios may affect the distribution of household wealth.  Monetary and macroprudential policies alone cannot address the imbalances in the RRE markets.