Bausparen (Contractual Savings System)

Bausparen or a Contractual Savings System involves a contract on the part of a customer to save an agreed amount over a prescribed period in return for a commitment on the part of a credit institution to provide a loan, at pre-specified terms and of which the amount is dependent on the amount saved.[1] Bausparen is characterized by fixed, below-market rates on savings and subsequent loans. By design, Bausparen attempts to insulate customers from financial market volatility. An important part of the appeal of this system lies in the promise of loan availability at a predetermined rate of interest.

Basic features of Bauspar systems

The contract instruments and basic features of the contractual savings instruments developed and used in Continental Europe derive from the early U.K. experiences (beginning in the late 18th century) with mutual forms of housing finance. By entering a contractual savings system, a customer becomes a member of a collective. While the customer is saving he/she is a creditor to the collective and when she/he has taken out a loan a debtor.
A Bauspar contract comprises typically three distinct phases: the savings phase, the allocation for payout phase and the loan phase.[2] The savings phase is characterized by the agreement of the customer to save a prespecified total or a certain minimum amount each year or month. The interest paid on the deposit is fixed and unchangeable for the whole period. Households can draw on their bauspar-sums only, if a certain amount has been saved, a certain minimum savings period has elapsed and/or a certain qualification figure has been reached. The loan phase begins with the allocation of the bauspar-sum, which comprises both the deposits saved (plus the interest) and a low-interest loan. The interest on the loan has a fixed rate which has been agreed upon at the time signing the Bauspar contract. The actual time frames for the different periods vary depending on the system and/or contract chosen. Yet, the loan phase is usually not exceeding 10 years as bauspar-loans are usually second lien loans with a shorter maturity than typical market based main mortgage loans.
Bauspar systems had a very significant degree of success after World War II within Europe as they addressed two of the most important issues: the lack of information on borrowers as well as on properties and manage credit risk, and lack of long-term funding for housing.[3]

The German Bauspar system and the French épargne logement

Though several different types of Bauspar system designs exist around the world, almost all of them can be considered as offshoots of either the “closed” German Bauspar system or the “open” French épargne logement.
The modern Bauspar system was created in Germany in the 1920s based as much on social grounds as on economic and financial ones.[4] Originally, the Bausparkassen attempted to provide all the finance required by homebuyers. Yet, as the government deemed this to be not suitable it officially stated in 1938 that the main activity of Bausparkassen was to grant second mortgages. Hence, today, borrowers typically augment their contract loans with loans from other sources of credit secured by a first mortgage. Approximately 60 per cent of all housing transactions have partial finance from a Bausparkasse. Therefore, housing finance in Germany ideal-typical consists of 50-60 per cent mortgage loans provided by banks (secured by first mortgage), 20-30 per cent Bausparkassen loans (secured by second mortgage) and 20-30 per cent own equity.[5] In effect, the Bauspar system with its function as capital-forming and low-interest mortgages granting institution contributes to the fact that home ownership is usually solidly financed in Germany.
The German system is “closed” as it follows a strict principle of mutuality and transparency.[6] Bauspar deposits are mobilised by a specialised credit institution, the Bausparkasse, and are only made available to generate loans for participants in the system. In case the funds available are not adequate to meet the current Bauspar-loan demand, the participants will be served according to well defined queuing rules. The amount of the loan a customer can get is 1 to 1.5 times the amount saved by the household. In the beginning, savers fulfilling the term of a contract received a government interest premium equal to 25 per cent of the amount saved (up to a set maximum). Today, this premium has sunken to a mere 8.8 per cent and is tied to the usage of the funds for the acquisition/construction or modernisation/renovation of housing. Yet, since 2008, the Bauspar system is also an integral part of the government-sponsored private old-age provision.
The French system was inspired by the already established German system.[7] However, the original closed French system was deliberately modified by 1970 into an “open” system. It is called an “open” system as the saver can legally call its loan at contract maturity, irrespective of the prevailing liquidity conditions in the contract savings system. Furthermore, all deposit banks (and not only specialised institutions like in Germany) can issue épargne logement contracts. Therefore, in contrast to German Bausparen, the system is aimed at creating a group of savers who are willing to leave their savings in the system without exercising their loan rights (immediately) because of a deposit rate competitive with after tax yields on long-term treasury bonds. To establish this competitiveness the government funds a substantial interest rate premium of 40 or 50 per cent (dependent on the kind of savings contract) up to a set maximum. In addition, the extension of the number of years following the savings phase during which the option to a loan can be exercised, savers have an additional incentive to leave their funds into the system for extended periods thereby acting as “bons frères” (i.e. non-borrowing savers) and funding other’s loans. These incentives have produced a very large pool of long-term savings available to fund the mortgage bond market and a variety of housing-related purposes, not just contractual savings loans. The amount of the loan a household can receive in France is 2.5 times the amount of the contracted savings. The diffusion of the contract savings system in France can be considered as successful as in Germany. 

Critical Acclaim

The contractual savings systems are conducive to the supply of long-term funding and the capacity of lenders to lower credit risk. With their 4 to 6 years long saving periods contractual savings systems improve the duration gap between very long-term mortgage loans and very short-term deposit liabilities.[8] As well, a successful contract saver has demonstrated his ability to budget and set aside a portion of income for savings during an extended period, thus indicating that he will probably also be a reliable borrower.[9] Indeed, the delinquency and default rate of bauspar or épargne logement debtors are considerably lower than that of any other type of housing loan. This is also due to the fact that the capital obtained through contract savings helps to form a substantial downpayment, thus reducing the loan-to-value ratio and the probability of default, which is closely linked to it. Considering the wide diffusion of the contract savings systems in the countries where they are in place, it is possible to claim that they have contributed to a solidly financed homeownership and a comparatively more stable housing market.
One main rationale for creating a contractual savings system is also the attempt to provide middle-income and low-income households access to financial services.
All these features make contract savings systems ideally suited for countries in transition or developing countries, which suffer from the absence of sources for long-term funding, a lack of information on borrowers and less developed secondary (and primary) markets. 
However, critics claim that the social benefits of this system might be smaller than they appear. The impact of the low interest rate on the loan amount that can be borrowed is partially cancelled out by the shortness of the term of the low-rate loan (high amortization rates).[10] Some critical authors also claim that it is also not clear whether contractual savings systems can induce additional savings and investments, as there is evidence from the new Bauspar systems in Central Europe that most of the savings and housing investment would have happened anyway. Moreover, as the government usually has to support the low interest rates on saving deposits to obtain the attractiveness of the system the budgetary impact can be quite large (1.0 per cent of state budget; yet, this number has to be seen in comparison to the costs of over 3 per cent of the total budget of the almost unlimited, untargeted mortgage interest tax deduction in the United States). Some housing finance experts moan that the Bauspar and épargne logement system are also not very targeted by income, since there is a need to achieve a large scale of operation to support these separate institutions. However, there are limits on the subsidized amount of savings. Most of the subsidy goes to middle-income households who have the savings to put into the system. Contract savings systems might also impede the development of capital markets as their funds are channelled into a system independent of them.
The “open” French system with its excess funds that can be (and indeed are) used to fund other types of housing loans, has the tendency to increase disruptive competitive consequences for specialist lenders who fund themselves through the capital markets and not through retail deposits. It might represent also an obstacle to the decrease of market interest rates.

Bausparen in times of financial and real estate crises

Bauspar systems are independent of capital markets. Bausparkassen are not involved in speculative investments and have to hold a respectable equity buffer. Therefore, the Bauspar systems in place are not affected by the financial crisis. On the contrary, they contribute to the overall immunity of the domestic housing finance economy to negative effects from foreign markets and they stabilise the demand for the services of the building industry. Furthermore, with the outbreak of the financial crisis Bauspar systems have been considered by many households a safe haven; a fact which lead to an increase in the diffusion and popularity of the system. 

 [1] In the following cp.: Lea, Michael J./ Renaud, Bertrand: Contractual Savings for Housing: How Suitable Are They for Transitional Economies?, Washington 1995, p. 15. In the following: Lea/ Renaud, Contractual Savings.

 [2] In the following cp.: Deutsche Bausparkassen, The “Bauspar” System in Germany, Brussel 1995, p. 30. In the following: Bausparkassen, Bauspar system.

 [3] Cp. Lea/ Renaud, Contractual Savings, p. 2.

 [4] Cp. ibid, pp. 18-19.

 [5] In the following cp.: Bausparkassen, Bauspar system, p. 36.

 [6] In the following cp.: Lea/ Renaud, Contractual Savings, pp. 18-19.

 [7] Cp. ibid, pp. 20-21.

 [8] Cp. ibid, p. 54.

 [9] Taffin, Claude: ‘Epargne logement’ in France, in: Housing Finance International, 4, 1998, pp. 27-33. Here: p. 31.

[10] In the following cp.:  Hoek-Smit, Marja C./ Diamond, Douglas B.: The Design and Implementation

of Subsidies for Housing Finance, s.l. 2003, pp. 27-28.

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