Financial Sector Charter: Banking Association briefing

FINANCE PORTFOLIO COMMITTEE
19 September 2006
FINANCIAL SECTOR CHARTER: BANKING ASSOCIATION BRIEFING

Chairperson: Mr N M Nene (ANC)

Documents handed out:
Banking Association presentation
Financial Sector Charter

SUMMARY
The Banking Association is a voluntary association acting on behalf of its member banks to assist them in doing banking business profitably in a sound business environment. The briefing focused on the role the financial sector and the Association played in the housing section of the Financial Sector Charter. Financial service providers had voluntarily committed to making investments of R123 billion over a 12-year period up to 2014. R42 billion was allocated to housing. Banks picked up 36% of that commitment. The Charter targeted a specific sector, comprising 2 to 4 million households, who earned between R1 500 and R7 500 per month.

The main problem of housing was not the cost, but the lack of sufficient housing. The Banking Association’s research showed that the shortfall of housing in this sector could be reduced by 60% over five years if certain strategies were followed. Reasons for the shortfalls included the non-availability of contractors, the shortfall of assembled (serviced) land, the high cost of private sector land, and procurement regulations that created a barrier to acquisition of public land. The Banking Association did not support the suggestion that public land should first be transferred to a central authority and from there to end users. Supply constraints arose from delays in the servicing and building processes, lack of capacity in local government, inadequate bulk service supplies, and the increasing cost of housing.

The Banking Association believed it was vital to set up a more effective and efficient subsidy system. It suggested a gradual phasing out of the local government subsidies, an introduction of cross subsidy by schemes with state owned enterprises.  Risk costs were a major issue and the Association had suggested to Government that interest rates should be fixed, and that Government should assume some risk as a loss limiting insurer. Government had not agreed to these proposals. The way forward would include further discussion on these issues, attempts to reach fixed rates, prioritisation and improvement of supply issues, achieving a proper housing ladder system and a social housing net.

Members agreed that it would be useful to have further joint briefings with the Portfolio Committees on Housing and Local Government. Questions were raised on the target market, capacity to deliver, and the cost implications of the Charter to individuals in society. Clarity was sought as to the income grouping able to access financing, the costs of lending, the fixed rate proposed, and the proposal to cross-subsidise. The risk of default was explained in more detail. The Association was asked how far it had gone towards achieving the targets, whether it addressed the quality of housing, whether it worked to improve skills in the construction industry, and how inflation would affect the target market.

MINUTES
Briefing by Banking Association of South Africa
Mr Nicky Lala-Mohan (General Manager, Banking Association) confirmed, in response to a query from the Chairperson, that the Banking Council and the Banking Association were the same body. The name had been changed two years back since it was thought more appropriate that a voluntary group, as opposed to a regulatory body, should be known as an Association. The Banking Association acted on behalf of its member banks to assist them in doing banking business profitably in a sound business environment.

The briefing would focus on the Financial Sector Charter (“the Charter") and its role in the housing arena. The Charter was a voluntary commitment that had been undertaken in October 2003 whereby all financial service providers, including life offices, pension schemes and the Johannesburg Stock Exchange, would “collect investment”. The Charter encompassed very broad based black economic empowerment principles and was concerned with sound business practices. The timeframe for the Charter was set from January 2002 to December 2014, with a review in December 2008. The Financial Sector Council, an independent and fully representative body in the industry, would monitor the commitments made under the Charter.

The Charter had originated from enquiries as to what national savings were held in the country, and what the role players were doing to assist. It was found that the banks held R747 billion, retirement funds R730 billion, life schemes R456 billion, collective investment R136 billion and short term insurance R34 billion. This gave a total of R2 trillion held in national savings. A target of R123 billion (5.75% of total national savings) was set as commitment in the Charter. This was then broken down into various categories, and housing received an allocation of R42 billion. Banks were one of the stakeholders in the Charter and picked up 36% of the commitment in terms of the Charter

Housing was a vital part of the Charter. Seven million households were currently dependent on the social grant system. Above this there was an under serviced market, of between two and four million households, who earned an income of between R1 500 and R7 500 per month, and could therefore not service full bonds. Three to four million households earned above R7 500 and could afford bonds. The focus of the Charter for housing was the sector with an income of between R1 500 and R7 500. Certain targets had been set for achievement in 2008, but there were some unresolved issues with Government. There was targeted investment of R40 million, but this could rise to R50 million if Government were to assist.

Mr Jopie van Honschooten (Coordinator for Housing Initiative, Banking Association) stated that the real issue of housing within the Charter was not a financial issue, but was the fact that not enough housing was available. The availability of ready funding would worsen the problem since the few units available would rise in price through increased demand. Therefore the banks were trying rather to focus on the shortage and trying to reach solutions to the supply problem.

The Banking Association was focusing, through the Charter, on the sector earning between R1 500 and R7 500 per month. Research from a number of sources showed that mortgage borrowing was not an option for anyone earning less than R2 500 per month. South Africa needed 2.6 million houses, but currently only 1.9 million houses existed. In this sector alone there was a shortfall of 661 thousand houses. The shortage was more pronounced in the bigger magnet urban areas of Gauteng, Kwazulu Natal, Eastern Cape and Western Cape. The Banking Association could not meet this shortage in one fell swoop but had calculated that it was feasible, over a five year period, to aim to reduce the shortfall by 60%. This would require 132 000 houses per annum. Currently only 19 000 houses were becoming available. The challenge was great, and was compounded by the fact that the construction industry was being used for other projects such as stadiums and rail systems, which were more remunerative for developers. However, the Banking Association believed that if it could focus and find exceptional housing managers to tackle the problems a lot could be done.

The Banking Association had identified some of the reasons behind the shortages and was committed to finding solutions. It believed that it could play a significant part and was prepared to assist wherever it could. There was adequate land available, but the shortage lay in the “assembled land” - land with services - on which houses could be built. Private sector land existed that was suitable for inclusionary housing schemes, but it was expensive, making the final houses beyond the affordability of the sector. Public sector land was also available, currently owned by state owned enterprises (SOEs), provincial or local authorities. This land had not been assembled but the procurement regulations were not appropriate to the process and in fact were a barrier to the free market system. The current procurement regulations evaluated price only. If 100 hectares were available and 2000 houses were needed, these regulations would require the lowest cost housing. However, this did not match with the Department of Housing’s Breaking New Ground Policy, which sought to establish mixed housing and integrated areas that would in turn increase commercial enterprise and viability of areas. It was not possible to try to evaluate these kinds of development on price alone, as their value was more dependent upon the final outcome of the use of the property. Given the current tendering system, procurement on price tended to raise the land price unrealistically beyond the affordability levels of the target market. The tender process also did not filter out developers who lacked the necessary skills, experience or financial backing to complete the development.

There was a suggestion that land should be transferred to a central entity and from there to the end users. The Banking Association did not support this suggestion. If the transfer to the central authority concerned state owned land, transfer duty was payable and this would increase the end costs. The SOEs would be likely to require market value, and the value would be deleted from the books of the provincial entity.  The central entity would have to fund itself by borrowing money, and the holding cost again would be added to the end costs.

A further supply constraint related to the delays in the servicing procedures. It could take as much as five years from the date of proclamation of the land to the sites being identified and serviced. A developer acquiring land was therefore carrying the burden of interest payments for five years before recouping anything and this increased the cost beyond the reach of the target market.

A further delay arose in the building of houses on serviced sites. Building a house formerly took about five months. It currently took around two years. Once again, this added costs, as developers would still have to service their own loans during this time.

Capacity in local government was yet another issue contributing to delay. The bulk service capacity of many municipalities, in water provision, electricity and sewerage, was already overstretched and the systems inadequately maintained.

Another constraint related to the ever-increasing cost of housing, caused by rising land prices, material prices and labour costs. In 2004 an individual would need a salary of R6 400 to be able to acquire a newly built house costing R132 500. The cost of housing had risen way above the levels of inflation. In 2006 the individual would now need a salary of R9 200, since a newly built house of the same quality and size would cost R195 000. Although the labour unions and the building industry had been criticised for the cost increase, the increases were due mostly to the increased costs of serviced stands, compounded by the delays in the processes. Building costs over the period 2003 to 2006 had increased 19% but the stand costs had increased 102%.

The Financial Sector Charter was the only one of the Charters that had a broad base of empowerment, because it went beyond merely offering the chance of ownership to previously disadvantaged individuals, but also gave citizens the chance to gain access to finance. The banking sector had undertaken to provide R40 billion financing in the housing area. However, no corresponding obligations were placed upon the other role players such as contractors, building suppliers and landowners.

The Banking Association believed it was vital to set up a more effective and efficient subsidy system. It was accepted that any subsidy system would give rise to some distortion, but it was clear that subsidies were necessary to try to achieve a balance. However, an unintended consequence of the current system was that it distorted the market and gave few incentives to purchasers to try to raise their levels of income. Those earning above R3 500 would have to self-finance some of the costs. The current subsidy would grant R36 000 to individuals earning up to R3 500. Local government would add a top-up subsidy to allow for maintenance and to provide proper guttering, drainage and storm drains, and the total amount received would be R52 000. However, a person earning R3 501 would only qualify for a subsidy of R23 600, and this was scaled down until a person earning R7 000 received the lowest level of R3 400. Possible ways to manage this situation would be by phasing out the local government subsidies in the same way that the top structure was to be phased out, so that more incentives were created for developers to get into the market.

The Banking Association believed that a further solution might be to cross-subsidise. This would involve “having the mind of a capitalist but the heart of a socialist”. The Association suggested that it was possible to identify SOE land, use the book cost, rezone the land and develop it in such a way that it would provide housing and commercial ventures. For example, Transnet land at a book value of R2 million should not be sold to the highest bidder for the market value of R100 million. Instead, it should be kept in the books at R2 million while being developed. Half would be developed for sale to commercial enterprises such as chain stores, and this would be sold at the market value of R50 million, whilst the other half would be developed for housing for sale in the sector already identified. The commercial value would therefore help achieve reallocation and transfer duties would not apply.

Risk issues were another factor in housing that affected both ends of the supply chain. Risk arose owing to unaffordability and the fact that the market was dysfunctional in some segments. A fixed rate of interest would address some of the risk. The target market had no cushion to fall back upon when interest rates rose beyond salary increases. The presenters tabled a detailed slide to explain how interest rate increases would affect disposable income, and to break down the components of the actual costs to borrowers, over a ten year period. In order to access R195 000 of funding, the borrower would pay R354 000. 55% of the total repayment was for the physical asset, 25% was the cost of the money paid out to depositors, and 12% was the cost of the risk, which banks would charge at a premium. A one percent increase in interest rates would lead to an increase in the cost of money from 25% to 31%. Although the Banking Association had suggested a fixed rate to Government, Government had not agreed, saying that the private sector bore this responsibility. The banks had been able to develop some fixed-term offers, but these were for a limited period. The Banking Association was still trying to bring all the parties together to unblock the constraints.

Other risk issues arose from what was termed the housing ladder. It was necessary for society to offer various housing options. It was also necessary to establish a social housing safety net. Given that the market was dysfunctional, many borrowers were unable to offer much realisable value as security, owing to inability to secure final title to the property, properties being situated in undesirable areas or social environments, or being poorly serviced. There was insufficient alternative accommodation available. A person who lost his job and was unable to pay his housing loan might refuse to vacate the property because he simply had nowhere else to go. He was unable to move readily to rental property, or to access social housing to allow his financial situation to recover. If the banks were to sell the property there would certainly be no surplus for him, and the banks too might not even realise the amount owed.

The cost of risk related both to individual cover, and to the pool of money in the market. The Banking Association had proposed to Government that Government should share the cost of risk, particularly the risk arising from the dysfunctional market. It was proposed that the banks would take the commercial risk, which was reasonably predictable and could be provided for. Government would act as loss limitation insurers for the systemic risks that could not be predicted, and that arose from dysfunctionality due to a fluctuating and uncertain labour market. The below-R5000 income group showed a high propensity to default, and likelihood of a loss on resale of the property. The risk premium was therefore higher for this sector. It could be reduced if Government was prepared to act as insurer. Part of the remedy for dysfunctional markets was to make funding available. Government had not acceded to this proposal; although it agreed that it might, in individual cases, accept liability. In respect of the “pool” of funding, it would be possible to access further funding from the deposit sector, pension schemes, short term insurance and life offices, who should participate in sharing, but these sectors would not be prepared to put in funding unless they knew that they were protected from loss. The Banking Association would be prepared to take some loss and put its shareholder capital on risk to a defined level but would require further insurance. Once again, Government had so far refused to become the insurer. The proposed solutions had therefore not been able to be implemented.

The Banking Association proposed that the way forward would involve prioritisation and improvement of supply issues, especially the procurement regulations and inefficient processes. Limited risk should be explored further and the Association would continue in its discussions with Government and attempt, through further partnerships, to find solutions. It sought to achieve a housing ladder system and a housing net.

Discussion
The Chairperson commented that the briefing had been useful, but that ideally the Portfolio Committee on Housing should also have been present. He noted that the Charter was broad in scope and also encompassed agricultural issues, although these had not been the focus of this meeting. He asked if the Housing Portfolio Committee had received information from the Banking Association.

Mr van Honschooten  replied that the Housing Portfolio Committee had received two briefings previously from the Banking Association. The Association felt that the issues were so vital that as many people as possible should be made aware of them. Many issues did not pertain directly to finance and financial engineering alone would not solve the problems, which were cross cutting.

The Chairperson agreed and stated that correct forums would need to be identified that could assist in addressing the problems.

Mr M Johnson (ANC) commented that the figures presented seemed much lower than national figures, and asked for clarity.

Mr van Honschooten  clarified that the figures in this presentation were limited to the target sector earning between R1 500 and R7 500 per month, as all research had been concentrated in that sector.

Mr Johnson asked for an indication of whether there was indeed capacity to deliver the housing. He cited the example of the Nelson Mandela Metro where although a target was stated of 290 houses before the end of the year, there was doubt that this would be achieved.

Mr van Honschooten  replied that he was not qualified to give a definitive answer but had been impressed with the commitment by some areas. However, it would be foolhardy to think that all delivery would take place efficiently and effectively. Capacity was an area of concern.

Mr Johnson asked the cost implications of the Charter reaching all previously disadvantaged individuals. In particular, he asked whether bank costs were an attempt to recoup some of the money paid out, as they were considered by many to be exorbitant.

Mr van Honschooten  stressed that the underlying aim of the Banking Association was to assist its members to do business on a sustainable basis. The Charter did not require banks to do business in a way that would not give due returns to shareholders and depositors. It did seek to address affordability constraints. Lending rates, for example, had remained static since January 2004 at prime plus 2%. Money was therefore not lent at excessive or punitive rates. The Association believed that the market would determine an acceptable balance between risk and price. The rates for loans were competitive, were not out of line nor unaffordable to borrowers, but at the same time were calculated so that shareholders did receive a return on their investments with the banks.

Mr Lala-Mohan added that bank charges were a topical issue that the Competition Commission was presently addressing. The closing date for submissions on the issue was 27 September.

Dr M van Dyk (DA) noted that the figures had shown that by April 2006 a person requiring a property would have to be earning in excess of R9 000, although the sector was apparently restricted to the band of earnings between R1 500 and R7 500. He asked if those earning above R7 500 would be excluded from assistance. He asked if those earning less than R5000, which was generally considered the minimum figure for accessing home ownership finance, were included in the 7 million people dependent on government.

Mr van Honschooten  explained that income of R4 950 was considered to be the entry point for home ownership loans. However, this figure related to the purchase of a newly built home. Other options were still available for the lower end of the market. There were many homeowners who incrementally put up houses through short-term user loans, most often backed by their pension funds. Financing would be available at the lower end, and at the upper end there would be the need for incremental self-financing. No financing through the Charter was available to those with income in excess of R7 500 but those people would generally be able to access bond finance.

Dr van Dyk noted that the presenters had commented that the costs to borrowers could be reduced. He asked how specifically the 25% cost of loan could be reduced. Banks could not be expected to lend out at less than the rate they were paying to the Reserve Bank.

Mr van Honschooten  replied that factually it was not possible for banks to reduce the 25% cost of loans. This was a factor in the economy and was related to rates of interest.

Ms J Fubbs (ANC) commented that one of the solutions proposed was a fixed rate of interest. She asked what rate the Banking Association suggested, and if it was of the opinion that government subsidies were the answer.

Mr van Honschooten  commented that the Banking Association did not believe that there should be a subsidy. He had given the examples of an interest rate of prime plus 1.5%, but no absolutely set rate was suggested. The proposals put forward to Government had mentioned rates of between 13% and 16%. Fixing of the rates would go together with a hedging mechanism. For instance, if borrower A borrowed in January he would get a 13% fixed rate, which was applicable at that time.  Borrower B, borrowing six months later, would borrow at the then prevailing rate, say 15%. If the rates then dropped two months later to 12% both Borrower A and Borrower B’s rates would drop to 12% automatically as a refinancing operation. 

Ms Fubbs asked if the default rate for repayment was likely to drop if a housing ladder were introduced, and how the scheme proposed would actually affect the costs of risk.

Mr van Honschooten  believed the default rate would fall. Default occurred through unemployment that resulted in inability to pay. The market was not intrinsically bad or risky, and therefore the risks were external. He believed also that rationalising local areas would improve the unemployment risks.

Ms Fubbs asked for further clarity on the proposal that SOE land be retained in the books at cost value, and asked if local or provincial authorities would be expected to enter into joint ventures for developers and where they would access financing.

Mr van Honschooten  explained that land availability agreements would need to be made which allowed the owner not to put the land up for tender to the highest price. The land would continue to be held by the owner (usually a local authority or SOE). The owner would enter development contracts with a consortium. One of the conditions of sale would be that the land could only be transferred to the end-buyer. An average commercial rate would be used for the commercial section and a subsidised rate, calculated on the book value, for the housing buyers. That would give better opportunity for more to penetrate the market better than would imposed conditions such as “20% to low end finance operations”. The Banking Association believed this would achieve a balance.

Mr I Davidson (DA) asked what progress there had been on trying to address the subsidy distortion, and when the subsidies were to be phased out.

Mr van Honschooten  replied that there had been some good progress on the financial subsidies that were formulated in discussion with the Department of Housing. However, the finance-linked subsidies were ineffectual because of the precondition that savings must be put in. There were external risks and non-responsible customers, and further issues related to the claw-back provisions, the drop in subsidies from R36 000 to R23 600, which the Banking Association believed was far too steep a drop, and the distortions caused by the top-up subsidies. Bankers saw themselves as becoming more involved in the developments. There had been some successful work with Tshwane as a targeted municipality in trying to alleviate procurement issues. Ways to phase out the subsidies had been discussed, and it was hoped that if Tshwane was successful this could be a blueprint to be duplicated in other metros.

Mr Davidson asked whether a person who accessed a loan on the basis of income of R3 500 would lose that loan if he became unemployed or his income dropped.

Mr van Honschooten  noted that the grant was determined at the time of application and would not be affected by rises or drops in income. It would be administratively impossible to try to change the grants once received, and therefore the entry time was the determining factor.

Mr Davidson noted that mention was made that 19 000 houses had come on to the market. He asked how this affected the risk.

Mr van Honschooten  replied that the new houses were also subject to the same risks. If a market had been dysfunctional any activity in the market would have some impact but the impact would generally be felt at the top end, which was not the focus of the Charter.

Ms L Mabe (ANC- Chairperson, Joint Budget Committee) referred to the calculations that the housing shortfall could be reduced by 60% and asked if these took into account future growth and needs.

Mr van Honschooten  replied that this had been factored into the calculations. The full calculations were available on the www.banking.org.za website. They took into account population growth, income, all factors driving increases and decreases in the demand for housing.

Mr T Vezi (IFP) suggested that the Local Government Portfolio Committee should also be invited to attend a joint briefing, together with the Housing Portfolio Committee. He commented that the present problems were one of the legacies of the apartheid systems of job reservation and Group Areas enforcement, and the Committee appreciated that the problems were not the fault of the banking sector.

Mr van Honschooten  agreed with the comments, but stressed again that shortage of land was the main problem.

Mr K Moloto (ANC) asked how far the financial sector had gone to reach its target of R42 billion for housing.

Mr van Honschooten  stated that the sector strove to achieve the targets and although it was possible to say that a certain number of loans had been negotiated, these were still to be verified by the Charter Council. Up to December 2005, R17 billion worth of loans had been originated in this market segment. There had been substantial activity. Again, he stressed that more could have been achieved if more houses were available. The Banking Association would do all it could and would continue to lend at competitive rates.

Mr Y Bhamjee (ANC) asked whether there was a definition of social housing.

Mr van Honschooten  defined it as housing where the occupant may have contributed towards, but also had received government grant assistance for the house.

Mr Bhamjee also queried incremental housing, the size of the dwellings and the principle of core housing. The production of units might well have increased, but he enquired whether the quality had improved. Many issues of quality must be addressed and rectified to avoid a social nightmare.

Mr van Honschooten  stated that all ends of the income market had to be financed in some way. The Charter addressed a very specific market. Many people would only be able to achieve houses through the incremental method. The Banking Association was becoming involved more and more in the development aspects of housing. It was essentially involved at the lower end of the supply chain. The Association and the financial sector did not originally handle social housing and rental accommodation, and the target market of the Charter was not generally eligible for social housing. However, it was part of the housing ladder. The Breaking New Ground policy had tried to move away from the issue of “matchbox” houses and urban sprawl. Size was no longer the main issue, and the consideration was rather whether a house was being created in a reasonable environment, with social amenities, access to transport and schools and that could be upgraded. The minimum was a 35 square metre structure, but there were many worthwhile developments where the foundations laid would be able to support additions and upgrades. Houses were also planned for most effective layout of roads, sewerage and so forth. It was no longer necessary to specify a certain type of structure, as it was more important that the occupier should regard the house as a worthy investment. Therefore less formal structures, which were closer to amenities, would be more acceptable.

Mr Bhamjee commented that banks had not come into the market in 1994 as they were concerned about the risks, and only now had they appeared to realise that this was a lucrative market. He commented further that many banks would have financed developers who had bought land at cheap rates in the past for development. He believed that if the financial sector wanted to talk about social housing they should also be looking to stabilise the economy and the lifestyle of previously disadvantaged individuals. He thought there was a need to change mindsets.

Mr van Honschooten  replied that banks wanted to become part of the solution. He did not deny that banks could well have financed developers buying at cheap rates, but the reality was that currently the financial sector, through the Charter, was seeking solutions. These would not be found in financing alone and it was necessary to involve a chain of implementers.

Mr S Asiya (ANC) believed that skills and delivery of material were both problems in the construction industry and both would impact also upon the delivery of housing. He asked what the Banking Association would do to address skills development.

Mr van Honschooten  stated that skills of builders and contractors really resided in the construction industry. However, wherever possible, the Banking Association and the finance sector would be involved in creating innovative approaches. He indicated that ABSA, in association with the National Homebuilders Regulation Council, had invited a number of developers to put up a new housing development using innovative designs and materials. Once again, he wished to stress that the construction industry was not so much to blame for delays; it was the shortage of land that was the main problem.

Mr Asiya commented that many banks were unwilling to invest in certain areas and therefore people had to buy houses far away from where they were working.

Mr van Honschooten  stated that this was a controversial topic but if one were to take the broad view, it was impossible to push back the clock and revive dying areas. The economics of urbanisation had in fact overtaken the legacy of apartheid. Urbanisation was a reality and drove significant change.

The Chairperson stated that the income band covered by the Charter was originally pegged at incomes between R1 500 and R7 500, but this had been affected by inflation. He asked where the levels were presently.

Mr van Honschooten  stated that the target band of income had been recalculated on the consumer price index and so the target band was currently incomes between R1 600 and R8 200, which reflected an annual increase since inception of the Charter of 4.1%.

The Chairperson thanked the presenters and commented that the Committee would try to arrange a broader session in conjunction with the Portfolio Committees on Housing and Local Government, to follow up on the broader implications of the whole Financial Sector Charter.

The meeting was adjourned.