|Case Studies in Community-Based Credit Systems for Low-Income Housing (HABITAT, 1995, 63 p.)|
This short chapter describes how a community-based housing finance system, started by some visionary individuals in Copenhagen over one hundred years ago, evolved into a very sophisticated institution which now belongs solidly in the formal sector with all its characteristics of scale, efficiency and anonymity while having retained the old principle of mutuality.
At the time of the first Mortgage Societies conditions in Denmark were similar to those prevailing in many developing countries: narrow capital base, unfamiliarity with financial institutions which in any case were limited to those dealing with simple banking business and their fear of long-term loans to poor people. On the other hand, economic times were favourable and the capital city of Copenhagen was experiencing the effects of a strong rural-urban migration. Habitable space was at a premium - as was all kinds of shelter for shops, offices, factories and storage. In fact, the first groups of people to form for the purpose of raising long-term finance were businessmen who found lending from the banks too expensive.
The principle of mutuality was the same as today, but the motive was somewhat different, namely that they pledged as security already existing property in order to raise funds for expansion of their business. Having pooled their physical assets they securitised them and sold bonds to individual and institutional investors. But nothing succeeds like success, so very soon groups formed for the purpose of raising funds in the same way for housing. The result was that very soon mortgage societies formed all over. But these societies tended to form around purposes of the loans rather than around a common bond between the members. Thus, people seeking loans for commercial buildings joined a different society than those wanting to acquire houses. Societies eventually formed around such diverse objects as farms, ships, industrial plants, etc.
Several factors were responsible for the rapid growth of these societies. There was a high degree of trust in the initiators of the early societies, the economy was growing without inflation and the bonds which were issued in small denominations carried a competitive rate of interest to attract small investors. The interest differential was set at a level where reserve funds could be created as an added attraction for institutional investors. Moreover, a lottery was introduced so that by regular draws certain bonds were redeemed prematurely at a premium. This feature appealed to many individuals and carried no negative effect on borrowers because it did not affect their regular repayments.
As the movement continued to spread and it assets grew by leaps and bounds, the confidence in this type of housing finance prevailed to the point that it now caters to all but a small fraction of property finance in Denmark. The situation is similar in the other Scandinavian countries, albeit with small variations. The mortgage society bonds are held by individuals, insurance companies, pension funds and other institutional investors plus commercial banks. The Central Bank is the prime operator in this market in order to regulate money supply and control the interest rate.
Computerised administration of the system is now highly efficient and cost effective. For instance, it takes but a week to process a loan, and - just as significantly - the interest rate differential has been reduced to less than one percent. This means e.g. that the mortgage societies are cheaper to borrow from than commercial banks and Building Societies. A more recent cost-saving feature of the system is that the bonds no longer exist in a physical form. They have become numbers in a computer and neither the institutions nor the coupon cutters need to handle bulky documents. Interest payments (quarterly) are automatically transferred to the investors bank account just as borrowers accounts are automatically debited for the repayments.
Backing up the administrative system is a set of clear-cut legislation and directives which eliminates a lot of litigation and makes repossessions very fast. After falling into arrears of three months, notices are sent out. If the property is not sold within another month it will be auctioned by the courts. Likewise, the transfer of loans at the time of sale to a new owner is automatic and at no extra cost. There is no age limit on borrowers: The house is the security. And because of the large reserves, no collective security claims have been raised even in times of depression.
The fact that loans are securitised means that interest rates are fixed at the time of taking up the loan. This is a popular feature among borrowers and investors alike. There is also a choice between fixed annuity and simple loans just as graduated repayments is an option through (consumer price) index loans. Bonds are traded every day on the stock exchange and they are liquid to the point where most banks will buy and sell them over the counter at spot prices. This facility has made these bonds attractive to foreign investors as well. The larger the market the more funds can be mobilised. This is the stage many community-based finance institutions have an ambition to reach in order to make a real impact on the housing situation in their countries.
The Danish system has not been without its problems. As societies proliferated they began to compete with each other for members. Being small they were not cost effective, so a period of consolidation and mergers brought a concentration into 4-5 large amalgamation with a loss of democracy as a consequence. In fact some of them are now organised as companies. In their quest for more members many societies did not ask loan applicants about their income (after all, the house was the security, repossession was simple and costs were recovered). This worked well in times of expansion and inflation, but it brought too many personal tragedies during recessions. More recently, during relatively high inflation, some societies were over-generous with their evaluation of properties to be financed. This lead to severe losses when inflation ceased and most properties actually fell in price. Still, the system has flourished helped along by favourable tax concessions, particularly in the case of co-operative housing societies of which there are many in Denmark. In contrast to many groups with similar names in other countries which build houses for members to own, the Danish Cooperative Housing Societies own the houses they build and members are tenants.
In conclusion, suffice it to point out that the Danish system has evolved over a very long time. But because it started on a solid basis and built up large reserves, its credit-worthiness was recognised by institutional investors including commercial banks and the central bank, so much so that large foreign investors now also buy Danish mortgage bonds. Two of the major institutions have established branches in other European countries. DANIDA, the Danish International Development Agency, entertain applications for free expertise on cooperative finance at all levels of the operation - from training in community participation to cooperative banks and national apex organisations.