Luxembourg economic survey 2022

OECD: more monitoring needed as financial risks rise

Rapidly rising housing prices constitute a risk for Luxembourg’s financial sector, according to the OECD, an international policy forum. Photo: Matic Zorman / Masion Moderne

Rapidly rising housing prices constitute a risk for Luxembourg’s financial sector, according to the OECD, an international policy forum. Photo: Matic Zorman / Masion Moderne

Housing prices and low interest rates could very well challenge Luxembourg’s financial sector, the yearly economic survey by the Organisation for Economic Cooperation and Development has warned.

The OECD report on Luxembourg’s economic state for 2022 was published on 17 November, analysing key policy insights and the grand duchy’s path to greener economic pastures. Among the issues highlighted, the report identified that financial sector risks are on the rise.

Housing prices, a persistent issue

Prices that have grown by 9.7% per year for the last five years--close to twice the EU average rate--that led to worse household affordability ratios, price-to-income ratios above long-term trends, access to home loans increasingly restricted for middle-and lower income households--“the risks to the financial sector from the housing market boom require continued monitoring,” says the OECD.

Adding to this the current permacrisis, the fact that a few Luxembourg banks hold up to 22% of their assets in mortgages--a risk for them if household prices go down in response to higher interest rates--and an increased vulnerability for certain borrowers, Luxembourg’s financial sector might see its resilience heavily tested.

The OECD in its report lauded some of the actions undertaken by authorities, like setting out a macroprudential framework for activating borrower-based measures, increasing the number of social rental accommodations and preparing a tax on unused constructible land in the grand duchy.

But, to increase Luxembourg’s economic resilience and to make housing more accessible to all, more macroprudential measures should be implemented, says the organisation. Social rental housing should also be increased, while maintaining social mixity, as should be taxation of non-used constructible land.

The report also highlights that the existing mortgage interest deduction should be phased out, and that housing aid schemes should match local reference rents, so that lower income households can live in the city centre. For these two issues, no action has been taken by the government yet.

Monitoring efforts need to continue

“As global monetary policy tightens, strains will increase,” warns the OECD. While the organisation in its report highlights that its previous recommendations had led to semi-annual system stress-tests and a positive response to shocks--like the mitigation of economic consequences of the covid-19 pandemic on residents and companies--“non-performing loans are likely to rise further in 2022 and beyond, given that the war implies a second shock in quick succession for vulnerable firms, not just in Luxembourg but in Europe as a whole.”

“More recently, the robust local economic recovery in the context of the low interest rates has contributed to accelerating inflation,” the OECD adds. “The lags in price setting could mean that inflation continues to increase even as economic activity slows in response to higher interest rates.” Should the euro area monetary policy stance not cover the grand duchy well enough, “more measures might need to be taken.”

High standards in fight against corruption

Much has been done to decrease instances of money laundering and corruption in Luxembourg, the OECD notes in its report. “Overall perceptions of corruption remain low in the country, with Luxembourg one of the best performers in the OECD,” the report states. While stronger rules to protect whistleblowers were implemented, the organisation says that the framework to govern conflicts of interest should expand its targets beyond government officials.

The OECD also recommends that Luxembourg push forward the deadline for compulsory compliance with the national identity numbers system, as well as make more use of digitalisation to identify risks related to investment funds.