• Private sector development and banking

Private sector development and banking

This study discusses some of the recent key characteristics of the US subprime mortgage boom and bust. It contrasts them with characteristics of emerging mortgage markets and makes several policy recommendations for emerging market economies. The paper reveals further that crisis has raised questions in the minds of many as to the wisdom of extending mortgage lending to low and moderate income households. It is important to note, however, that prior to the growth of subprime lending in the 1990s, US mortgage markets already reached low and moderate-income households without taking large risks or suffering large losses.

In contrast, in most emerging market economies, mortgage finance is considered as a luxury good, restricted to upper income households. As policy makers in emerging markets seek to move lenders down market, they should adopt policies that include a variety of financing methods and should allow for rental or purchase as a function of the financial capacity of the household. Securitisation remains a useful tool when developed in the context of well-aligned incentives and oversight. It is possible to extend mortgage lending down market without repeating the mistakes of the subprime boom and bust.

Specifically the paper underscores that, there has been no more subprime mortgage lending in emerging market economies than in advanced economies. Instead, mortgage lending is typically made on conservative terms to middle and upper income households employed in the formal sector:

• most emerging market households handle their economic lives in cash, lack bank  accounts, and few have access to credit
• bank branches are concentrated in wealthier urban areas and their products are targeted at upper income earners
• consumer finance markets are relatively small in emerging markets and tend to carry less debt than do their developed country counterparts
• given the overall lack of access to credit, and the relatively high cost of registering and enforcing a mortgage related legal claim, emerging market banks have been slow to move down market with mortgages
• mortgage credit in emerging markets carries relatively short maturities
• since the macroeconomic crises of the late 1990s, low interest rates, low inflation, and financial sector reforms have caused mortgage default rates to fall dramatically
• many emerging mortgage markets lack long term funding tools such as covered bonds and securitisation that permit lenders to extend the maturity of their loans
  

To address subprime crises, the author recommends as follows:

• housing policies for low and moderate income groups should not be excessively  weighted towards owner-occupied solutions. Households with low and uncertain  incomes may be better off renting than owning housing that meets standards for health and safety. If subsidies are provided, they should be available for either ownership or rental, and in either case for new or used units
  

• there should be balanced protections in law for mortgage lenders and borrowers, and for rental landlords and tenants

• emerging markets should increase access to housing finance for moderate and low income households while maintaining strong standards for credit risk management

• governments can reduce the cost of housing by increasing efficiency in land markets

• banks may increase the supply and maturity of mortgages by financing themselves with covered bonds or by securitising portfolios. They may extend credit to lower income households by employing more labor-intensive microfinance management methods
  

• emerging market lenders can extend credit to moderate income households using alternative documentation methods and credit scoring technology while maintaining strong credit underwriting standards

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