Strategies to develop mortgage markets in transition economies

Strategies to develop mortgage markets in transition economies

Published Jan 1996

Authors

Dwight M. Jaffee, Bertrand Renaud

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Factors that hinder the development of mortgage markets in transition economies and a proposed strategy to expedite their development. The transformation of the planned economies of central and eastern Europe to market economies has focused on economic stabilization and liberalization, privatization, and financial sector development. The housing sector and its financial dimension, the mortgage market, have been factors in each of these processes but not always positive ones.

Jaffee and analyze the factors that hinder the development of mortgage markets in these transition economies and propose a strategy to expedite that development.

They show that banks in transition economies are reluctant to make mortgage loans because of the risks in mortgage lending (credit, interest rate, and liquidity risk). Together with the required improvements in the primary market, a secondary mortgage market is likely to help solve this problem. A secondary mortgage market separates the act of making mortgage loans (which can still be carried out by banks)from the act of holding mortgage loans (which can be carried out more effectively by capital market investors).

Given the importance of real estate's share of a country's tangible capital, and the potential for real estate collateral to secure large amounts of secured debt, the housing finance system should become an engine of innovation for the rest of the financial sector. Moreover, if the housing finance system is stunted, other non market devices will develop for financing and subsidizing the housing sector - creating negative externalities for the rest of the system.

But a market based housing finance system is unlikely to emerge without initial government support, which the developed economies required. Moreover, the transition economies face a hurdle the developed economies did not face: they must first create an economic and legal infrastructure to support the long term and complex market relationships and contracts that constitute a housing financial system.

This paper - a product of the Financial Sector Development Department - is part of a larger effort in the department to strengthen financial development in transition economies. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Rozzy Garner, room G8010, telephone 2024737670, fax 2025223198, Internet address lgarner@worldbank.org. (29 pages)

The full report is available on the World Bank FTP server

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