1. 1 BNA HOUSING FINANCE WORKSHOP 4 Nov 2005 DEVELOPING HOUSING FINANCE: BUILDING BLOCKS, CHALLENGES & POLICY OPTIONS World Bank Olivier Hassler ohassler@worldbank.org

2. 2 Presentation Overview  The need for housing finance  The building blocks of a system  Selected challenges and policy options

3. 3 The Need for Housing Finance  Urbanization : ●A strong trend – the urban population rate is still low in Africa (37%) ● Requires huge investments ●“Cities are built the way they are financed”  Building an asset = wealth ladder  Promotion of housing supply  Alleviation of government finance burden  Synergies with the development of financial market: ●Long term income source for intermediaries ●Diversification of investment opportunities

4. 4 Housing Finance is difficult to develop  Long maturities: Housing Finance makes a large investment affordable by spreading its cost over a long period of time  Necessity of efficient collateralization: a condition of long term lending, but also of a wide access to finance  Neither characteristics are easy to achieve in a nascent market

5. 5 A Nascent Market in Most Sub-Saharan Africa

6. 6 THE BUILDING BLOCKS 1.MACROECONOMIC CONDITIONS 2.PROPERTY RIGHTS 3.PROPERTY MARKET 4.MORTGAGE MARKET INFRASTRUCTURE 5.FUNDING

7. 7 Building Block 1 : Macro-economic Stability  Long term finance requires confidence in the value of money  High interest rates make finance unaffordable  Unemployment and volatile interest rates create credit risk  Angola on the right track

8. 8 Building Block 2 : Legal Framework of Property Rights  Sound and conducive property rights regime requires: ●Clear individual right to sell and pledge land ●Clear procedures to regularize informal tenure, including litigation resolution  In addition, specific legal schemes are necessary:  Property subdivision, & condominium law  Developer finance A strong impact on the supply of new housing

9. 9 Building Block 3 : Property Market  An efficient housing supply chain Frequent obstacles: ●Release of land, especially by government ●Infrastructure (sewages, roads, water &electricity transportation..) lack of proper municipal services, cost often incorporated in new units prices ●Construction bottlenecks ( weak construction industry, high import content) ●A synthetic indicator of supply constraints: Price-to- Income Ratio (PIR) If PIR > 5 = housing little affordable  A minimal number of property transactions Otherwise, property pledging of little use

10. 10 Building Block 4 : Mortgage market infrastructure (I)  Title and collateral registration systems ●Objectives : enforcing rights, encouraging formal tenure, checking chain of titles, fighting corruption ●Characteristics:  Validity of inputs  Security of information  Consistency of data bases ( properties, persons, transfers)  Adequate cost – not to encourage informalities or restrict transactions  Foreclosure process ● Objective: ensuring lenders’ security ●If judicial procedure, must be expedient ●If courts clogged or ill-prepared: out-of-court process (numerous ex. in Africa: Ghana, Ethiopia, Rwanda) ●Adequate Balance of rights/power Potential best practice: Chile, Recovery Officers in India

11. 11 Building Block 4 : Mortgage market infrastructure (II)  Risk assessment & management tools ●Borrower :  Credit information  Income verification / Proxy for informal sector borrowers ●Property: Need of credible appraisal capacities  Adequate Payment System (numerous little payments) Angola in the process of completing equipment Payroll deduction can help in both cases

12. 12 Building Block 5 : Funding (I) Bank Deposits  In most countries, housing finance is largely funded by deposits (although sight or very short term ) 70% in Europe, even 50% in he US. Rare exceptions: Chile, Denmark  To do so implies an ability to manage financial risks ●Reasonably stable deposit bases See Latin America- Importance of : political stability, currency stability, banking sector soundness ●No fixed interest rates unless hedging available ●Liquidity management tools (asset pledging, repos,…) Critical role for the Central Bank to play ●Access to capital market when needed

13. 13 Building Block 5 : Funding (II) Decentralized Capital Market instruments  Mortgages appropriate to back long term secured financial instruments ●Securitization- Huge market in the USA, growing in Europe., Recent take off in Latin America, Asia, RSA  Benefits: bankruptcy remoteness, transfer of financial risk, possible reduction of capital requirement  Challenges: transfer of credit risk (credit enhancement), pricing ●Mortgage bonds- Strong in continental Europe, well known in some LA countries, new in UK/NL  Benefits: two level of security (general debt obligation + collateral), prone to liquidity (simple pricing and trading)  Challenge: only partial transfer of financial risk

14. 14 Building Block 5 : Funding (III) Centralized institutional options  Second tier liquidity facility Pool small funding requirements, enhance lenders' credit, help manage liquidity Ex.: Malaysia (Cagamas), Jordan (JMRC), Algeria (SRH),RSA (NHFC). Projects in Egypt, WAEMU  State lending: a generally inefficient solution ● Direct: Generally ends up being very costly and inefficient (Chile, Brazil, Venezuela..): low recovery & moral hazard consume budgets ● Indirect : Better credit risk management, but still limited capacity Better is to use public finance for direct, explicit subsidies and seek leverage of private resources

15. 15 Selected Challenges and options 1.Property rights 2.Inflation 3.Individual Savings mobilization 4.Channeling institutional savings 5.Market strategies and access to HF 6.Housing assistance policy 7.Development strategy

16. 16 Issue : Property rights  Legal insecurity of property rights in urban expansion areas is a common and acute problem in Africa For anti-speculative purposes, conditionalities are often set that limit ownership rights on previously informal, or government owned land. Examples : ●Delivery of title withheld until near building completion ●Short term or withdrawable lease hold rights subject to compliance with land use regulation ●Temporary Certificates of Occupancy ●Unclear leases renewal conditions These uncertainties affect transferability and the capacity to raise funds. Fighting land price inflation must take other routes

17. 17 Issue: Inflation  May hinder long term investment, or make it unaffordable through a high risk premium  Indexation can be an answer, but raises difficult issues ●CPI indexation can make borrowers insolvent if wages do not follow (Ghana) ●Protecting borrowers can make lenders insolvent (if bear the discrepancy CPI/wages)  Basic conditions for successful indexation: ●Inflation within certain limits (Chile) ●Need of objective and well accepted index

18. 18 Issue: Individual Savings Mobilization (I) Domestic savings often scarce, or outside banks A counterproductive option: compulsory savings funds –Numerous experiences in Latin America (Mexico Infonavit, Venezuela Fundo Mutual Habitacional, Jamaica..), In Asia (Philippines Pag-IBIG, Malaysia, China) also in Africa (Nigeria National Housing Trust Fund) –Numerous shortcomings: Implicit taxation of individual savings Non-transparent management of borrowers' waiting lines or even of funds Below-market return  self depletion Exclusion of informal sector –Similar negative results with directed allocation of Social Security Fund

19. 19 Issue: Individual Savings Mobilization (II) Better options: –Voluntary Contractual Savings for Housing Schemes: Compatible with the market development Can include informal sector borrowers Ex. Rwandan Banques Populaires : Phase I savings amounts = phase II mortgage payments Market rates Inducement to build downpayment, not a commitment to lend –Grass root networks : credit unions, savings groups, can be mobilized to build up downpayment –If subsidies, prior savings important as an eligibility criteria –Careful mobilization of expatriates savings - may distort housing prices

20. 20 Issue: Channeling institutional savings towards investment needs  “Reverse term transformation”: a common phenomenon in Africa Some institutional savings exists, but stays in deposits (besides T. or Central Bank Bills and Real Estate) due to underdeveloped capital market  Option: Introduce “pre-capital market” financial instruments to bridge long term savings and investment. Examples: ●collateralized, tradable promissory notes (FR) ●Transferable mortgage loans (Chile) ●Sale of mortgage portfolios (Mali)

21. 21 Issue: Financial Institutions Willingness to lend  The lack of long term funding can be perceived as an absolute deterrent Possible option: Central liquidity facility. ●Experiences of catalytic impact: Malaysia, Jordan ●Can be funded by WB or other IFIs (Paraguay, Tanzania)  Specific obstacles to serving moderate income groups ●Credit risk  Default insurance? Ex.: Mali, RSA (HLGC). Adequacy to market needs is key, several failed attempts ●Commercial strategy  Promote lending by alternative FIs  Often have a wider outreach than banks (Rwanda Banques Populaires, Mali Nyesigiso)  May require a “plug” to external funding source and credit enhancement ( Ex: Mex SHF for SOFOLES, IFI support)

22. 22 A costly temptation: State Housing Banks  Many governments, especially in Africa, seek to overcome market failures by creating a state- controlled retail lender  This route is not recommended: ●Generally an obstacle to the global l housing finance supply because of their privileges ●A factor of mis-allocation of subsidized resources and poor recovery performance because of governance problems ●They mostly end up insolvent, and often are bailed out at a high cost for tax payers. Ex.: Pakistan, Bangladesh, Indonesia, Argentina, Brazil, Colombia, Uruguay, Algeria Ivory Coast, Tanzania, Rwanda, Niger

23. 23 Issue: Social Housing Policy  A Housing Policy is necessary : ●Explicit social objectives ●Measure of opportunity costs ●Consistency of actions  Conditions for an efficient assistance policy ●Avoid interest rate subsidies (affect the supply of finance) ●Avoid subsidizing institutions (high risk of capture by the entity) ●Promote leverage by private resources (avoid direct lending)  Incentive for more savings  Combination with lending – for bankable households- = multiplier effect  Subsidies via guarantee schemes: link accessing favorable funding conditions with serving low-income groups (US FHA, RSA HLGC, Mexico SHF) ●Precise targeting, transparent eligibility and priority criteria

24. 24 Development Strategy A favorable macro economic background can spark the growth of the market Recent examples: Algeria, Pakistan (bank liquidity, fall of interest rates) Develop building blocks early in the process - but not all the components have to be in place before take-off Carry out catalytic actions and support “ market makers”, often necessary Examples: Specialized lenders (India: HDFC, Mexico: SOFOLES, Bangladesh), Second tier institutions (Jordan: JMRC) Develop first a large enough, well tested primary mortgage market before organizing a secondary market World Bank can support GoA and the Central Bank in creating market foundations, designing a roadmap, building capacities and initiating catalytic actions