Residential Mortgage Finance and Housing Markets in Russia February 9, 2004 Britt Gwinner The World Bank 1
Overview of Presentation Two Sections: 1. Residential Mortgage Finance Internationally 2. Mortgage Finance in Russia 2
1. Residential Mortgage Finance Internationally 3
What Does Housing Finance Provide in Other Countries?! Access to high quality housing for moderate income families! Safe, long term assets for banks and investors! A stable source of financing for developers! Jobs in finance, construction, and maintenance! An important source of savings and wealth creation 4
Housing Finance Depth 39% of EU GDP v. 0.1% Russia Denm ark Netherlands UK Germany Sw eden Portugal Norw ay EU-15 Ireland Spain Finland Belgium France Greece Italy 12% 10% 19% 70% 66% 59% 54% 50% 47% 45% 39% 33% 32% 29% 27% European figures for 2001. Source: Renaud, 2003 5
Housing Finance and Economic Development " Strategies to develop mortgage finance systems are an integral part of developing the financial sector " The core functions of mortgage finance systems are universal. System expansion depends on lowering the costs of these core functions. " There is no universally applicable model of a mortgage finance system. Source: Renaud, 2003 6
What Does it Take to Develop Housing Finance?! Macroeconomic stability is a prerequisite. Macroeconomic volatility affects disproportionately all forms of long-term finance, of which mortgage finance is the most important.! Finance is a derivative of the real sector. How do local housing markets operate:! What is the share of informal or extra-legal housing supply?! Share of rental versus owned housing supply?! How affordable is housing? What is the price-to-income ratio level?! What is the total cost of mortgage borrowing: loan rate + transaction taxes and fees?! What is the structure of subsidies and what are their main channels?! High transaction taxes and fees can suppress mortgage demand! Small financial systems are very common in emerging economies. Unfortunately, in finance small is seldom efficient. Source: Renaud, 2003 7
2. Mortgage Finance in Russia 8
Weak Primary Housing Markets Fail to Deliver Enough Apartments! Homeowners do not pay for maintenance - Soviet- era administrative and legal structures reduce the value of apartments! Risky, inefficient share financing funds construction - a major business for banks in other countries! Difficult and expensive to obtain land, sell or buy properties, or register title changes reduces value of apartments! For banks to offer mortgages, borrowers must risk losing their property if they default -- # Re-housing requirement, residential registration obstructs execution of mortgage pledge 9
A Fragmented Financing System State Pension Fund Private Pension Funds No links yet Insurance Companies Taxes Public Regional Agencies Mortgages Mortgages Cash Federal Agency Cash Bonds Some Savings Banks Home Buyers Mortgages 10
Savings Are Not Mobilized Effectively! Limited funding cycle - most savings remain in cash, outside of banks! Lenders are funded by: # External funds (e.g., Raffeisenbank,, Delta Credit) # Taxes (regional agencies) # A Few Deposits (e.g., Sberbank, Vneshtorgbank) 11
Lenders Lack Funding Instruments! Mortgages with terms of twenty years need similar term funding to avoid mismatch risk! Mortgage bonds permit banks to match fund, retain mortgages on balance sheet! Securitization permits sale of risk, specialization as originators & servicers! Banks should be able to choose mortgage bonds or securitization based on financial risk, market pricing, and strategic decisions, not on the basis of gaps in regulatory framework 12
No Links to Institutional Investors! Pension funds, insurers need long-lived lived assets as they grow, will have the resources to support the mortgage finance market! Regional mortgage agencies are funded with taxes and by sales of mortgages to Federal Agency but resources limited! Need to implement recent mortgage securities law -- mortgage bonds or MBS for investors! Rating agencies should play an important part in transparency 13
Currency Risk! Mortgage lending needs to be in Rubles to reach broadly into moderate income households! Much bank lending has been in U.S. Dollars, but most borrowers earn Rubles # Burdens borrowers with currency risk, # Raises credit risk of lenders should the Ruble devalue 14
Risk is Not Allocated Efficiently! Risk is not currently priced well or shared effectively among borrowers, banks, regional & Federal governments # Borrowers need to know their home is at risk if they default; # Banks need to price mismatch and credit risks, hold capital against them or sell them # Investors need to earn an adequate rate of return, intermediaries need to be paid for risks and costs 15
Requirements for Sustainability! To deliver adequate housing for the long term, the financing system must: # Compensate investors and lenders for risk, # Compensate each business process, # Mobilize savings, # Reward effective risk management 16
Alternative Structures for Risk Sharing! Regional agencies could take a limited credit risk position, pay banks to originate loans, banks would also bear a portion of credit risk.! The Federal Government, together with private insurers, could offer credit risk insurance on a portion of each loan.! The government and private sector could offer credit enhancements for bank-issued mortgage bonds or MBS # Better leverage of government guarantees, # A motivation for large banks to lend. 17
Subsidies Need to be Targeted, Efficient, and Transparent! Subsidizing interest rates for borrowers hinders the development of financial markets! Subsidizing interest rates for savers tends to allocate subsidies to the wealthy! Any tax breaks for mortgage borrowers should be targeted and limited! Targeted, up-front subsidies for qualified families can contribute to the growth of the housing system and wealth-building for targeted populations 18
Level Regulatory Playing Field! Regulate according to the risk taken! Reporting requirements should be detailed and thorough for lenders and investors! Public and private sector lenders should be subject to the same safety and soundness rules - similar regulatory regime for similar risks taken! Consumer disclosures must clearly describe the financial and legal obligations of the mortgage 19
Conclusions! The housing needs of Russia are acute! Mortgage finance can help, if incentives and policy structures support markets! Government involvement must support markets, be limited, and be carefully targeted, if it is to lead to a sustainable supply of housing! At this conference, we will discuss feasible solutions for Russia 20