IT was only in 1990, at the initiative of the USAID that some practical steps were taken.Tt was then realised that market-oriented housing industry had great potential to serve as an engine of growth for the economy as it provides direct and indirect investment in 40 to 60 industries and the employment opportunities only second to the agriculture sector.

A legal framework was therefore issued by the government which approved the establishment of seven house finance commissions (HFCs) in 1991. Loaning operations started by one company in December 1992 and by the other in 1993. Today only one company is in the field and that too is going to merge with a commercial bank shortly. The reasons for this failure are manifold and inter alia relate to lack of capital with the sponsors, difficulties in resources mobilization, absence of a secondary market, high defective land titling and transfer costs, legal problems in recovery of loans, and above all lack of government support for the sector and a host of other factors.

The present government and the State Bank of Pakistan (SBP) have shown some concern to expand mortgage finance. Commercial banks were allowed to float long term bonds to mobilise fund for housing to match assets with liabilities. The upper limit for mortgage financing was raised ten times. New recovery law allows bank to take possession of the mortgaged property without recourse to courts. Deduction of mortgage interest from taxable income was raised to Rs100,000 for commercial banks and for the HBFC in public sector and not for the HFCs in the private sector.

The measures had limited response because of the myth of high risk in housing sector and attractive profitability of other sectors,particularly trading. Notwithstanding these policy measures disbursement by HFCs declined from Rs858.7 million in FY01 to Rs460.2 million in FY02— partly because the HBFC in public sector stopped loaning operations due to rulings of Shariat Court and the Supreme Court. This article is primarily meant to discuss problems relating to resource mobilization so that market-oriented housing finance system does not collapse completely.

Resource mobilisation: HFCs are at a distinct disadvantage in relation to other NBFIs, commercial banks and the government in their competition for mobilization of resources. Market-oriented housing finance is only in its infancy and shall have to establish its credibility for attracting deposits and funds. If any thing there is an environment of distrust created by performance of cooperatives in general and housing cooperatives in particular. HFCs do not have any branching network to generate deposits, which could lower cost of funds and provide capital for lending. Commercial banks have much lower cost of funds. The government is the largest mobiliser of funds and offers six-month Treasury Bills almost at no risk at around 13 per cent and federal investment bonds between 13 to 15 per cent, The cost of funds for HFCs has been around 17 to 18 per cent. HFCs do not have access to Pass Book savings account. There is no bank of last resort to bail out HFCs from short-term liquidity problems. By the very nature of the industry there is an inherent mismatch of funds; lending for long term and borrowing short term. Even there is no access to inter-bank borrowing and foreign exchange deposits. It is almost impossible for HFCs to structure debt instruments that can be underwritten, and traded in capital market. They have no capacity to issue mortgage-backed securities or bond instruments to raise capital. There is an urgent need to provide for long term liquidity needs through some type of discount or refinance window which would lower both the interest and liquidity risks and provide a greater level of matching funds at lower cost for long term lending at affordable rates.

With recent measures to bring down government’s budget deficit, liberalization of financial sector, greater autonomy of the SBP, planned close monitoring by them under Prudential Regulations, expected consistent monetary policy without interference from the government, and phased movement towards open market operations, essential steps have been “taken to create an enabling environment for development of capital markets.

It should be remembered that development of capital markets in general and its interfacing with housing finance sector in particular, is an evolutionary process and shall take time. However, to stabilise the financial system and provide basis for functioning and improvement of capital markets to assist the development of housing finance industry and meet its liquidity requirements, following action programme needs immediate consideration:

i) Refinance window/apex bank: To meet liquidity requirements of HFCs and establish secondary mortgage market, a refinance window at the SBP with the assistance of financial support of USAID of $15 million was supposed to start functioning in 1994. The amount was provided at an interest rate of about 8 per cent for 30 years with a grace period of 10 years. It was the cheapest loan going. This has not seen the light of the day so far due to institutional and legal problems faced by ministry of finance and the SBP— in fact due to lack of priority assigned to it by the government and now when the discount rate has been reduced to 7-1/2 per cent, the government should immediately take up with the USAID to reduce the interest rate so that it can be advanced to HFCs at single digit rate i.e. under 10 per cent as is the case with the Agriculture Development Bank or as provided to the export sector and recommended by USAID. It should be made clear that no subsidy is intended.

Fluctuating interest rates are quite popular in granting housing finance. This window is expected to provide an interim arrangement until such time that an apex institution is established. In addition to the funds provided by USAID mortgages of about Rs10 billion are available with HBFC. At least 30 per cent could be utilised at the first stage as they have been audited by the World Bank.

HFCs, by their very nature of operations, are exposed to mismatching of funds-borrowing short term and lending long term. This generates both liquidity and interest rate risks. Refinance window initially and the apex bank later would reduce these risks by providing longer-term capital to match maturities and also reduce interest risks. The apex bank shall take over on the basis of experience gained by operating refinance window. Its function will be both in the field of resource mobilisation, meeting short and long tern requirements of funds and performing supervisory and regulatory function. It shall mobilise and manage resources from both public and private sectors at home and abroad, design and issue various capital market instruments, such as house bonds, commercial paper, mortgage backed securities, design home-linked savings and other deposit schemes.

It shall lay down standard loan document and procedures for loan documentation and standard underwriting rules for refinance. It shall serve as a discount facility for short tern liquidity needs - bank of last resort. It shall also perform supervisory function-regulatory function being undertaken by the State Bank-to ensure efficient and effective operation and keep liaison of the industry with the government.

Entry of a commercial bank: Commercial banks both in developed and developing countries have played a pioneering role in providing housing finance and encourage savings. Housing finance was never taken seriously by commercial banks which were engaged in traditional and typical core banking activities such as loans and advances against imports, exports and working capital on short-term basis only. Reasons for commercial banks not venturing into housing finance have been: Prudential Regulations limited the ceiling on housing finance to 1 per cent of total advances (State Bank has recently allowed the Banks to extend housing finance upto Rs5 million or 5 per cent of the total advances); property documentation is complicated and cumbersome; recovery laws are not effective and efficient. Foreign banks were hard hit by the freeze of US Dollar account in May 1998. It is hoped that with the initiative taken by the State Bank of Pakistan in holding a seminar on housing finance on 11-12 December 2002. The roadblocks in their entry in the housing finance sector shall be removed and their mindset shall become friendly.

Saving deposits: A number of savings deposits schemes for housing finance companies have been designed in almost all countries which have a market-oriented housing finance system. They may be home-linked or just individual deposit schemes. The schemes have been a great source of resource mobilisation and have resulted in a net increase in domestic savings. The main factors which have been instrumental in the success, of deposit mobilisation in India are the incentives provided in the form of exempting the interest income from payment of income tax deposits of certain limit, exemption from payment of wealth tax and other taxes.

It is therefore imperative that deposits kept with HFCs for more than a year or profits earned on deposits with HFCs upto a certain limit may be exempted not only from payment of profits but also from mandatory deduction of Zakat and turnover tax,and withholding tax. The least that can be done, is to treat the income on saving deposits at par with the income on government-sponsored savings schemes.

It therefore, seams necessary that HFCs should be allowed to mobilize foreign currency so that they are able to mobilize large amounts of foreign currency deposits from Pakistanis living abroad for housing which will not only improve the foreign exchange reserve position of the country but will help in diverting non-residents savings from consumption to asset building.

Pension, provident and insurance funds: These funds presently are not allowed to operate in the equities market. If the capital market is to be provided both depth and liquidity, it will be necessary to develop legal, procedural and institutional framework for flow of these funds, in the capital market. Insurance funds have played a very important role in the development of housing finance system world over. Not only the insurance funds have been invested in the securitization of mortgages, insurance companies have found it profitable to set up their housing finance subsidiaries. Insurance companies have played a crucial role in providing attractive packages for deposit insurance; for life insurance of borrowers; insurance of mortgage payments etc, which have facilitated the emergence of secondary market in mortgages.

Mortgage insurance: Mortgage insurance, particularly government-sponsored mortgage insurance can be greatly instrumental as a means of promoting financial integration. Institutions and private investors unfamiliar with or scared with mortgages or mortgage-backed securities may find it attractive to enter this field if the mortgages and/or securities carry government insurance against default risk.

Stock market: Stock market is a key player in providing depth to, and expanding the base of, capital markets. The basic requirements of good trading system for servicing customers are information, transparency, liquidity, efficiency and reliability. The retail customer lacks information. The problem is not only of poor disclosure, insider trading, manipulation and other malpractices but also of poor infrastructure to service the customers. System lacks the facility of computerisation, registration of complaints and settlement of disputes. This urgently needs changes in settlement procedures to enable the market to function smoothly. There is also need for an organisation to deal with legal issues of securities. An institution somewhat on the lines of Securities and Exchange Commission of the USA may be required, which may work as an apex institution for regulating the securities markets.

Conclusion: The above measures should facilitate development of a secondary capital market, which shall provide the necessary liquidity rather than the limited SBP’s discount/repo window. Secondary mortgage market is a fundamental vehicle for financial integration of housing finance system in the overall financial system. In the Initial stages, the secondary market process is focused around institutional wholesale investors. In the secondary stage, mortgages are marketed through the capital market with a two-way quotation being offered for the purchase and sale of securities.

This function is more cogeneric to money ‘market players and activities of investment banks. The rapid integration of HFCs with the banking sector shall be possible with close cooperation of these institutions. In India this trend is illustrated by close cooperation between the infrastructure leasing and Financial Services Limited (FIL) and the Housing Development Finance Corporation (HDFC) and among HDFC and National Housing Bank (NHB) and ILF&S in promoting real estate mutual fund. Malaysia provides an excellent example of a developed secondary market and close cooperation of borrowers, lenders (financial institutions) and government agencies.