A fresh strategy is being developed by the State Bank of Pakistan (SBP) to divert long-term domestic savings flowing into the National Saving Scheme (NSS) to proposed privately managed pension funds to finance housing development.

And a task force set up by the Security Exchange Commission of Pakistan (SECP) is busy giving final touches to its recommendations for pension scheme for the private sector. Officials expect that the rules for pensions funds would be announced by the end of this year.

The total stocks of NSS certificates of different maturities are worth about one trillion rupees that includes national prize bonds. The long-term investment in the Defence Saving Certificates was recently estimated at about 40 per cent.

Dr Ishrat Husain, governor, SBP, has also advised the finance ministry to allocate the long-term funds mobilized under the NSS in excess of budgetary requirements to the commercial banks for housing finance. Besides,Finance Minister Shaukat Aziz wants the Central Directorate of National Savings (CDNS) to consider floating a mutual fund.

A number of options may be available but pension fund is seen as the most appropriate vehicle for mortgage financing.

Official economists point out that the pension fund match in the nature of security, supply and demand for mortgage loans. The risk and return parameters of loans are set in such a way that the two match.

The pension funds are much more a moral and legal issue than bank deposits. Life savings put in pension funds must cover safe investment or are those with very low risk.These funds have therefore to be put in very low and safe long-term investments whose returns are not generally open to interest rate risks. The benefits are defined that reduce uncertainty over the long term. Mortgage related asset class is viewed as stable avenue for investment in pension funds.

The nature of operations of the pension funds and their investment is such that the concerned organizations would neither engage in lending operations nor would have the expertise or the network to do so. Initially, it is proposed that the banks can float bonds which could be purchased by pension fund managers.

The SBP has already allowed commercial banks to float long- term mortgage bonds to match their mortgage assets. This can be done as soon as the commercial banks feel the need for long-term funds. In developed markets, corporate bonds are annually rated by credit rating agencies. With corporate bond market not yet developed, the fund managers would initially have very few choices.

The banks have also been permitted to develop pools of mortgage-backed securities which can be traded in the market and off-loaded from their balance-sheet. This will only happen when the primary mortgage market gains momentum and acquires a critical mass. The mortgage loan transfers to pension funds and insurance industry in developed market through securitization has also become a controversial issue because such transactions lack transparency and the non-bank financial institutions lack the expertise to assess any package of loan risks.

For a retiring person, the key issue is whether the pension would be pre-determined or depend on the profit and loss on investment made from his contribution.

Finance Minister Shaukat Aziz wants mutual funds “to look at the options like defined benefits which will ensure a pre-determined pension to a retiring person or defined contribution scheme which will deliver the benefits depending on the profitability of investment.” Corporates rule out pre-determined pension in a volatile financial environment.

Under the defined contribution scheme, an individual parks his contribution in the Fund and shares the end-benefit in proportion to his contribution. If he leaves his job, the new employer sends his contribution to the Fund. Since the 1980s, many corporations in the United States have shifted from traditional defined-benefit plans to defined contribution plans to cap the company’s liability and shift the risk to workers and retirees, writes Robert Kuttner of Businessweek.

Given the present corporate culture, the contribution scheme may not turn out to be an attractive proposition for prospective pensioners. Banks deny depositors a fair return which is below the rate of inflation. Despite cut in excise duty by 25 per cent to lessen the cost of construction, the cement cartel has raised prices. As demand picked up, the steel mills followed suit. A jobless rebound of the economy is eroding into the incomes of the middle incomes groups, whom the mortgage finance scheme is intended to serve. In such circumstances, the mortgage loans may not be affordable for anyone except the upper bracket income group. The continuous stream of repayment of mortgage loans can not be guaranteed by joblessness or growing poverty.

Policy makers have taken a number of measures to encourage commercial banks to finance housing and build up a portfolio of mortgage loans. Banks’ exposure to house financing has been enhanced to 10 per cent of their net advances, the maximum per party limit has been increased to Rs7.5 million with debt equity ratio of 80:20 for a period extending upto 20 years.

Similarly, tax credit on borrowing cost has been enhanced to Rs0.5 million or 40 per cent of the income of the mortgagor, the limit of property income for withholding tax has been reduced to 5 per cent, profit or interest on mortgage of property or other capital charge have been made tax deductible.

Mortgage loan recovery has been made easier by the foreclosure laws that allow the banks to repossess mortgaged properties without recourse to judicial processes, except for the courts’ assistance for repossession.

But the snags in housing development have yet to be removed by the provincial governments to increase availability of land with clear title. Dr Ishrat Husain is pressing the provinces to set up land banks to promote housing development.Areas could be earmarked for mini-townships. Similarly, the governor has advised the Sindh government to settle disputes relating to 250-300 buildings in the city of Karachi so that ownership of apartments could be given to the allottees. Penalties could be imposed and the land and construction should be regularized. The provincial governments, he says, must not sit tight on state lands or allow it to be taken up surreptitiously by land mafia for illegal encroachment.

An advisory group set up by the SBP is co-ordinating efforts of all stakeholders, banks, provincial governments, local governments and the ministry of finance.

While mounting official efforts to develop the capital market, asset management skills become all important. Once the investments of pension money was restricted in government securities which enjoyed triple AAA status because the government is sovereign and defaults takes place only in extremely extraordinary situation. Now, the pension fund are being invested by big corporations in corporate bonds and equities for which the company and not the individual is responsible. In privately-managed pension funds, individuals are exposed to risks, often incalculable in volatile financial markets. Risks to pension funds have to be minimized by proper safeguards.

If pension funds and mortgage finance can be matched to provide a fair return/benefit to the middle income groups, the potential for investment in housing is immense. In rich, countries, the investment in housing is estimated at twice as much as in stocks.