South Asia Private and Financial Sector Bangladesh Housing Finance Seminar Ball Room, Hotel Sheraton January 28, 2008 Tatiana Nenova Senior Economist South Asia Private and Financial Sector World Bank

A growing mortgage market with great potential… Both banks and private non bank finance companies are scaling up their mortgage production. Credit conditions remain relatively expensive for the loans extended by private lenders (14-15% at 10-15 years) but reflect the changing macro situation / inflation. The timing for further reforms is appropriate as the production of accessible housing for a larger part of the urban population is a national priority by authorities

… with certain areas where improvement is possible Housing finance in the country is limited to the top income group. Titling is not fool-proof. Mortgage lenders have to rely on short-term funding for financing the loans they give out. The legal, regulatory, and taxation frameworks are not enabling primary and secondary housing finance market development.

An active housing finance system, with mortgages available to a wider population group at a lower cost, has important benefits: Is important to meeting urbanization and demographics challenges, and preventing slum proliferation. Provides key real economic benefits and positively impacts savings, investment, and household wealth. Catalyzes economic activity in other sectors, indirectly benefiting employment levels, the retirement system, fiscal returns, and consumption. Plays a role in boosting equitable economic growth and reducing poverty through helping households build assets, improving living conditions, as well as empowering the middle and lower income population and strengthening communities.

Looking ahead: policy options: HBFC Improved efficiency and effectiveness of HBFC. HBFC, the state-owned mortgage lender, is currently subsidized, not competitive, crowds out private sector mortgage lending (most notably in owner construction), and mis-targets subsidies to others than the lower income groups. It also suffers from improper procedures and systems, an inadequate credit underwriting and servicing policy, a high proportion of NPL loans, weak debt recovery practice. Suggested improvements involve overhauling its pricing and product mix, risk management, staffing, and corporate governance strategies, legal status, HBFC’s financial plan and its business plan, and identification of a viable recapitalization plan and optimal capital structure for HBFC.

Looking ahead: policy options: HBFC Improved efficiency and effectiveness of HBFC. HBFC, the state-owned mortgage lender, is currently subsidized, not competitive, crowds out private sector mortgage lending (most notably in owner construction), and mis-targets subsidies to others than the lower income groups. It also suffers from improper procedures and systems, an inadequate credit underwriting and servicing policy, a high proportion of NPL loans, weak debt recovery practice. Suggested improvements involve overhauling its operational efficiency, pricing and product mix, risk management, staffing, corporate governance strategies, legal status, as well as HBFC’s financial plan and its business plan.

Looking ahead: policy options - HBFC Operational efficiency. Computerization, quickening and streamlining of loan processing (2-3 days), re-thinking of branching distribution as well as collections outsourcing strategy. Pricing and product mix. Diversification away from the single type of mortgage currently offered which exposes HBFC to interest rate risk and into variable rate mortgages, revamping of credit underwriting policies to take into account the expected rental incomes from the financed housing investment, thus allowing the expansion of the portfolio beyond 1-2 urban centers, revisiting the range of allowable securities, including using personal income as a further security and thus lending at higher loan to value ratios. Risk management. Reducing credit risk by revamping debt recovery and servicing standards, and addressing any moral hazard behavior among borrowers towards such a state owned lender. Use of non-judicial collateral sale right?

HBFC, continued Staffing. Training and a revision of staff skill mix to enable staff to effectuate the changes as suggested in this presentation. Corporate governance. Isolating HBFC from any political/bureaucrating and other influence and skewed incentive risk, increased transparency and accountability and improved incentives and profitability. Legal status. Improvements at HBFC in operational efficiency and viability would be predicated upon a change in HBFC’s legal status. Funding and a new business plan. HBFC is in need of a viable strategy for financing, in view of its restructured product mix and taking into account the new performance targets. Access to long-term financing of some kind will be required (be in via a liquidity facility or HBFC/strategic partner bonds).

Looking ahead – Liquidity Facility / Housing Fund To provide longer term funding to mortgage lenders, especially those that have limited or no rights to issue deposits, a liquidity facility / housing funds could be introduced. The liquidity facility would refinance all eligible lenders (both banks and finance companies) that provide as collateral high quality mortgage loans. The facility would issue low-risk private bonds among institutional investors (a key success factor to keep the price attractive among lenders would be the eligibility of these bonds to SLR assets). This development would require considerable institutional building, initial debt support, as well as the separation of subsidies and finance. Subsidies to middle-higher income groups would be reduced, and those to most lower-middle and lower income groups will be needed only during the initial 5 years of the loan life as incomes nominally increase.

Looking ahead – other policy options Computerization and modernization of the titling registries, to decrease the existing 17 procedures (including, in the case of government-owned leased land, the need for the mortgage lender to obtain permission from the government to transfer usage rights to the new homeowner). As a result of the high fees, property values are considerably under-declared. The government is planning reforms in land registration, including a planned decrease of registration and transfer fees from the current levels to 5%, as well as a simplification of registration procedures to a one-stop shop under the management of Rajuk. Enabling rental markets helps lower income groups, especially in an environment of high prices and low housing affordability. Better understanding the driving forces and constraints of the rental market would permit the formulation of regulatory enabling strategies to encourage the market. Housing Savings Scheme (such as the Eastern European model)

Looking ahead – other policy options, continued Supporting developer activities, eliminating existing legislative and regulatory gaps (such as titling issues during construction), as well as correcting certain flaws of the current system (e.g. the transfer of construction risk to home buyers due to significant advance payments to developers prior to completion of the construction). Further work is needed to examine options to secure advances made by clients to developers, including the possibility to introduce either escrowing or insurance guarantee schemes in Bangladesh to protect advances and secure the completion of projects. Scaling up low cost housing provision by NHA, e.g. via via public-private partnerships with private developers where NHA will provide the land and require that some fraction of the flats constructed will be provided to low-income households. An alternative (and not mutually exclusive) strategy to scale up would involve cross-subsidies between the middle-income units pricing and the low-income ones, permitting NHA to increase its leverage and invest the additional funds in low-cost housing construction, servicing the loans in part with profits from middle-income housing sold (the middle income housing prices would still remain below market levels).