The Financial Express

Funding home loan by selling bonds

Nironjan Roy | Published: January 10, 2020 21:21:10 | Updated: January 17, 2020 21:32:21

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Bangladesh Bank last year raised maximum cap on home loan from TK 12 million to TK 20 million. In response to a proposal submitted by the Association of Bankers, the central bank revised home loan policy where in addition to raising maximum ceiling, debt equity ratio has been fixed at 70 per cent. The central bank's decision will widen investment scope for banks and financial institutions and at the same time, some affluent people will have easy access to the housing market. In the modern economy, real-estate market plays a very important role and its price index is treated as one of the key economic indicators. Housing market indicates the trend of the economy both in terms of boom and recession. In developed economies, particularly in the USA and Canada, stock market index and housing market are recognised as the two strongest indicators of the economic trend.

HOME LOAN MARKET IN THE DEVELOPED WORLD: In the developed world, housing loan not only serves the purpose of purchasing real-estate property but also provides adequate disposable fund to the property owner whose lifestyle is changed with mortgage loan. Many derivative products from mortgage loan have been introduced in the market to cater for the rising financial needs of the people. Among them, home-equity finance, refinancing, second / third mortgage are very popular products that substantially increase disposable fund of the property owners. Many people can easily maintain their luxury lifestyle simply by availing those derivative products of mortgage loan. These derivative products have virtually turned home loan market into an ever increasing investment opportunity that the lenders have efficiently capitalised on. There is another side of the coin too; home loan may adversely affect the economy if it is allowed to go uncontrolled. The financial meltdown in the USA resulting in worldwide recession was the result of unbridled housing market and banks' over-exposure to this sector. Having been allured by making easy money from derivative products of mortgage loan, banks and financial institutions resorted to creating hybrid product in the name of sub-prime mortgage loan which eventually backfired and led to financial crash in the USA and other developed countries. After that bitter experience, the USA and other developed countries enforced stringent control on home loan, yet the practice is continuing unabated because this is a very lucrative sector for both the borrowers and the lenders.

GROWING REAL-ESTATE MARKET IN BANGLADESH AND ITS CONTROLLING TOOLS: Needless to say, housing market has not yet taken such strong position in Bangladesh. However, this market will flourish rapidly keeping pace with the country's economic growth and it is believed that it will not remain confined to metropolitan cities, particularly Dhaka and Chattogram, but will expand in other large and small cities. With the expansion trend of the market, the demand for houses will also rise exponentially. As a consequence, the possibility of market crash, manipulation and losing of common people's money cannot be ruled out. Therefore, with the growth of housing market, some precautionary measures, oversight and strict control are required  to prevent any bad consequence on this market. Keeping this in view, Bangladesh Bank has probably tried to apply its regulatory control by fixing maximum loan cap and debt-equity ratio. But this is not good enough because these two restrictive measures will not play sufficient controlling role. Maximum cap on individual loan should not be a regulatory measure, rather this should be the decision of lending entity. However, debt equity ratio, if applied along other factors, can play a very effective role in the housing market and among them, determining borrower's debt-servicing capability, calculating disposable income and borrower's stress test are very important tools. The central bank may provide some parameters of deducting household expense in order to derive borrower's disposable income to get to know borrower's debt servicing capacity which may be used as a yardstick by the lender to determine borrower's maximum loan amount. As for example, if borrower has four family members with two school going children and lives in Dhaka city, there will be restriction of deducting minimum TK 10,000 per children's educational cost, TK 40,000 for living expense, TK 20,000 for conveyance and other similar regular expense from his total disposable income in order to calculate borrower's amortising means. In fact, our banks apply some sort of similar measures but not in a standardised form. Similarly, stress test helps the lender assess borrower's ability to continue amortisation in the event of rising interest rate. It may be mentioned here that housing loan is approved with longer amortisation period such as 20 to 25 years but other conditions are reviewed and renewed periodically. So, the borrower who is capable of repaying installment regularly during the lower interest rate period may not continue to repay when interest rate rises.

NATURE OF MORTGAGE LOAN & BANK FINANCE: Real-estate can hardly be purchased with purchasers' own savings, so purchasers mostly use bank loan. Again, regular lending facility from bank is not always conducive for housing finance. Naturally amortisation of mortgage loan is in general very long and interest rate should be relatively less which banks cannot afford in normal course of business. Bank cannot afford to lend for very long term at lower rate of interest as its only source of fund is depositors' savings which is short-term in nature and bears higher rate of interest. If bank cannot make special funding arrangement for mortgage lending, it will have to charge higher rate of interest which will make installment size big and as such will cause severe hardship on the borrower who eventually may default. Similarly, if bank mobilises short-term deposits and lends for long-term housing finance, sever mismatch between bank's asset and liability arises which may expose bank's liquidity crisis. So far, our banking sector has disbursed housing loan in a selective cases, so severity has not been experienced yet. However, when, industry-wide financing will start, problem may arise. So, bank must find alternative long-term source of funding at comparatively cheaper cost. Bank may issue long-term bonds commensurate with the terms of housing finance and can thus mobilise long-term fund for lending in the housing market. Since banks enjoy competitive advantage and highest credit-worthiness among the investors, they can easily issue bonds at very cheaper rate and thus will be able to lend at relatively lower rate in real-estate finance. In general, bank retains the title of the property purchased with bank loan as collateral security which can be securitised for issuing bond. Bank bundles all collateral securities retained against disbursement of housing loans which constitute a basket of assets, used as security to mobilise fund by issuing bond commonly known as ABS (Asset Backed Securities). This is a very popular financial product not only in the developed world but also in many developing countries for mobilising fund to the real-estate sector.

Housing market is growing in our country and at the same time mortgage loan is taking the form of a popular financial product. However, this sector is very sensitive with implicit and explicit implication in the economy and therefore, stringent regulatory oversight and restrictive measures are required from the very beginning to keep this market under control and as such out of unusual movement. Similarly, long-term fund at cheaper cost must be made available to loan-seeking buyers, and mobilising fund by selling bond could be an easy and standard means of lending in the country's real-estate market.  


Nironjan Roy is a banker based in Toronto, Canada. 


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