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A housing bank is a government-owned or -affiliated lender that makes home loans directly to consumers. It is a common practice in many developing countries.
While they offer a wide variety of financing options, these banks typically suffer from high rates of loan default. They also have poor collections systems.
The role of financial intermediaries
Financial intermediaries such as banks, insurance companies, and pension funds connect savers and borrowers. They pool risk and create efficient markets that lower the cost of conducting business.
Banks provide capital for loans and investment opportunities while insurance companies connect borrowers to policy benefits. The process benefits both parties and the market as a whole, as well as individuals and households.
However, the role of financial intermediaries in bank housing can be problematic, especially in the current global economic environment. The 2008 global financial crisis was triggered by a series of factors that included homeowners’ leverage, bank leverage, and mortgage securitization.
The role of financial intermediaries can be strengthened through promoting financial literacy among the poor and educating them on money management and discipline to increase their access to complex financial products offered by rural-based microfinance banks. Therefore, policy makers and advocates should work with microfinance banks to roll out financial literacy programs that are specifically tailored to the needs of the poor living in rural areas.
Procyclical mortgage lending of conventional banks
In the housing market, banks and building and loan associations (BLs) play a major role in influencing the mortgage granting decision. While CBs focus mainly on collateral values, BLs consider endogenously created customer information to decide which applicants are suitable for mortgage financing.
As a result, the mortgage granting decisions of BLs tend to dampen prevailing price oscillations and increase stability. Simulations show that if both types of financial intermediaries serve the mortgage lending market jointly, market conditions are more stable than those in the presence of solely CBs.
The best of all worlds is a residential property market in which both conventional banks and BLs act as financial intermediaries simultaneously. This creates the most stable market condition, with high transaction and homeownership rates.
Stability of the housing market in the presence of building and loan associations
A computational simulation experiment reveals that a combination of two types of financial institutions, namely the conventional banks and building and loan associations, may be the key to stability in this complex, but lucrative, real estate market. We present a gambit of simulations that demonstrate that the most stable housing markets are characterized by a high transaction and homeownership rate, low interest rates, and a low loan-to-value ratio. Amongst other things, we prove that a small initial down payment is a smart decision, since it reduces the risk of default and subsequent foreclosure. In addition, the best way to fund a down payment is through a mortgage, rather than a home equity line of credit. We also find that a single institution can manage multiple transactions per hour, thereby enhancing liquidity and smoothing the ride. The results are impressive and illustrative of the power of information and communication technologies that are central to a healthy and productive economy.
Stability of the housing market in the presence of solely CBs
Housing markets have a significant impact on economies’ health, wealth, and stability. Moreover, they play an important role in monetary policy transmission and facilitate labor mobility.
Especially in countries with large and growing mortgage markets, housing plays an important role as a stabilizing factor of the economic cycle. They also help to mitigate cyclical shocks, thus enhancing a country’s overall growth potential.
However, the lending practices of financial intermediaries can cause a high level of market volatility. This is shown by a set of computational simulations of the model presented above (see “The Model”).
The housing market in which solely CBs operate as financial intermediaries displays sharp oscillations in house prices. As they focus on collateral values, they grant mortgages generously in times of previous house price appreciations and reject applications during downturns.
