Preliminary Evaluation of the Mortgage Markets in Islamic Countries
In many of the Islamic countries, buying a home for the first time is generally the biggest investment or the largest acquisition most individuals will make in their lifetime. Most consumers do not have the financial wherewithal to purchase a home outright and must obtain a real estate loan to finance the transaction. That is why now it is a commitment in the part of the governments in all countries to help national mortgage industry to design efficient mortgage market and economic mortgage plans. And, that is why the total real estate debt in many countries is the largest single item in their financial markets. An efficient mortgage market is one with a wide range of loan products available to meet the varied financial needs of consumers.
In current world experience, the residential real estate lending industry is comprised of two distinct areas: the primary market and the secondary mortgage market with a host of other ancillary entities that service and support the real estate lending process as well. The mortgage market in which loans are originated consists of lenders such as commercial banks, savings and loan associations and mutual savings banks. Most primary lenders make mortgage loans and sell them to secondary market investors to maintain a steady stream of funds for future loans. Primary lenders that generally keep their loans in portfolio, such as commercial banks and thrifts, also use the secondary market to maintain liquidity and restructure portfolios.
The secondary mortgage market consists of investors that buy mortgages from primary lenders such as mortgage bankers, banks and savings and loan associations, thus providing them with the cash required to make new loans. This market purchases mortgages from lenders and packages them into securities that are sold to investors. By doing so, it ultimately provides homeowners and renters with lower housing costs and better access to home financing. Because of the long-term nature of mortgages, the secondary market is an essential factor in maintaining lender liquidity. The secondary market also provides a significant means of redistributing funds nationwide, moving them from areas where there are surpluses to areas where additional funds are needed.
In Islamic countries, the real estate lending industry has not grown substantially over the past 20 years to help the young population to meet their housing demands, and to create a continuous flow of funds to mortgage lenders in support of homeownership and rental housing. In fact, the mortgage market has been so small and primitive that many Muslim economists foresee a housing crisis in some of these countries second only to unemployment impasse in the next decade.
Islamic states not only lack strong financial depository Institutions and efficient mortgage bankers to expand their primary mortgage markets, but they also have not yet designed a secondary market for mortgage contracts. They are also destitute of many ancillary services required to guide them to an established formal housing capital market and to support their mortgage lending process. These countries are in need of institutions such as real estate broker and real estate sales associates, mortgage brokers, title companies, closing agents, appraisers, credit reporting agencies, private mortgage insurance companies, hazard insurance companies…. These institutions must be defined further in a framework acceptable to Islamic banking rules.
In Islamic primary mortgage markets, the citizens must find various types of residential mortgage products in line with Islamic principles to meet their varied consumer demands and to give choice to those in need of buying residential homes. The same deficiencies can be observed in mortgage process; i.e., in the development of the standardized mortgages and in designing uniform instruments.
At present, most Islamic countries have got a long way to go before developing an efficient primary mortgage market with knowledgeable mortgage originators and sufficient sources of funds to alleviate the crisis and respond to the current extraordinary figure of housing demands. These countries should design private sector participation methods in the development of their primary and secondary markets, the new mortgage conduits of linking their mortgage markets to their total capital markets, and to securitize their portfolios of mortgages. They need to define enough types of mortgage securities to extend choice to potential investors in the mortgage markets; They have to regulate their real estate financing markets with special tax considerations, thus accommodating for the possibility to have mortgage-backed securities offered to foreign investors.
In designing such a set up to provide practical base to materialize hopes of millions of Muslims wishing to fulfill their dreams of home ownership, risk transformation is the participants essential role in the system. They must create mortgage products that from risk viewpoint, consumers want and raise capital to finance them by creating investment securities that investors want. At the same time the increase in investments should not increase the indebtedness of the respective governments, though a direct profit or fees subsidy may be paid for a short period of time to make installments affordable for the youth. The new institutions’ ability to manage and transform risk should make them safe institutions in order to have a continuous flow of funds to the mortgage markets. While their businesses revolve around one kind of asset, but their asset bases must come from all regions of the respective country and consist of various mortgage product types, diversifying their risk and protect them from the disproportionate impact of regional economic slumps. Such a diversification programs may be more successful if the institutions can hold extended portfolios across a few Islamic states. In this way, they will not suffer unsustainable losses when certain regions experience severe economic downturns. Furthermore, they should manage their risks of their assets in a way that transform these risks into instruments that appeal to a wide range of local and foreign investors.
To develop a system where citizens in Islamic countries can buy their homes by their future savings, like in many other countries with established capital markets, the pertinent institutions must be subject to rigorous safety and soundness standards. We need the lawmakers to impose on mortgage bankers various stress tests with extreme credit and interest rate conditions, forcing them to find the ability to closely match their assets and liabilities, have purchase and funding activities that are transparent, and apply market discipline to their operations.
The article will present an overview of the current state of mortgage markets and the recent developments in enhancing housing funds to provide households with low profit rate facilities and minimal down-payments to acquire inexpensive housing units. The author, a finance professor with 25-year top teaching experience, has been in the center of similar developments for the last 13 years in Iran. He has designed mortgage related products, engineered various mortgage institutions, and at present is the chairman of a developing company with over 40,000 shareholders responsible to deliver over 30,000 inexpensive housing units within 30 months to the depositors. He is also the chairman of the 1st Iranian private bank.