JUL 09 -
The failure of banks to apply risk management and
improve the mortgage industry, combined with the government’s practice of merely issuing regulations to control their high-risk behaviour, are key weaknesses in one of the most vital sectors of Nepal’s financial world. The real estate business occupies 75 percent of the capital market and has seen more than 50 percent of the total investment. However, it lies at the centre of a financial mess from which the country has been trying to free itself.
Nepali banks sank a lot of money in real estate for a lack of investment options, which triggered an artificial boom. When the bubble burst due to market saturation and new government regulations, prices plunged, leading to economic turmoil. When Nepal Rastra Bank (NRB) enforced a monetary policy and fixed a ceiling on real estate lending by banks to ease the crisis, it created a negative impact on the financial system putting all investments in a critical situation.
The cause
An unscientific mortgage lending system in the past six years increased investments extensively, which fuelled an unhealthy housing market boom and encouraged debt-financing consumption enormously.
The ability and creditworthiness of potential borrowers was not available from the Credit Information Bureau’s (CIB) credit database system. The CIB’s database was limited to a list of individuals and companies that had been blacklisted. Importantly, it could not distinguish between high-risk and low-risk borrowers. Also, banks’ aggressive lending trend, the self-interest of financial barbarians to grant loans to their vested borrowers and inflated and increased mortgage lending bubbles led to the fiasco.
Additionally, after the political change of 2007, a huge volume of black money entered the market, which was mostly invested in real estate. This also led to an unnatural growth in realty investment. The mushrooming growth of cooperatives encouraged people to invest in real estate as they provided easy access to credit without a proper study of their financial prospects and strengths. Bureaucratic corruption and embezzlement of government funds and increasing extortion by organised criminal gangs also contributed to the real estate boom as this ill-gotten wealth poured into the real estate market.
Consequently, all these malpractices and an unhealthy investment climate created a trend of lowered lending standards for banks, higher-risk mortgage investment and artificial growth of the mortgage market. So a housing bubble was created when housing prices, especially in the Kathmandu Valley, went on an unhealthy climb, instead of rising gradually with inflation or with a rise in average incomes. When the bubble burst, housing prices tumbled, causing the real estate market to collapse.
When home prices declined suddenly after peaking in mid-2009, the ability of borrowers to refinance their loans became more difficult. As adjustable-rate mortgages began to reset at higher interest rates after 2010, mortgage delinquencies soared. Mortgage backed securities of borrowers, widely held by financial firms, lost most of their value and there was no trading of mortgages in the market. As a result of adjustable-rate mortgages, financial barbarians, vested interests of promoters and board directors along with loan officers and property valuators, a lack of understanding of market dynamics and the deteriorating financial strength of borrowers, there were adverse consequences on the Nepali financial market.
The upcoming budget should focus on making new policies regarding mortgage management and should upgrade old-fashioned banking to cutting-edge banking services to produce better results and create a competitive mortgage market from which the government, people, bankers and investors can benefit.
The first requirement is a consumer credit report bureau, which will provide a borrower’s credibility assessment for a loan and also assess their credit bearing level through a credit score. These will be key factors for lenders to analyse risk and will go some way towards protect the dire investment climate in Nepal. The second course of action is mortgage refinancing by state-owned banks, which could provide long-term loans with a fixed-rate mortgage at a reasonable interest rates and create homeowners even among civil servants. They will then create housing demand gradually, prompting the stagnant housing market to rev up once again to foster economic growth. This way, state-run banks also have a lucrative investment opportunity to mobilise sleeping funds.
The third requirement is a mortgage licensing system. This will eradicate financial barbarians of vested interest groups, including unofficial mortgage brokers, promoters, officers and board members who are misrepresenting their clients’ interests, falsifying loan documents and committing fraud by making artificially inflated mortgage-backed securities (MBSs). Establishing a secondary mortgage market is the fourth course of action that is necessary to diversify mortgage risks and manage economic stability. The situation of mortgages today is alarming. In order to solve this problem, it would be more efficient to promote sale of MBSs to investment groups by pooling all unsold mortgages.
There are several benefits of implementing these four pillars. First, they will create opportunity for debt consolidation into one loan and reduce the monthly repayment amount, thus freeing up cash for borrowers. Ultimately, the government will benefit due to good governance and a better investment environment where commercial banks will have enough liquidity to invest in new and lucrative ventures. The stagnant mortgage market and many borrowers, who are in default position and have a debt crisis due to interest and penalty, will both be revitalised step-by-step. Moreover, the tendency to overvalue mortgage securities among financial barbarians, which is a key problem for financial institutions that are under NRB’s management, will stop.
In addition to this, the access to equity for people from all strata, including civil servants, will increase, along with an increase in the size of the mortgage industry and homeownership, thus improving the lives of people, civil servants and the community. There will be a new job market for young graduates and professionals. Eventually, with the better liquidity position of banks, they will be able to invest in productive and industrial sectors, instead of unproductive sectors like real estate. Moreover, investment risks will be minimised and that will provide an opportunity to diversify risks as per market trends.
Pramesh KC
KC holds an MBA in Finance from TU
Posted on: 2013-07-09 08:52
http://ekantipur.com/2013/07/09/opinion/betting-the-house/374531.html
Betting the house
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