Despite its recognized economic and social importance, housing finance has remained under-developed in India. The proportion of households living in permanent structures in India rose from 41.7% in 1991 to 51.8% in 2001, but a high proportion of 38.5% of households still lives in one-room structures in 2001, which was 40.5% in 1991.
A vibrant secondary market will be an efficient, low cost and stable way of raising money and managing cash flows in the overall mortgages market. This will be achieved due to economies of scale in raising money, in processing the purchase and servicing of large numbers of mortgage loans, and in managing risks through diversification.
We have analyzed several mortgage refinancing models, and have strongly recommended capital market based models, as the same minimize agency costs, integrate capital markets and mortgage markets, and over long run will reduce the cost of mortgage lending.
Till October 2004, National Housing Bank has made 10 MBS issues in the secondary market with total issue size of INR 512.27 crores and comprising of 35,116 housing loans. But the mortgages that are securitized annually account for only 0.5% of the amount that is disbursed in the primary mortgages market.
We have estimated the size of secondary mortgages market in India using various methodologies. The estimate using housing data of India and Malaysian ratio of housing loans securitized for 2002-2003 comes to INR 6682.27 crores. If the funds required in the housing sector are taken into account, then the mortgage securities that can be issued per year can be INR 14272 crores. Also, assuming the present CAGR of 24.42% in disbursals to continue till 2010 and if 15.9% (Malaysian ratio) of the amount disbursed is securitized, then the amount corresponding to mortgage securities issued in 2010 would be INR 32625 crores.
From the perspective of the long term debt market and using the ratio of MBS to government debt in Malaysia, the total mortgage securities that could have been issued in India in the year 2002-2003 would have been INR 18091 crores. With the average loan size in India of INR 2 lakhs, this extra liquidity of INR 18091 crores, would have facilitated housing finance to around 904550 people in India.
The potential for secondary mortgages market in India is huge even when we take the most conservative ratios (of the Malaysian market), which are lowest among the developed and semi-developed secondary mortgages market of the world. If like in US, the two-third of our home loans are securitized and based on the disbursals figure of 2002-2003, the MBS issued in 2002-2003 would have been of INR 28017.91 crores.
We have elaborately discussed the reasons why securitisation should bring down the cost of funding for the mortgage originator. In India, inefficiency is breeding inefficiency and the cost of securitisation remains high due to either rating agencies exaggerating the credit enhancements or the investors demanding high premiums for risks they have not properly appreciated. Therefore, Indian housing finance companies regard the gain-on-sale booking as one of the prime motivators for securitisation, which, as we have demonstrated, is quite misplaced.
We have made significant recommendations for an institutional framework for development of the securitisation market. NHB, in our recommendation, should play an increased role in securitisations in at least two ways that it does not currently do:
A strong legal framework is essential for the establishment of securitisation market in the country. We have tried to identify the problems in the legal system that stifle the growth of securitisation. Laws relating to mortgages date back to the 19th century and obviously cannot be expected to be securitisation-friendly. We have suggested simple amendments that would take RMBS paper from the fold of Transfer of Property law, a 19th century enactment, and would avoid the need to have a conveyance for transfer of mortgage debt, thereby eliminating the stamp duty issue.
The primary mortgages market should be developed through standardization of documents and underwriting practices, and by using professional standards of property appraisal.
We have also made comprehensive analysis of the risks underlying investment in RMBS, and made a case that the credit and prepayment risks in MBS investing are quite often misunderstood and are exaggerated. There are significant differences between market practices in the US market and those in the Indian market – so the US-style prepayment risks are not relevant to the Indian market.