Key Policy and Regulatory Issues for Credit Insurance and Guarantee Schemes
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Transcript of Key Policy and Regulatory Issues for Credit Insurance and Guarantee Schemes
Key Policy and Regulatory Issuesfor Credit Insurance and Guarantee Schemes
The World BankWashington, D.C.March 12, 2003
Housing Finance in Emerging Markets
Mortgage Default Insurance for Emerging Markets 2
Mortgage default insurance for emerging markets
Definition and purpose
Types of risk assumed
Preconditions for success
Regulatory framework
Sponsorship and implementation
Mortgage Default Insurance for Emerging Markets 3
Distinguishing characteristics
Unique insurance hazard Longer exposure period Longer loss cycle Dominant influence of government/economic policies
Mortgage default insurance (MI) is a specialized form of credit insurance that protects home mortgage lenders and investors against loss by reason of borrower default
Definition
Mortgage Default Insurance for Emerging Markets 4
Purpose and benefits
Expand affordability – increase homeownership
Increase home construction/economic activity
Induce liberalized loan underwriting/stimulate direct lending
Expedite flow of funds from secondary/capital markets– Boost investor confidence– Increase market liquidity
Improve market efficiency/credit risk management
Upgrade physical housing standards
MI is not a subsidy, does not reduce directly cost of homeownership
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Types of risk assumed
Borrower inability to repay
Borrower unwillingness to repay
Substandard property valuation
Loss of individual home market value
Real estate market risk
Mortgage instrument risk
Agent risk / adverse risk selection
Local/regional recession
Economic catastrophe
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Default risks that may be excluded
Failure to recover property after default
Failure to establish clear property title
Physical damage to property
Fraud
Loan administrator performance failure
Natural disaster*
Environmental risk*
Political risk*
*Uninsurable risks may be covered by a backup government guaranty
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Preconditions for success
Functional primary mortgage market– Reasonable, economic, and political stability– Contract enforceability (“rule of law”)– Data availability (mortgage, credit, and property)– Functional system for transferring, recording real property titles
and liens (reliability, cost)– Lender competence in loan underwriting and administration– Effective banking supervision– Credit and homeownership “culture”
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Preconditions for success
Functional home resale and rental housing markets
If condominium lending, functional condo governance regulations
Functional insurance regulation– Competent regulator– Specialized mortgage default insurance regulation
Market justification and need– Lender motivation/borrower acceptance– Threshold business volume
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Regulatory framework
Specialized insurance regulation needed– Risk-based capital/catastrophic loss reserve– Segregation of capital reserves – “monoline” charter– “Conflict of interest” provisions to assure underwriting
independence– Premium rebates prohibited– Underwriting, coverage, and risk concentration limits– “Case basis” loss reserves for insured NPAs– Approval of rates and contract forms
Banking regulator recognition of MI– Risk-based capital credit (incentive)– Deter “adverse risk selection” (mandate)
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Sponsorship and implementation
Government versus private sponsorship– Many governments unprepared to become MIs– Problems with government guaranty program versus actuarially-
based insurance– “Moral hazard”/political interference
Government support roles short of outright sponsorship– Compatible direct/targeted subsidies– Regulatory incentives/mandates– Tax breaks– Reinsurance/risk sharing– Catastrophic risk backup– Shared government sponsorship with sunset provision
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Sponsorship and implementation
Domestic versus foreign sponsorship– Must consider secondary investor requirements– Type of investment rating needed (claims-paying capacity)– Ability to attract adequate risk capital (see prerequisite conditions)– Possible-shared sponsorship (including international development
bank?)– Domestic sponsorship with foreign reinsurance
Lenders as possible co-sponsors
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What type of MI program?
Critical features – Shared risk with originating lenders– Full coverage to secondary investors– Clear LTV, mortgage instrument, owner-occupancy standards– Built-in features to avoid adverse risk selection, moral hazard– Actuarially-based premiums– Clear definition of default, collateral recovery as precondition to
claims– Investment grade rating for claims-paying capacity
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Sponsorship and implementation
Role of regulator– Insurance regulator should assume lead role– Work with market participants, elected officials, possible applicant,
to establish monoline MI regulations– Manage initial charter approval, including review of business plan– Establish method and ability to assure that proposed rates are
adequate, not excessive– Banking regulation should play secondary role governing lender
use of qualified MI programs
Risk-based capital rules for mortgage lenders and insurers should be rationalized to avoid “regulatory arbitrage”
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Sponsorship and implementation
“Franchise value”– A private sponsor – domestic or foreign – that sinks substantial
long-term MI risk capital into an emerging national market will look for some comfort that the “franchise value” of its investment will be reasonably secure during its startup years
– In a small national market that will support just one MI provider (public or private), need to avoid monopolistic behavior
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Thailand
Macroeconomic conditions– Recovery strengthening in 2002-03 after post-1997 crisis period of
weaknesses, uncertainty– Continued high NPA rates overhang banking and housing sectors
Housing and mortgage markets– Relatively small: Estimated annual demand = about 128,000 units– Annual residential originations: about $US3 billion
Housing and homeownership– Stock is plentiful, diverse, moderately priced relative to incomes– Active urban rental market; home resale market developing– Homeownership rate >50% in greater Bangkok; >75% nationwide
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Thailand
Mortgage financing system– Serving existing needs rather well– Capable lenders with competitive loan products serving wide range
of homeowners– Home mortgage origination, including cost of title transfers, lien
registration, working well– Abundant funds available from primary lenders at modest rates– Prevailing mortgage instruments volatile, risky
Homeownership impediments– Cash down payment accumulation– Many lenders reluctant to serve lower income borrowers– Relative to other countries, homeownership is quite accessible
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Thailand
Secondary market– Secondary Market Corporation (SMC) poised to become active– Excess bank liquidity (temporary?) means little demand for
secondary sources of capital
Market acceptance of MI– Lenders, other market participants see MI as useful, say borrowers
will pay reasonable MI premium for access to homeownership– Banks are already making many high LTV (90%+) loans uninsured– MI market penetration may depend on:
- End of excess bank liquidity/need for secondary market access- Rising losses on recent uninsured loan portfolios- Regulatory action creating incentives and/or mandates for use
of MI on high LTV loans
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Thailand
Low-income lending– MI can do little to induce bank “down market”– Some cooperative lenders already serving lower income borrowers
may serve more with use of MI
Mortgage credit quality: Many “positives”; a few “doubtfuls”– Many lenders originate and administer home loan competently– New Thai Credit Bureau moving toward high level of credit
reporting capability, driven by consumer lending– Non-housing debt levels appear rather high; concept of “back ratio”
(total debt burden) not well established in home loan underwriting– Property valuations are improving; full confidence not yet warranted
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Thailand
– Data availability, including historical loan level data, is remarkably rich, at least for Government Housing Bank (GHB) portfolio
– Standardized documentation not yet achieved, but Thai Housing Finance Association has begun to address
– “Borrower culture”: Financial obligations – especially car and home loans – are taken seriously. Some “stretching the truth” on loan applications.
– Borrower equity, essential to establishing true LTV and related risk, needs better documentation. Same is true for owner occupancy.
– “Restructured” NPAs: A large, though declining share of portfolios. To avoid recognition of default and final write-off, too many NPAs are restructured as “current,” only to re-default later.
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Thailand
Legal and regulatory issues– Non-Life Insurance Act does not recognize any form of credit
insurance. A new section is needed to cover credit insurance, financial guaranty, and mortgage default insurance, with special MI provisions as noted above
– Banking regulation needs regulatory incentive (risk-based capital credit) and/or mandate for use of MI on high LTV ratio loans to assure threshold volume and financial solidity
– Foreclosure laws and procedures entail excessive costs and time delays. Reforms are needed that will enable most home loan foreclosures to bypass full judicial procedures, while retaining essential consumer protections.
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Thailand
Estimated potential MI market penetration/volume
– With regulatory support:
Market penetration
25-33%
Annual MI $volume
$750MM-$1.2BB
Market penetration
5-10%
Annual MI $volume
$150-$350MM
– Without regulatory support:
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Thailand
Implementing MI– Thai government not inclined to be a direct sponsor– Legislative and regulatory action to expedite creation of MI entity
is needed– Hybrid sponsorship (e.g., public-private, domestic-foreign)
a possibility– Enlisting foreign expertise can accelerate implementation
Conclusion– MI is close to full feasibility in Thailand– Market functions reasonably well without MI– MI is key component to developing secondary market– Achieving threshold MI volume, even with regulatory support,
could be a challenge