A Breakdown of Mortgage Policy in Mongolia

Overview:

As Mongolia continues to experience rapid GDP and population growth, the availability of affordable mortgage financing for people seeking proper accommodation in Mongolia is in high demand. Similarly, as Mongolia’s financial system deepens, housing finance emerges as an increasingly important part of the maturation of its financial system. In emerging markets, the maturation of financial systems appears to lead to the development of housing finance, and this deeper, more extensive financial system, in turn, contributes to higher rates of growth.

However, while the need for housing finance in Mongolia is obvious, the 40,000 homes project illustrated the country’s lack of a fully developed and reliable mortgage system. Many banks in Mongolia simply do not have the financial expertise to offer attractive mortgage loan packages or even provide the liquidity and the necessary legal framework to deliver the loans. Consequently, Mongolia’s mortgage market faces a variety of structural and procedural issues that must be resolved before ordinary Mongolians can have access to financing for house purchases and in turn contribute to Mongolia’s economic growth.

A Brief History:

The institutional structure of the present Mongolian housing finance market has been under development since 1997, when the Asian Development Bank and the Government of Mongolia initiated a drive to create legal and policy frameworks and standardized documentation for mortgage loans in Mongolia. However, the first loans were not offered until May of 2003 under the ADB’s Housing Finance Sector Program. Since then, the Government of Mongolia has enacted legislation such as the Mortgage Collateral Law and the Asset-Backed Securities Law as a means of regulating Mongolia’s mortgage market and more recently, has undertaken action to simplify origination processes and lower origination costs. In 2007, the Bank of Mongolia partnered with the National Statistic Committee (NSC) to develop a methodology for computing a Housing Price Index in Mongolia, which is computed on a quarterly basis.

Current Issues:

In order to support an efficient primary mortgage market, an incredible amount of progress needs to be made to improve the current mechanisms for property appraisal and credit risk assessment. Lack of information continues to hamper efforts to expand mortgage lending in Mongolia. For example, credit history information, which is stored by the Bank of Mongolia is extremely limited and is often out of date, making it hard for banks to measure the risk of their loans accurately. The Bank of Mongolia only carries information about the current status and not about loan performance and information from non-banking financial institutions is not stored, making it impossible to observe the history of a creditors utilities or telecom payment history. The debt to income ratio (ratio between monthly mortgage repayments including insurance and taxes and gross monthly income) is used to analyze a borrower’s capacity to repay a mortgage loan, yet there is no uniform method of calculating this. For foreign citizens, housing finance in nearly impossible to find, as the majority of commercial banks have policies that explicitly restrict lending to foreign citizens.

Before mortgages can become affordable the real estate market must also adapt by developing professional surveying and valuing services that will underpin a market undergirded by fundamental property values as well as supply and demand dynamics to provide extra security for lending institutions. Furthermore,  the sanctity of property rights should be reviewed to make it easier for banks to foreclose on property attached to defaulted loans. Without the assurance of being able to foreclose on immovable property most commercial banks are unwilling to risk lower interest rates as in the event of default they presently have little certainty of obtaining a collateralized property asset. Although great breakthroughs have been made in recent years, much work is still need in order to make foreclosure a simple and dynamic process.

The Secondary Mortgage Market:

The development of the secondary mortgage market through the establishment of the Mongolia Mortgage Corporation (MIK) in 2006 is one way the Government of Mongolia is attempting to provide increased access to housing finance. By issuing bonds on foreign and domestic markets, MIK will provide long-term funds to the Housing Finance Sector (HFS). The current shareholders of the Mongolian Mortgage Corporation are Bank of Mongolia and nine commercial banks. In 2009 MIK was approved to issue 25 Billion MNT in securitized mortgage bonds, 6.3 billion of which were sold between 2009 and 2010.

The market for MIK bonds is small since the main investors are all banks and there is a distinct lack of institutional investors. There is also an absence of rating agencies and a market based yield curve, as well as no constant issuance of government bond. The premise of mortgage securities in on the existence of supportive legal and regulatory framework, sizable and standardized primary mortgage markets, and well-developed bond markets. Specialized lenders can create efficiencies; however they need an external funding source such as a government lending window or secondary market. Their viability will ultimately depend on the willingness of investors to buy mortgage-backed securities and provide short-term funding, which in turn depends on their confidence in the credit quality of the underlying assets.

The potential benefits of a highly successful secondary mortgage market are many. Primarily, the MIK has the ability to raise large funds for subsidized housing finance, such as the 100,000 Homes Project, as well as increase the liquidity and efficiency of the housing finance system. If executed correctly, a thriving secondary mortgage market can even lower interest rates by encouraging the development of a new industry of loan originators.

Conversely, a major challenge for MIK in the next two or three years will be to preserve and enhance its private-sector-led status. Given the failure of government-created agencies to promote housing, MIK may become an attractive target for GOM investment and control. Current shareholders will have to decide whether to move more aggressively to enhance MIK’s current preeminent market position by, among other things, developing and issuing investment- grade mortgage-backed securities or losing control.

Conclusion:

The experience of the 1990s suggests that the provision of housing finance can exacerbate macro volatility. The volatility of housing prices and the potential for a boom-bust is higher if the housing supply is severely constrained by land access and urban regulation problems, which is an issue considering the short supply of land in UB with access to critical infrastructure. Going forward, the Government of Mongolia must also enact mechanisms to ensure the transparency of housing finance processes as well as create a more elastic supply of housing in order to reduce the probability of adverse real estate cycles and sharp run-ups in house prices. A strong but nimble and delimited public role in sector development is critical for the deployment of the measures.

Certainly, the extension of mortgage markets also relies upon a well functioning secondary market, which will rely on the ability of MIK to prepare and sell mortgage backed securities. The regulatory framework governing mortgage providers must also improve drastically if commercial banks are to eliminate some of the risks that push up interest rates on mortgages. These requirements are presently being worked through by the Government of Mongolia in cooperation with several multilateral organizations in order that Mongolia’s mortgage market can fuel growth in the property sector and contribute a solution to Ulaanbaatar’s housing shortage.

A stable, growing economy will encourage the growth of the housing finance system through lower inflation, lower interest rates, and lower systemic risk. In this evolutionary perspective, beyond a certain level of per capita income, housing finance will emerge with household demand for it; that is, as long as the macro, legal, and housing-market regulation environments are conducive to its emergence. In such cases, a virtuous circle can emerge as growth if the financial system promotes overall economic growth, and this higher growth, in turn, will encourage both further financial-sector and housing-finance development.


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