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Business News/ Opinion / Mortgage guarantee more than just a safety net

Mortgage guarantee more than just a safety net

In India, it's estimated that mortgage guarantee's coverage will be in the range of 10-50%

Shyamal Banerjee/MintPremium
Shyamal Banerjee/Mint

All over the world, the housing market has been a key contributor to shaping an economy. Predictably so, as most of the economies are driven by consumer spending and this becomes the single most important criterion to shape the housing market. Consumer confidence, increased earnings, high individual income leveraging capacity and the risk taking ability of the banking ecosystem has defined the housing market. However, a critical component of the story has been the role of mortgage guarantee (MG), popularly known as mortgage insurance in other parts of the world.

MG is most common in the US, Canada and Australia although there are several other smaller markets as well where it is used. The benefit MG provides is additional housing finance flexibility for lenders and consumers by facilitating enhanced lending (higher loan-to-value, or LTV) and incentivized capital relief on underlying mortgages.

The structure of the mortgage guarantee industry across countries varies considerably and is affected by the domestic regulatory landscape and the extent of government participation in each jurisdiction.

Regulatory arrangements have been supporting the use of MG in various countries. If we were to take the example of countries where MG is a mandatory product, high-LTV mortgages originated by regulated deposit taking institutions in Canada and Hong Kong as well as those purchased by the government-sponsored enterprises in the US must be insured. Canada mandates MG for all residential mortgage loans above 80% LTV (up to 95%) whereas Australia mandates the same as well as for low document loans above 60% LTV. In some countries such as Hong Kong and South Korea, MG facilitates higher LTV lending.

It is interesting to note that mortgage default losses do not occur uniformly across a country. Local economic conditions, especially linked to unemployment or as a result of different lender origination, underwriting and servicing strategies and capabilities, add to the geographic and national differences. As a result of this, when capital requirements are estimated on market-wide loss experience, they may not be at the exact capacity to manage individual lender performance. MG, in comparison, provides for a more efficient and effective way to manage resilience within the financial system. It spreads across geographies, lenders and variety of loan programmes diversify the risk profile across markets. Also, MG provides for a capital buffer by having the capital fungible to be applied in pockets of loss and the capital is also available outside the banking system to pay for losses during economic stress. Needless to mention, the prudent consideration of loan origination specifics and underwriting guidelines add to the market stability as a whole.

An example of MG companies playing a role in managing financial risk is when Mortgage Insurance Companies of America (MICA) began to alert US regulators on growing mortgage market crisis as early as 2002. MICA sought regulatory intervention in a wide array of avenues with the hope of getting the US banking agencies to bar high-risk origination and securitization practices. It also highlighted the risk of non-traditional mortgage lending.

If we were to now look at the India scenario, MG in India will take the form of a credit risk mitigant with several other benefits—directly to the lender and indirectly to the borrower—that make the product attractive from a lenders’ perspective. The mortgage product is a long-cycle product and the Indian market is moving in the same direction in which more mature markets have moved with longer loan terms. Hence the product is one where the benefits accrue over time and MG cannot be used as a quick fix from where returns pour in immediately. The multifaceted benefits of this product are reduction in regulatory capital based on risk weights and the rating assigned to the MG company; reduction in economic capital; efficient use of capital enabling a lender to write more business without taking on any incremental risk, thereby improving return on equity; and capital efficiency and in light of the new guidance on securitization, the MG product can act as a facilitator for certain specific types of transactions which require credit enhancement.

The product has the flexibility to be structured to meet the specific needs of the lender either in terms of level of coverage for optimum capital efficiency or to address a market segment. The product can vary on type and extent of coverage. Globally, the product can cover up to 100% of the loan amount. However, in India it is estimated that the coverage will be in the range of 10-50% depending on the product variant.

As the MG product matures, it is expected to add significant value to the mortgage sector through efficient use of capital, risk transfer and risk mitigation which will also translate to earlier homeownership for the end consumer. Other than the direct value the product brings to the lenders, the MG platform brings in higher operational efficiencies and standardization through extensive use of technology and product innovation. As acceptance of the product increases, it will help shape the ecosystem of the mortgage market through value addition.

Amitava Mehra is CEO, India Mortgage Guarantee Corp. Pvt. Ltd.

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Published: 22 Dec 2013, 10:01 PM IST
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