Funding Housing Finance



Housing lenders receive funding from a variety of sources. The most important are deposits, which comprise the majority of funding in most countries. Savings for housing programs constitute a dedicated source of funding in a few countries. The capital markets are important additional sources of funding in many countries—and provide the majority of funding in a few countries. Lenders tap the capital markets through unsecured and secured debt. Covered bonds and securitization are the most common capital market funding instruments. Government-owned or -backed agencies such as liquidity facilities and securitization conduits facilitate access to the capital markets for many lenders.



Background and Evolution

Housing lending has evolved from three different funding models. The building society model from the UK developed from a specialized deposit-funded system to the more general bank-dominated depository model we see in most countries today. The mortgage bank model was created in Germany and Scandinavia and progressed to the covered bond system that provides significant capital market funding to European and, more recently, developing country markets. A temporary lender system predicated on securitization as a means to raise capital market funds developed in the United States in the 1970s and 1980s, spreading to both developed and emerging markets.  

  • Bank deposits are an important source of funding for housing because they represent the largest accumulation of funds in most countries. Over the years commercial banks supplanted specialized building societies and savings and loans to become principal providers of loans. However dependence on deposits for funding has disadvantages for housing lenders as well. They are short term, creating liquidity risk for lenders providing long-term mortgages. In order to avoid excessive interest rate risk, lenders must write adjustable rate mortgages, exposing borrowers to interest rate risk. Deposits are not a cost-effective way to raise funding on short notice. For these reasons many lenders supplement deposits with debt (bond, note) issues. Liquidity facility loans are an alternative to bond issues (the facility acts as a centralized issuer).
  • Corporate bonds are an increasingly important source of funding for housing lenders. Many commercial and mortgage banks issue unsecured debt (fixed or floating rate notes). However mortgage-covered bonds have emerged as the most cost-effective and extensively used form of corporate debt. Covered bonds are dual-recourse instruments with investors having a priority claim on the cover pool assets in the event of an issuer default as well as a general claim on the assets of the institution. Banks are the sole users of covered bonds (by legislation in most countries). Covered bonds are a €2 trillion asset class in Europe and have been introduced in a number of emerging markets (primarily Eastern Europe and Latin America).
  • Securitization rose to prominence in the United States and spread to both developed and emerging markets in the 1990s and 2000s. Securitization allows off-balance sheet finance, enabling thinly capitalized non-bank lenders to obtain funding. A recent World Bank report identified 24 emerging markets that have successfully securitized mortgage assets. Private-label securitization came to a halt in the financial crisis of 2008-2009. It has yet to restart in the United States but there have been recent issues in Australia and Europe. The United States market is now heavily dependent on government guarantees. Emerging markets were less affected by the crisis and several have continued to see new issuance.



Main Approaches

  • The type of funding a lender uses depends on its institutional form (e.g., bank, non-bank), funding and risk management needs. It also depends on the existence and depth of capital markets in emerging countries.
  • In most cases banks will primarily fund with deposits and augment these resources with bond issues. As markets grow deeper and more sophisticated, the proportion of funding from the capital markets typically increases.
  • Covered bond markets most often develop after passage of special legislation defining the characteristics of the bonds and issuers as well as the legal rights and responsibilities of issuers and investors.
  • Securitization is a more flexible form of funding that can be done without legislation in many countries. However it is the most fragile, depending critically on confidence of investors in the issuer and assets. Use of government guarantees has jump-started the securitization process in a number of countries. However the crisis has exposed the risks to the government of such guarantees.



Key Cases to Watch

  • Mexico has successfully securitized mortgage loans made by banks and specialized housing lenders (Sofols). The latter specialize in loans to low- and moderate-income borrowers. Most loans have been made with partial mortgage insurance and guarantees from a state-owned development bank, the SHF. The market has slowed dramatically in the crisis. Its re-emergence is a key indicator of the health of capital market funding in emerging markets.
  • Colombia has been able to issue mortgage-backed securities in the crisis. A privately owned conduit, Titularizadora Colombiana has facilitated capital market access for bank lenders.  
  • Covered bond legislation has been passed in Turkey and Uruguay and is under discussion in Peru. Issuance of covered bonds in these markets will signal a new form of finance available to lenders.




Deposits, covered bonds, securitization, liquidity facility, conduit, interest rate risk, liquidity risk


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