Asset Liability Mismatch in the Housing Sector of Pakistan

Housing finance is considered a substantially risky investment by commercial banks in Pakistan. Though, this is largely due to the lack of foreclosure laws and clarity of property titles—both of which need immediate attention of the government—another major deterrent, the asset-liability mismatch, coupled with lack of long-term funding avenues, contribute significantly to the mortgage-averse attitude of banks.

Mortgages typically have a high debt burden with a long-term tenor. The liability profile of Pakistani banks, however, is skewed toward short term liabilities –mainly Current Accounts and Savings Accounts. Banks face the critical challenge of maturity mismatch in long term lending instruments as they lack long-term liabilities to match these long-term assets.

It is evident that there is a strong need is to build capital market pockets at longer tenure, not only to price the assets rightly but also to reduce the maturity risk.

In developed economies, the capital markets are largely liquid and banks’ risk appetite to lend in long term mortgages is high. The problem in Pakistan, however, is that banks do not have borrowing options from the capital market to lend in long term mortgages.

The short-term deposits are used to finance long-term housing loans which are pegged to short-term interest rates. In order for any financing institution to lend a 15-20-year mortgage, funding with similar maturity would be needed. The problem is not specific to Pakistan alone. Banking systems in most of the developing economies face the same problem.

To resolve this mismatch, the availability of long-term refinancing facilities and funding arrangements is of paramount importance. This could be ensured through an active bond market that would hedge mortgage lending against volatility in interest rates since higher volatility of interest rates in Pakistan has historically also made housing loans riskier.

Banks tend to invest in government papers because non-banking financial institutions are not in competition. Pension and insurance funds are not ample, the savers are short of options and the mutual fund industry is small. That is why banks offer lower rates to depositors, and because of low cost, banks are able to earn spreads by investing in government papers.

The peculiarity in Pakistan’s banking is that depositors are offered lower rates than those on government papers with the same maturity. The banks do not look for higher returns on long term asset options. This ultimately impedes banks’ entry into housing finance.

The pricing problem is also very concerning. Long-term assets are pegged to short-term interest rates which means mortgages are linked to 6-month Kibor. As interest rates fluctuate, mortgages become riskier.

The ideal scenario is to create a long-term fixed-rate bond market which will allow banks to also provide fixed-rate mortgages at longer terms. For this purpose, the development of the capital market is imperative.

For this reason, as a stop-gap solution, the Pakistan Mortgage Refinance Company (PMRC) was established in 2015 to inject liquidity into the financial system. Moreover, financial institutions could provide fixed-rate or hybrid mortgages once the secondary mortgage market is developed and pockets at varying (3.5 and 10 years) rates are developed.

The PMRC would primarily help banks to attain a stable source of funding. It would also contribute to the development of the long-term bond market by floating longer maturity bonds. This would serve as a long-term investment instrument and provide a similar degree of security but better yield from Pakistan Investment Bonds (PIBs).

Since then, and the State Bank of Pakistan’s push for low-cost housing finance in Pakistan, the PMRC has already acquired a funding line from the World Bank to provide refinancing to financial institutions. This funding has been availed by the Housing Building Finance Corporation (HBFC) though the credit line is currently limited to $140 million only which will cover only a few thousand mortgages.

PMRC’s intervention itself will make a significant, but still a small contribution, towards bridging the housing finance gap. There will have to be a concurrent and concerted effort to develop alternative saving avenues in the economy, as well as building a long-term debt capital market that will help in developing the long-term yield curve.

Eventually, this will get the ball rolling for corporate bonds as the private sector issues bonds at a premium in competition with government bonds. The greater supply of bonds in the market will bring long term rates down and will raise the bank’s appetite for housing finance.