Default insurance

The case for a mortgage guarantee industry in an economy springs from an all-too-prevalent phenomenon. Suppose a housing finance company gives Ram Lal a loan to buy a home. Mr Lal agrees to some EMI. But there is every possibility that he may not be able to pay back the whole loan on time. As of now, India offers no protection to the lender who in order to provide itself some protection ends up not only lending less than it could but also charging a higher rate of interest on the loan. This, in turn, makes the EMI larger than it need be and increases the risk of default. Both lender and borrower are worse off as a result. When this is multiplied by lakhs of borrowers and several lenders, the adverse impact is felt throughout the economy in the form of higher costs and lower demand for housing.

The solution, globally, is called mortgage insurance, and there are specialised banks that offer it. They get their revenue from the premium paid by either the lender or the borrower or, as is often the case, both. So after a decade and half of a housing boom, India, too, has finally taken its first steps towards mortgage insurance. The Reserve Bank of India has said that India’s first mortgage guarantee company, the India Mortgage Guarantee Corporation (IMGC), can start functioning. Its capital will come from three investors – the National Housing Bank (38 per cent), an American company called Genworth Financial (36 per cent) to provide technical help and ADB and IFC (with 13 per cent each). It is interesting to note that the Government will not have a stake.

All this is very nice, but how successful will this new institution be in the absence of two critical pre-conditions – an easy foreclosure regime and, as a result, a transparent secondary market in real estate? Although there has been talk of remedying these two problems, precious little has been done. In 2009, the Committee of Financial Sector Assessment (CFSA), which had been set up by the Finance Ministry and the RBI, had, after labouring for three years, submitted detailed recommendations to address the foreclosure issue. Only some of these have been implemented, that too in a piecemeal and half-hearted manner, primarily because some new provisions have to be inserted into existing laws like the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, to name just one of the more important ones. Even a quick reading of the CFSA report reveals the many things that still need to be done before mortgage guarantee can become a success. Hopefully, as often happens in India, the new mortgage bank will be able to create the necessary pressure on Government to get on expeditiously with the amendments. The cooperation of state governments will also be crucial.

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