Factors affecting financial institutions

Last Updated: 20 Apr 2022
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For the first time in world history, more people now live in cities than in rural areas. As a consequence, the successful development of efficient and stable mortgage finance systems is now of global importance because economic productivity as well as the quality of life in cities depend on efficient financial services for sound urban investments.

At present, housing finance systems remain underdeveloped in most developing countries where residential mortgage lending is typically small in scale, difficult of access and only bank-based with little reliance on capital markets.  Yet, comparative work on housing finance systems has barely begun. In particular, there is no systematic work on the great diversity of experiences across the 184 countries that are currently members of the International Monetary Fund and the World Bank.

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Based, on the latest comparative data available, this paper presents an initial overview of the scale and depth of overall financial systems in 180 countries and shows why three tiers of financial systems should be distinguished in evaluating performance and selecting policies.  Then the paper examines five recurring structural constraints that often affect the scale and depth of mortgage finance systems in developing economies and differentiate them from mature financial systems. To clarify the overall financial contexts in which mortgage finance systems must expand, the paper reports findings from the first global survey of financial systems carried out in 1999 at the World Bank.  This survey reveals regularities in the way the structure of financial systems evolves across income levels, which are important in shaping options to develop a given mortgage finance system. Within the three tiers of financial systems previously defined, on-going research shows that five broad types of financial systems shape the specific options available to develop mortgage finance systems market.


At present, the economy of Turkey has been expanding strongly, registering growth rates of 8.9% and 7.4% for the 2004 and 2005 fiscal years respectively[1].  This is a much greater improvement from the early 1970s when the Turkish Economy reached its worst crisis since the fall of the Ottoman Empire. During this period, the Turkish authorities had failed to take sufficient measures to adjust to the effects of the sharp increase in world oil prices in 1973-74 and had financed the resulting deficits with short-term loans from foreign lenders. By 1979 inflation had reached triple-digit levels, unemployment had risen to about 15 percent, industry was using only half its capacity, and the government was unable to pay even the interest on foreign loans.

The country's progress in recent years, however, has been remarkable. The benefits of the government's commitment to its economic program are clearly visible.  Much has been achieved since the current reform program was started. The challenge that remains for Turkey now is to build on those achievements and exploit Turkey's potential as a rapidly-growing and increasingly sophisticated economy[2].

This study will examine the effect of these factors on the financial institutions of Turkey, especially the banks.  The initial step of this study will provide a brief background on the historical antecedents that previously existed in Turkey to arrive at a better understanding of the fundamentals of the Turkish financial institutions.  The next step will be an examination of the legal framework of the study which is aimed at setting the parameters of what the financial institutions can do.  This will be followed by a discussion on the other pertinent laws, rules and guidelines that govern the financial institutions of Turkey.

Relevance of Study

According to Anne O. Krueger, First Deputy Managing Director of the International Monetary Fund (IMF), the key to the resurgence of the Turkish economy lies in “raising the potential growth rate of the economy. Structural reforms-reforms that make the economy more flexible, that permit individuals and firms to respond to incentives more rapidly and more flexibly-will raise the economy's growth potential. More rapid growth, sustained over a long period, will raise living standards and reduce poverty.”[3]

The study of the Turkish Financial Sector, therefore, is quite important because of the role that it plays in its resurgence. Turkey is amongst the leading developing nations but its economy has been eclipsed by chronic macroeconomic instability, heavy taxation and a weak loan portfolio superimposed by heavy government involvement.

Despite enormous obstacles, the Turkish Financial Sector has been able to sail through severe crisis and presently it is closer to achieving macro-stability than it has ever been in recent years. The Turkish Financial Sector presents a role model for rest of the developing world in setting up best practices and offers a tremendous opportunity for students of economics to get a fair idea of the resilient nature of the financial sector during its evolutionary and revolutionary processes.

A study of the role that the banking sector plays in the Turkish economy will also help at arriving at a better understanding of how structural reform, which is a never-ending process in the modern global economy, can properly be achieved and sustained through a solid financial sector.

Historical Background

The new liberal economic policy in 1980’s aimed at integration with world markets by establishing a free market economy. As a reflection of this policy, this period witnessed continuous legal, structural and institutional changes and developments in the Turkish banking sector. In these years, a series of reforms were undertaken to promote financial market development. The main aim of these reforms was to increase the efficiency of the financial system by fostering competition among banks.

In this context, interest and foreign exchange rates were liberalized, new entrants to the banking system were permitted and foreign banks were encouraged to operate in Turkey. Turkish banks intensified their business relations abroad either by purchasing banks in foreign countries or by opening branches and representative offices. The liberalization of foreign exchange regulations increased foreign exchange transactions of the banks. Beginning in 1984 the special finance institutions, which are renamed as participation banks with recent changes in the banking regulations and operating according to Islamic banking principles, also became part of the financial system.

The Interbank Money Market, which is administrated by the Central Bank, was established in 1986 with the purpose of regulating liquidity in the banking system. A uniform accounting plan and accounting principles as well as a standard reporting system were adopted in the same year. In 1987, external auditing of the banks in accordance with internationally accepted accounting principles was initiated. In addition, legal and institutional arrangements were introduced to foster the development of the capital market. As a result, banks began to provide additional services such as trading in securities, underwriting fund management, establishing mutual funds and financial consultation.

Besides diversifying their services, banks improved their technological infrastructure by extensive use of computer systems; began employing more qualified human resources; and at the same time put an emphasis on training programs.

Legal Framework and Supervision of the Banking System

All banks in Turkey are subject to the Banking Act and to the provisions of other laws pertaining to banks. Prior to the changes in the Banks Act No.4389, which was issued on June 23rd, 1999, the Undersecretariat of Treasury and the Central Bank had been the two main regulatory and supervisory bodies in the banking sector. With this Act, the Banking Regulation and Supervision Agency (BRSA) with financial and administrative autonomy, was formed. The mission of the Agency is to safeguard the rights and benefits of depositors and create the proper environment in which, banks and financial institutions can operate with market discipline, in a healthy, efficient and globally competitive manner, thus contributing to the achievement of long-run economic growth and stability of the country.

With the establishment of the BRSA, the Savings Deposits Insurance Fund (SDIF), which was under the authority of the Central Bank before, started to operate under the administration of the BRSA. Later on, with the enactment of the Act Nr. 5020 on December 26, 2003, the management of the SDIF was separated from the management of the BRSA. The decision-making body of the Agency is the Banking Regulation and Supervision Board (BRSB), which is appointed by the Council of Ministers and consists of seven members. Following the appointment of the members of the Board, the Agency commenced its operations as of August 31, 2000. Banks in Turkey have the status of joint-stock companies and are subject to general controls under the provisions of the Turkish Commercial Code and of various tax laws. Besides, banks are subject to special supervision by the Banking Regulation and Supervision Agency. As the representative body of the banking sector, the Banks Association of Turkey (BAT) aims protecting and promoting the professional interests of its members.

The BRSA exercises its supervisory authority on a direct and ongoing basis in terms of legal considerations and financial soundness. Additionally, the banks’ financial statements are audited by external auditors in accordance with internationally accepted principles of accounting. Banks are also examined by their own auditors, who are required to submit quarterly reports to the BRSA. Recently, the supervisory system has been further strengthened by legislative arrangements and a number of decisions taken in accordance with the standards of the prudential regulation exercised by the international banking community and in general covered the following banking related areas: foreign exchange exposures, capital adequacy, internal control and risk management, lending limits, conditions to be met by bank owners, bank ownership control in transfer of shares, consolidated and cross-border supervision of banks, accounting standards for financial disclosure purposes, prudential reporting and loan loss provisioning.

For the purpose of bringing further competitive force in the financial system, to minimize the risks that may arise, to decrease the costs of operation and intermediation to achieve integration with other regulations and implementations of financial markets, a more active and more transparent financial system by providing a more active course of the markets, new Banking Act (5411) was issued on November 1st, 2005. In the process of preparing this Act international standards including National Program, Urgent Action Plan of the 59th Government, European Union Improvement Report, Turkey Report of OECD, European Union Directives, BIS’s Core Principles for Effective Bank Supervision, Corporate Management Principles of OECD, the Laws of European Union Member Countries, important provisions which take place in the laws of certain countries, experiences and culmination of BRSA and SDIF were used.

One of the main highlights is that under this new regulation, the financial holding companies, leasing, factoring and consumer finance companies come under the supervision and surveillance of the BRSA.  The act also provides new innovations such as the inclusion of the definitions of assurance fund, development and investment bank, Fund bank, participation bank, financial institution, financial holding company, control, qualified share, savings deposit, private current account, participation account, participation fund, savings account, support service institution and off-shore banking which are now included in the Act.

The impact of this act is such that the activities that the banks may engage in are listed clearly and as compatible with the directives of the EU, in order to identify the financial institutions and determine the scope of effective supervision and surveillance.  There are also provisions with regard to the conditions for a transparent and clear partnership structure, organization scheme which should not hinder the effective supervision of the BRSA, and principles of corporate governance are brought for the banks to be established in Turkey and a minimum YTL of 30 million paid-up capital is foreseen.

In attempt to further strengthen the confidence in the Turkish banking sector, within the principle of transparency, the banks shall now publish their articles of incorporation in their web-sites.  Furthermore, for the banks and the financial holding companies, good governance is stipulated to govern by developing the principles of corporate management.

Perhaps one of the most significant changes instituted by thus act is the inclusion of provisions regarding the establishment of an audit committee with all members chosen from the non-executive members of the board of directors, to assist board of directors for on-side and off-side supervision activities. The main duties of the committee are determined as monitoring and assessing the adequacy of internal control, risk management and internal audit systems, ensuring accounting and reporting systems are operating in a sound manner and producing reliable information. It is stated in the Act that the duties, authorities and responsibilities of the audit committee shall be determined by the board of directors.

Other changes that were included in this act call for the amendment of the principles concerning the authorization of auxiliary services institutions, the change in the minimum level of the capital adequacy is determined as 8% in parallel with other countries, and liquidity adequacy is foreseen in the Act.  The Act also forbids banks to transfer funds to close the deficit of their funds and foundations established by their employees for health and social services, retirement saving purposes.  It is adopted that the amount of donation which banks and institutions, subjected to consolidated supervision shall not exceed 4 per thousand of the bank’s own funds and at least half of these donations can be done in fields exempted from tax by law.  It is forbidden to carry on transactions with shareholders with dominant influence, board of directors, their husbands, wives and children and the subsidiaries causing hidden profit in better circumstance.  Processes regarding to take corrective, rehabilitating and restrictive measures are listed in line with their priority. The institutions, the financial structures of which cannot be improved despite taking these measures, shall be transferred to the Fund or their license shall be revoked.  The Act also includes provisions providing the Agency to work in a more effective, productive, transparent and accountable manner.

 The independent auditing, evaluation and auxiliary institutions are now also compelled to get liability insurance for any loss stemming from their services.  A supervision system which can respond to rapid changes and new necessities of the financial markets shall also be established. The institutions in the scope of the Act shall be audited by the professional staff of the Authority or by independent audit institutions having specialist in these subjects, as well as sworn bank auditors.

All of these new provisions are designed at revitalizing the Turkish banking sector which is still recovering from the effects of the 1990 economic crisis which rocked the Turkish economy.

The Structure and the Financial Data

In a study entitled, “Credit growth in Turkey: Drivers and challenges” by Erdem Ba?ç?[4] a discussion was made on the main drivers of the recent credit boom in Turkey and the potential problems and challenges associated with it. According to the paper, the basic problem in Turkey during the last fifteen years has been the relatively large stock of public debt compared with the small deposit base in the banking system. The recovery period, however, has witnessed a decline in the inflation rate single-digit levels for the first time in three decades and it is concluded by the author that the two main drivers of the recent credit boom observed in Turkey have been fiscal consolidation and disinflation.[5]  This basically means that for the banking sector in Turkey to play a major role in the resurgence of the economy the deposit base needs to be strengthened to generate funds to be used for funding to allow banks to lend more to new industries to jump start the local economies.

Similarly, in another study, by Kibritcioglu entitled “Banking Sector Crises and Related New Regulations in Turkey,”[6] a chronological account of the development of the banking sector in Turkey was done. It starts with a report on the past three decades of instability and crises in Turkish economy which were marked with populist macroeconomic policies, moral hazard problems, huge public sector deficits, high real interest rates, overvalued Turkish lira, strong currency substitution, large current account deficits, volatile short-term international capital flows, extremely risk-taking behavior of banks, volatile economic growth, and high and persistent inflation resulted in several successive crises in the real and financial sectors. It then recounts how Turkish economy was able to recover from its banking and currency crises in the year 2001 thru a restructuring and rehabilitation of the banking sector.

The future of the Turkish banking sector is then presented in the end: increasing macroeconomic stability, improving sovereign creditworthiness, higher economic growth, increasing domestic savings and EU-related institutional reforms during the EU-convergence process within the coming 10 to 15 years, and increased consolidation and foreign competition.  This study further supports the theory that the key to the resurgence of the banking sector lies in its being able to encourage more savings in the domestic market which will also lend to the improvement of creditworthiness of not only the local businesses but of these financial institutions as well.

In understanding the relevance of improving the credit worthiness of banks and local businesses in Turkey, it is important to first analyze which industries contribute to the financial and economic growth to the Turkish economy.  In the years after World War II, the Turkish economy became capable of supplying a much broader range of goods and services. By 1994 the industrial sector accounted for just under 40 percent of GDP, having surpassed agriculture (including forestry and fishing), which contributed about 16 percent of production. The rapid shift in industry's relative importance resulted from government policies in effect since the 1930s favoring industrialization (see fig. 8). In the early 1990s, the government aimed at continued increases in industry's share of the economy, especially by means of export promotion.

Services increased from a small fraction of the economy in the 1920s to just under half of GDP by 1994. Several factors accounted for the growth of the services sector. Government--already sizable under the Ottomans--expanded as defense expenditures rose; health, education, and welfare programs were implemented; and the government work force was increased to staff the numerous new public organizations. Trade, tourism, transportation, and financial services also became more important as the economy developed and diversified.  These developments however relied heavily on banks for financing which led to interest rate hikes and increases in the non-performing loans of local banks.  Increasing the loanable funds of banks through improvements in domestic savings and creditworthiness will therefore give these important industries the capital boost that is needed to generate economic growth.

There are 47 banks operating in Turkey as of January 2006. 13 of these banks are investment and development banks, and the rest are commercial banks. Three of the commercial banks (excluding 1 SDIF bridge bank) and three of the investment banks are state owned. Total number of the foreign banks is 13. There are 4 participation banks also. There are no local banks, and most of the banks are multi-branched. The total number of branches in the system declined to 6,568 as of December 2005 after the crises and the restructuring program. There were mergers and liquidations of the SDIF banks and also closures of branches during the restructuring of state owned banks.

One third of the assets of the Turkish banking system are controlled by the state-owned banks. The number of these banks is three; their total share in the financial system as of December 2005 is 30.6%. While they have collected 37.6% of the total deposits by December 2005, they have extended 20.2% of the total loans. Private commercial banks’ share in the total assets of the sector was 53.9 % as of December 2003. They have extended 65.4% of the total loans of the sector while they have collected 55.1% of the total deposits. Total amount of the deposits of the sector by the end of December 2005 is TL 243.1 quadrillion (USD 181.1 billion). 63.6% of these deposits is denominated in TL and rest 36.4% percent in FX. The three state-owned banks hold 37.6% of, while 5 large scaled private banks hold 46.2% of the total deposits. The fact that 89.7% of the total is held by the 10 large scale deposit banks shows the high level of concentration in the sector. The maturities of most of the deposits are short-term. Deposits having maturities of less than three months constitute about 89.9% of total deposits.

Since 2002 total assets of Turkish Banking System is growing steadily. As of 2005 total assets reached USD 295.8 billion. During this period loan portfolio TBS also displayed an impressive growth. As of December 2005, the amount of in-cash loans extended by banks was USD 111.7 billion and the ratio of loans to deposits was 64.5%. The non-performing loans which amounted USD 9.6 billion in end-2001, decreased to USD 5.6 billion as of December 2005. The amount of provisions set aside for these loans was USD 5.0 billion. Securities portfolios have an important part in the balance sheets of banks. Total placements made on public securities by banks were TL 143.0 quadrillion (106.5 billion USD) as of December 2005 leading to the conclusion that TL 59 of each TL 100 deposits collected was lent to the Treasury.

The results of the financial and operational restructuring of banking system show that there is an improvement in the profitability ratios of the whole sector. The net profit of state-owned banks and private banks which amounted TL 0.9 quadrillion and TL1.4 quadrillion respectively as of November 2002, increased to TL 1.4 quadrillion and TL 2.8 quadrillion in December 2003. Capital structures of the banks in the system were the core of the restructuring program. The three-phase audit revealed the real capital needs of private banks. The capital structures of the banks having capital shortage were strengthened and capital was set aside for market risks. Average capital adequacy ratio of the whole sector as of December 2005 is 24.2%. The open FX position of the system, which was a continuous problem of the last decade, decreased to USD 157 million by December 2005 from a level of USD 14.6 billion in December 2000. In addition to the foreign exchange risk, the interest rate and credit risks came down to manageable levels.

In parallel with the improvements provided by the Banking Sector Restructuring Program, several policies concerning the high intermediation costs which have a negative effect on the competitive structure and effectiveness of sector were implemented. The Government and related institutions are making considerable efforts in order to decrease the intermediation costs caused by the taxes and other public liabilities. In this context, recently stamp duty and charges on loans were removed, deposit insurance premiums were considerably decreased, and special transaction tax on deposits was eliminated.

Banking Sector Restructuring Program

Following the November 2000 and February 2001 crises, which had negative impacts both on the economy and the banking system, an extensive streamlining plan, Banking Sector Restructuring Program was started and announced to the public in May 2001 by the BRSA. The restructuring program was based on the following main pillars: (1) Restructuring of state banks, (2) Prompt resolution of the SDIF banks, (3) Strengthening of private banks, and (4) Strengthening the regulatory and supervisory framework. Progress achieved in these fields is presented below.

Restructuring of State Banks

Financial restructuring of state banks was completed, and correspondingly they began to make profits. Similarly, significant steps have been taken within the framework of operational restructuring. Organizational, technological, product, human resources, loan issue, fiscal control, planning, risk management and service structures of the banks have been restructured in compliance with requirements of modern banking and international competition. Besides, number of branches of the state banks which was 2,494 as of December 2000 was brought down to 2,110 as of December 2005; and number of personnel which was 61,601 was brought down to 38,037.

A resolution plan was put into force with regard to the restructuring program of Ziraat and Halk Bank (Emlakbank was transferred to Ziraat in July 2001). The resolution strategy for the duty loss problem (losses incurred by the state banks due to subsidized lending) included two components: Preventing new duty losses (aside from interest accruing on past duty loss claims) and managing the stock of outstanding claims. The overall total resources transferred to the state banks with the aim of tying the duty loss receivables from Treasury (which reached TL 17.4 quadrillion as of end 2000) to securities and providing capital support amounted TL 28.7 quadrillion by the end of 2001. In addition to the removal of the duty loss problem and capital strengthening, the short-term liabilities of the state banks were eliminated and deposit rates of these banks are determined in line with the market rates.

Resolution of the SDIF Banks

20 banks were taken over by the SDIF between 1997-2003 while two banks (?mar and K?br?s Kredi) were liquidated directly without being taking over by the SDIF. After the BRSA started its operations on August 31, 2000 (in addition to the existing 8 banks) administration of 13 banks were assumed by the SDIF upon the resolutions of the BRSA. Of these 20 banks, 12 banks were merged; 5 banks were sold to domestic and foreign investors; and license of 2 banks was revoked. By the end of October 2005 there is only 1 bank (Bay?nd?rbank) left under the administration of the SDIF as a bridge bank which is not accepting any new business and is thus well along towards resolution.

With a view to accelerating resolution process, the SDIF banks have been subjected to a comprehensive financial and operational restructuring process. Accordingly, short-term liabilities of the SDIF Banks have been liquidated and a portion of deposits and F/X liabilities has been transferred to the other banks. In addition, receivables under follow-up of the SDIF banks have been transferred to the Collection Department and thus efficiency in follow-up and collection activities is ensured. Likewise, subsidiaries and real estates of these banks are disposed by taking market conditions into account. As of December 2005, USD 2.7 billion have been collected from receivables under follow-up.

Strengthening the Private Banking System

Strengthening private banks, whose financial structures and profitability performances were worsened due to the crises experienced, composes an important part of the Banking Sector Restructuring Program. Within the scope of the program focused on private banks, first steps were taken towards strengthening of the capital structures of private banks with their own resources and limiting the market risks. Along these lines, important progress has been realized in these areas. In the context of Bank Capital Strengthening Program, 25 private banks were subjected to a three-phased audit process. Cash capital increases, correction of provisions set aside for non–performing loans, positive changes engendered in the market risk and valuation of securities were taken into account during the evaluations and accordingly, three banks were determined to have capital needs. The capital needs of these banks were provided either by their shareholders and or by allocation of subordinated loan by the SDIF upon the resolution of the BRSA. By the end of December 2005 total own funds of the sector amounts TL 53.7 quadrillion (USD 40,0 billion). With the improvement observed in profitability, the average capital adequacy ratio of the sector was realized as 24.1 % as of December 2005.

Strengthening the Regulatory and Supervisory Framework

Concurrently with financial and operational restructuring of banking sector, significant progress has been achieved in legal and institutional regulations, which will strengthen the surveillance and supervisory framework, ensure competitiveness and efficiency and improve confidence in the sector.

In this context, regulations were issued to prevent risk concentration in loans, limit participation of banks in non-bank financial institutions and ensure preparation and disclosure of banks’ balance sheets in compliance with international accounting standards. Among many other structural ones, banking reform intended to upgrade and modernize the current rules and in general covered the following banking related areas: capital adequacy, foreign exchange exposure, internal control and risk management, deposit guarantee schemes, accounting standards for financial disclosure purposes, prudential reporting and loan loss provisioning.

Results of the Restructuring Program

            The implementation of the restructuring had the following effects on the Turkish Banking Sector.  Due to the structural changes that were implemented, the banking sector entered a consolidation process and the weight or percentage of state owned banks, as well as SDIF banks, in the Turkish Banking System greatly declined.  This in turn lead to the strengthening of the financial sector as caused by the reduction of financial risks and boost in investor confidence on the stability of the Turkish Banking System.  The boost in investor confidence also had a positive impact as it lead to the strengthening of the capital structure of the local economy and spurred the Turkish Banking Sector into a growth period at rates almost equal to what they were previous to the economic crisis.  This increased growth also led to the increase in the profitability performance of private banks has improved and state-owned banks have started to generate profit thus improving the overall performance of the Turkish Banking system.


This section of this study shall focus on the effects of housing finance and economic development.  Housing finance is not neutral to economic development. There are multiple and well-known negative consequences of poor access to housing finance. On the other hand, international experience and research in high income economies shows that a well functioning mortgage market will provide large external benefits to the national economy: efficient real estate development, construction sector employment, easier labor mobility, capital market development, more efficient resources allocation, and lower macroeconomic volatility.

From the perspective of world history, urbanization is a new story and the second half of the 20th Century was marked by the urbanization take-off.  What will now differentiate urbanization in the 21rst century from the past is that it will be totally dominated by urbanization in emerging markets.  Most of world population growth over the next three decades will take place in developing economies and 95% of that growth is projected to be in cities.  As a result, the latent demand for the efficient real estate finance systems needed to manage the production and trading of urban assets in the cities of developing economies is strong. Pressure to act is high because the lead time for the diffusion of an already known financial innovation in a new market is often of the order of five to seven years during which city population will grow in large numbers.

So far, there has been no comparative finance work of a relatively systematic nature on the organization, structure and performance of housing finance systems in emerging markets. Even for higher income emerging economies, there are very few comparative studies. When it comes to what to do in emerging financial markets, views of mortgage market development policies remain framed by the experience of a few high-income economies; especially by the remarkable rate of innovation in the US financial markets during the last thirty years.  However, in shaping a mortgage finance development strategy for an emerging market can a direct transfer of institutional arrangements found in advanced economies be readily suitable? Why is it that so many attempts to introduce mortgage securitization in emerging economies have met with so few successes?

The absence of credible comparative studies of mortgage finance systems in emerging economies might be attributed to their potential cost, the scarcity of relevant skills, the lack of private profit incentives for global investors to fund such work, and from the viewpoint of regulators to the perceived lack of systemic risks that a fragile housing finance system might create for regional or global financial markets.  The situation might change for middle-income emerging economies. A new driver for more comparative analysis of housing finance systems is the potential impact of real estate assets volatility on the stability of domestic financial systems. Another one is the approval of the Basel Capital Accord II on 26th June 2004 for implementation by 2006. This second Basel Accord is expected to have strong direct and indirect effects worldwide on mortgage finance systems through its new rules on credit risk, interest risk, and securitization that are embedded in its ‘three pillars” on banking regulation, banking supervision, and financial market development.

Given that almost all the major innovations in mortgage finance have originated in high-income countries how can this technical capital be brought to bear on the design of suitable strategies to develop mortgage markets in a given emerging economy. We can expect such strategies to be shaped by two core factors: the current scale and development depth of the domestic financial markets, and the degree of organization of housing markets in the cities of the country.  The aim of this paper is to map out some important structural differences between emerging markets and developed economies.

This paper first discusses five recurring structural issues that need to be considered when proposing a mortgage market strategy: market size, macroeconomic stability, the degree of development of financial market infrastructure, legal and structural path-dependency in the development of this financial infrastructure, the feasibility of domestic risk-based pricing for medium and long-term financial instruments. The second part reports recent new findings on the measurement and determinants of financial structure across some 175 countries that affect the growth of mortgage finance systems.

What are the strategic implications of these findings about the evolution of financial market structure across income levels for mortgage market development? The third part shows the impact of housing market structure on finance. The fourth part reports on the mortgage markets actually observed in emerging economies. The last section offers observations on the development path of mortgage finance in developing economies


Small Financial System

Two basic indicators of financial development are the total volume of financial assets to reflect scale and financial assets per capita to reflect financial depth. By these two measures, many emerging financial systems are quite small and shallow: they lack economies of scale and scope.  Other things being equal, larger financial systems and larger banks are more efficient and more profitable than small ones for three basic reasons. A larger financial system will have lower fixed cost relative to its assets. It will have greater overall liquidity and its larger individual banks will also have less internal need for liquidity. Third, the system will be able to use its capital more efficiently through better pooling of risks without increasing the probability of insolvency and instability. For an individual bank or other financial intermediaries, a larger scale and a stronger reputation also enhance each other.

While economies of scale result from doing more of the same activity, economies of scope result from carrying out different but related activities. Financial innovation is more likely to arise in larger markets where the necessary instruments, tools and know-how are already available or can be more easily developed.  The smaller a financial system, the more incomplete its range of financial instruments and services is likely to be for risk management and for funding.

The most recent year for which global comparative data on financial systems from the IMF’s International Financial Statistics together with the demographic and economic structure of their economy from the World Bank’s Development Indicators are available is the year 2000. This database covers 183 countries and shows that many financial systems are in fact extremely small: 63 countries had an aggregate financial sector size (measured by money supply M2) of less than USD 1 billion, i.e. no larger than a single small bank in an industrial country. These countries are dispersed around the world. Yet in aggregate these small economies represent a population over 200 million, i.e. a total larger than Indonesia, Brazil’s, Bangladesh’s, or Russia’s population.

A higher size threshold of USD 10 billion would be of the magnitude of the balance sheet of a medium-size bank in an industrial country. We find that 115 countries still fell under this second cut-off point. These countries accounted for a population of almost 820 million in 2000. These financial systems include all of Sub-Saharan Africa except Nigeria and South Africa, some large transition economies such as Ukraine and Vietnam, a number of Latin American countries and in particular all the countries of Central America, as well as the three Baltic states in Europe.

Complementing Figure 1, Table 1 provides data on the size distribution of financial systems in 2000. Based on the value of M2, 125 countries had a financial system of $100 billion or less. Only 25 countries dominate the global financial markets. The population share of these 25 countries represented 61% percent of the world because it includes China and India. Their share of global financial assets was 95% in terms of M2, and would be greater if better measures of net total financial assets were available. Predictably, the attention of most market analysts focuses on these 25 largest countries where the returns on information gathering and processing are positive.

As expected, comparisons based on financial depth measured in terms of M2 per capita as a proxy yield very different country groupings and rankings. One hundred countries have a level of financial depth below US $1,000 of M2 assets per capita. Small advanced economies such as Switzerland, Singapore, Hong Kong and Luxembourg have very deep financial systems. Due to its global role as a banking center located in the middle of Europe. Luxembourg has the deepest financial system, followed immediately by the US. In contrast, India and China that ranked among the twenty largest systems drop respectively by 115 and 70 places.

The globalization of financial markets does not mean that all financial systems can actually operate in a worldwide market. Licensing and regulation of banks remains a national responsibility. Cross-border transactions such as deposit taking, borrowing and lending may be constrained either by regulation or by business prudence. Moreover, when it comes to small enterprises and consumer finance – including mortgage finance – small and medium enterprises (SME) and households are confined to the services of local financial intermediaries.

For the design of strategies to develop mortgage finance systems and comparative analysis it is therefore necessary to distinguish three broad tiers in the global financial system across which diagnoses, prescriptions as well as the sequencing of reforms are expected to differ significantly. These three tiers are:

·   Tier 1: Mortgage finance in very small financial systems lacking economies of scale and scope.

·  Tier 2: Mortgage finance in emerging markets. This group is fairly well reflected in the Morgan Stanley “Emerging Market Index” (MSCI), which presently covers 25 very different financial systems. In 2000, their M2 scale ranged between $10 billion in Jordan and $1,640 billion in China. Their M2 per capita depth ranged from $260 in India and $17,100 in Israel. This second tier could include more financial systems in addition to those presently in the MSCI index. The list of the 25 financial systems included in the MSCI Emerging Market Index is provided in Appendix Table A-3. An additional list of 8 countries that could be included in Tier 2 is provided in Table A-4. It is in the Tier-2 countries that the links with mature financial markets are growing the most rapidly. Estimates from the Bank of International Settlements for 2002 show that 80% of bank loans, over 90% of foreign direct investment and over 95% of debt security issues are concentrated in these 25 countries. (See Wooldrige et al, BIS, 2003, p.52).

· Tier 3: Mortgage finance in the high-income financial systems of North America, Western Europe, Australasia and Japan. These countries are the source of innovation, financial capital and human capital transfers in mortgage finance to developing economies.  As Table suggests, 95% of global financial assets are concentrated in only 25 countries.

For the large number of small systems belonging in Tier 1, strategies to develop housing finance systems face very significant structural constraints in terms of economies of scale for financial intermediaries and markets, the lesser degree of local competition and efficiency in services, the limited capacity for domestic risk diversification, inadequate economies of scale for regulation and supervision, without overlooking the size of the pool of human resources to manage such systems.

Some mortgage market development responses to the constraints in small domestic financial markets of Tier 1 have been:

In Africa, the development of a regional supervisory authority and of regional securities markets for both fixed-income securities and equities in the WAEMU common currency zone of West Africa with its regional central bank based in Senegal. However, the impact of these institutional efforts on the development of mortgage finance services across the countries of the WAEMU zone remains minimal.

Other approaches have been the use of currency boards for a fixed rate to a dominant regional currency such as the US dollar in Panama or the Euro for the Baltic States.

· Proposals for regional mortgage market funding arrangements for countries of Central America have not yet been able to overcome national regulatory differences and multi-currency risks, as well as heterogeneous housing market conditions.

· The creation of a liquidity facility for the small islands of the Eastern Caribbean Currency Area has also met with very slow success so far.

·  Individual cross-border residential mortgage securitization issues can take place at a price, as was the case in Costa Rica in 2001 with the support of international credit enhancements by the Dutch financial development agency FMO.  Moving from such pilots to a systemic access to international funding remains to be confirmed as a sustainable strategy rather than a one time transaction.

At the threshold between Tier 1 and Tier 2, small countries such as Jordan have a financial system that is developing well. Following the model of Malaysia, the central bank of Jordan has successfully supported the creation of a liquidity facility the Jordan Mortgage Refinancing Corporation in 1996 in order to expand the competitive supply of mortgage finance by commercial banks and other retail institutions.

Macroeconomic and Financial Instability

            In addition to financial market scale, another leading issue that cuts across developing economies of various sizes is their greater degree of macroeconomic instability than in high income economies.

Macroeconomic instability and its corollary of high and volatile domestic interest rates have a disproportionate impact on long-term mortgage finance. A shared regularity between mortgage finance in advanced economies and emerging markets is that interest rate risk is typically larger than credit risk for a mortgage lender. The interest rate premium over more secure US treasuries will often be high.

A variety of factors contribute to greater macroeconomic volatility in emerging markets. Their production structure is typically much less diversified than that of advanced economies and they are often dependent on primary commodities. Domestically, market segmentation tends to be greater for capital, labor, goods, and foreign exchange markets.  In an opening economy there are also transition risks including a proper sequencing of financial sector deregulation, supervision and modernization.  The political economy of managing the macro-economy is also more prominent as a stability factor in emerging economies.

Given this background, triggers for a specific macroeconomic shock can be of various kinds:

Structural: wrong industrial policies and deteriorating competitiveness

Cyclical: falling commodity prices and sharp terms of trade decline

Financial: excessive leverage, weak domestic financial system, moral hazard

Developmental: inadequate management of the opening of the economy

Macroeconomic: macroeconomic imbalances, especially large and growing fiscal deficits

Global: contagion effects among global investors

The net effect of macroeconomic volatility is to generate a significant country risk premium in addition to a substantial inflation risk premium for the country debt of “emerging markets”, which actually consist of a limited number of middle-income emerging economies out of the 180 economies represented in Figure 1.  To the extent that a country can issue debt in its own currency there is also a significant exchange rate risk premium. The aggregate of these premia tends to spike sharply during episodes of systemic crises as show in Figure 2 that tracks the evolution of the average merging market premium over US treasuries during the last 12 years.


Recent research shows that the real exchange rate of developing countries is “approximately three times more volatile than the real exchange rate (RER) in industrial countries” and that “there has been a much higher persistence of deviations of the variance of the RER from its long run value when the economy suffers shocks of various kinds.” (See Hausmann, Panizza, and Rigobon [2004]). This is an additional challenge for the creation of robust mortgage finance systems.

Not surprisingly, many plans to develop mortgage securities markets in emerging economies face serious pricing issues in terms of interest rate levels and volatility, which negative consequences for the price of the retail mortgage loans to be funded by these securities.

However, a given emerging economy can greatly improve its position on the global financial markets over time through its demonstrated ability for sustained macroeconomic management and effective control of inflation. This is the case of Mexico today, in great contrast with the decades of the 1980s and the 1990s. (Figure 3)  The effect on domestic interest rates has been quite beneficial: the Mexican private mortgage market that had been shut down by the financial crisis of 1995 has now reopened and the market is finally growing well in 2004.

In countries with underdeveloped capital markets, large interest rate risks have to be born by individual borrowers that do not have a comparative advantage in doing so. The spread of pension reforms and the rise of long-term institutional investors during the 1990s is a major opportunity for better risk allocation and the growth of the mortgage finance system with new types of mortgage instruments, in particular the offer of fixed-rate mortgages instead of prevalent variable rate mortgages. Read also which helps enable an oligopoly to form within a market?

Financial infrastructure and incomplete financial systems

The last decade of research has been marked by the wide confirmation of the pioneering work done by Raymond Goldsmith [1969] regarding the positive effects of financial development on economic growth. This new research shows that the organization and structure of the financial system also plays an important causal role in the quality and rate of economic growth.

In particular, the quality of the financial infrastructure -- or rather the lack of it -- provides an explanation of why traditional banking predominates in the early stages of development. This lack of infrastructure is one reason behind the recent emergence of microfinance as a recognized, legitimate component of financial development, in addition to the low income level of the micro-entrepreneurs to be served. We expect the financial infrastructure of a country to shape the structure, organization and performance of the finance industry and the process of capital formation – and therefore mortgage market development strategies.

What is meant by financial infrastructure in the context of financial development in emerging markets?  Reflecting the numerous financial crises of the last two decades in advanced economies and emerging markets alike, most financial economists now include the following components under the term ‘financial infrastructure’

  • 1. The legal and regulatory infrastructure:

·         Financial legal and regulatory frameworks, including bankruptcy codes, enforcement, and conflict resolutions mechanisms between creditors and debtors;

·         Supervision, accounting, auditing, as well as the rules, practices and professions that go with them;

·         Financial corporate governance and institutions;

  • 2. The information infrastructure:

·         Public registries;

·         Laws and rules about disclosures;

·         Valuers;

·         Credit bureaus;

·         Rating agencies;

·         Financial and industry analysts;

·         Macroeconomic analysts;

·         Timeliness, accuracy, coverage and access to public statistics

  • 3. The risk-pricing infrastructure:

·         Government securities markets

·         Sub-national bond markets

·         Private sector bond markets

  • 4. The payments and settlements infrastructure:

·         Clearing and settlements systems;

·         Rules and standards;

·         IT technology platforms;

·         Networks.

  • 5.  The financial stability infrastructure:

·         Liquidity facilities;

·         Other safety net facilities.

From an examination of this, two points can immediately be made.  First, the mere listing of these five categories of financial infrastructure is enough to suggest that bank-based systems will predominate in the early stages of financial development.  Financial systems will be able to evolve from being “bank-based” to becoming increasingly “market based” as the financial infrastructure permits an increasing unbundling and the more efficient pricing of the risks underlying the supply of financial services initially provided by banks.

Second, the provision of all these infrastructure components includes a significant mix of public goods and private goods and is therefore shaped by the political economy of financial reforms. Therefore, in addition to a domestic lack of human capital and technology, the interactions between governments and domestic rent-seeking interest groups will determine what infrastructure component is going to be developed and what is going to be ignored or at least long-delayed. It often takes a crisis to create new alignments in private interests and public incentives and opens opportunities for infrastructure improvements.

Why do we expect ‘bank-based’ financial system to dominate in emerging markets? In financial systems where the infrastructure is inadequate, traditional banks as financial intermediaries develop relationships and contracts for both deposits and loans with their clients.  These contracts aim to minimize or mitigate information asymmetry problems and the associated transaction costs. To a subset of potential borrowers they offer access to funding at prices and conditions that is not feasible through non-bank finance.  These banks give incentive-compatible debt contracts that give the creditor the ability to save on the costs of monitoring the borrower’s performance throughout the life of the contract, and give borrowers incentives to minimize the risk of default and discourage them from hiding the true performance of their business.

A basic proposition of financial development is that this information asymmetry leads bank to engage in credit rationing. In economies with limited financial infrastructure we expect that banks will lend for trade finance and to firms with large tangible assets that can serve as collateral, which usually is real estate.  Traditional banks will also exhibit a strong preference for repeat business with firms in more established activities, in better-known production sectors.

A barrier to improving and developing a solid financial market infrastructure --and indirectly to the development of housing finance -- can be the presence of an oligopolistic and politically influential traditional banking industry that is rent seeking and may successfully lobby the government to limit the entry of new financial intermediaries in order to protect high margins. In such environments of rationed finance, established preferred borrowers may also lobby to protect their relationships with these banks.

The significance of an opaque, traditional, bank-based financial system is that the seriousness of the information asymmetry problem will tend to limit banking relationships to repeat business with mostly blue-chip customers who need to maintain their access to finance.  Such a market structure can become a very important obstacle to the development of housing finance, which is characterized for banks as a business line of small-scale loans to infrequent customers, whose collateral may not be easily enforceable.  Banks find it less attractive to develop lines of business for retail commodity products like mortgage loans. For these reasons government often resort to the creation of special circuits for housing finance.

Does the long list of infrastructure pre-requisites to a sound financial system condemn developing economies to a weak development of their mortgage finance systems? The analytical answer appears to be no. One important strategic opportunity to better risk management in housing finance is pension reform and the rise of institutional investors as seen during the last decade in Latin America and elsewhere. Where do you start? A suggestive answer to a workable strategy relevant to mortgage finance has been offered for pension reforms by Vittas [1998]:

“….Consider an imaginary country that lacks all the fundamental elements of a well functioning financial system: no solvent banks and insurance companies; no mutual funds and securities markets for equities; no long-term financial instruments and annuity products; no experienced regulators and supervisors; no bankers and actuaries; no accountants and lawyers; and no rating agencies. Should such a country reform its pension system and introduce a mandatory retirement savings scheme? Normally, my answer would be a firm no. [….]

            There are, however, three preconditions whose fulfillment would allow even a country lacking all the essentials of a well developed financial system to consider undertaking systemic pension reform. These include: a strong, long-term and persistent government commitment to implement a successful pension reform; introduction of effective arrangements for the safe custody of pension fund assets (to prevent theft and misuse of assets); and free access to foreign expertise”.

Dimitri Vittas [1998], p.2.

As the examples of mature financial systems shows, the cornerstone of mortgage finance development does not lie so much in the private sector but in this ‘strong, long-term and persistent government commitment’ for financial reforms as shown by the on-going efforts of two very different reforming countries such as Mexico and Pakistan.

Path Dependency

The successful transfer of known mortgage finance innovations to a developing financial market requires adaptation to local institutional and financial conditions.

The comparative work on financial systems by Allen and Gale [2000] focuses only on a very small subset of five advanced economies (US, UK, Germany, France and Japan) to generate a rich set of hypotheses about why different countries have different financial systems, why these different systems came to exist, and, whether these differences eventually matter. Allen and Gale also highlight the fact that financial systems in different countries have a tendency to maintain their core structural and organization characteristics over considerable periods time, some being more bank-based that capital-markets based for instance.

A central factor in shaping the development of a financial system appears to be the nature of the legal system. Within that context, the basic point of path dependency is that “the path of the law shapes the law.” Recent work in comparative law and economics has shown for instance that different legal system may favor or hinder the development of capital markets.

In the context of global financial development, it would be myopic to limit ones attention only to simplified comparisons between countries of civil law versus countries of common law, especially when it comes to issue of real estate property.  Mortgage finance systems are being developed not only under civil or common law regimes whose path dependency varies even across neighboring countries, as the difficulties in harmonizing collateral laws, regulations and practices within the Euro zone. There are countries that are influenced by Ottoman law, other forms of Islamic laws, and/or traditional tribal ownership rights. Some large countries like Indonesia may have to contend with a reconciliation of most of these legal traditions at once.

There are two areas where path-dependency is specifically important for the development of modern mortgage finance systems:

First there is the contrast between common law and civil law countries in the treatment of real property rights, which affects the nature of ‘secured lending’ and the legal possibility of trusts for securitization and the transfer of property.

Another path dependency issue of significance is the fragmentation of property rights that is the legacy of Marxist ideology and central planning in former centrally planned economies, in which 40% of the world’s population lived in 1990. The fragmentation of property rights among a number of different owners in the cities of making the transition to markets is a fundamental obstacle to the efficient use and trading of urban assets; especially in the initial years of the transition to markets.  This fragmentation of property rights across different administrations, state enterprises and new private owners must first be resolved in the main body of laws in a few years. However, ncorporation into official behavior and local practices can take substantially longer in large countries such as Russia and China.

Heller [1998] coined the expression “the anticommons” in a law paper on the costs of fragmented property rights during Russian property reforms in the early 1990s. Heller‘s definition is that “when there are too many owners holding rights of exclusion, the resource is prone to underuse -- a ‘tragedy of the anticommons’ “.

This anticommons problem was first analyzed in the case of Russian commercial real estate by Harding [1995]. She was investigating why the services sector and small enterprises had such great difficulties in securing commercial space in spite of the great demand for retail services in all Russian cities during the early years of the transition to markets in the early 1990s. Figure 4 taken from her analysis describes the fragmentation of the ownership right bundles across central government, local government, and private market participants that kept stores empty.

Absence of Risk-pricing Infrastructure

            Given the rapid development of capital markets and of mortgage-related securities in advanced economies during the last two-decades and in particular during the 1990s there has been a strong tendency for public and private providers of international advice to promote vigorously the development of mortgage securities in emerging markets with the perception that such markets would grow on a large or at least a significant scale. On the ground, however, the success of these efforts has been limited because weaknesses in the infrastructure as well as the lack of domestic bond markets and the absence of a domestic yield curve off which to price domestic risks were overlooked or ignored by this international advice, time after time.

Two factors are finally bringing positive changes in support of the development of domestic government bond markets, which are a fundamental component for the development of markets in mortgage-related securities. Government policies regarding debt financing have been changing significantly with financial liberalization.  Reliance by governments on captive sources of funding whereby financial institutions are required to purchase and hold government securities, often at below-market prices is receding in most countries. Instead, countries now pursue explicit strategies aiming to develop a diversified investor base for their government securities ranging from wholesale domestic and foreign institutional investors to small-scale investors. Usually, the most important investor segment is the contractual savings industry.

The second factor behind the emergence of government bond markets has been the spread of pension reforms in many emerging countries since the influential experience of Chile two decades ago. The rise of institutional investors who demand high-quality, long-term, fixed-income securities is a major new development particularly favorable to the emergence of market-based housing finance systems.

A related development of the late 1990s is the shift away from bond issuance in the international markets in favor of issuance in local-currency bond markets in emerging economies. This development has been actively supported by the World Bank and IMF.  This trend has been reinforced in the aftermath of the series of national, regional and global financial crises and the policy advice of the Financial Stability Forum. This trend is most visible in higher-income emerging economies and a lower-income but large economy like India; see Figure 5. It is accompanied by the modernization of these bond markets. (World Bank and IMF, 2001).


Fundamental to the emergence of a modern, risk-based mortgage finance system is the development of a benchmark 10-year, fixed-rate, coupon bond, which is being achieved in an increasing number of upper middle-income emerging financial markets. Equally significant, is the convergence of their yields with those of US and Euro markets; see Figure 6.


The “home bias” in international policy advice

            An additional issue does not reflect the structure of emerging mortgage markets, yet affects the mortgage market development strategy that a country might adopt. This issue is the nature of the international advice provided that has been given pragmatically in the absence of systematic comparative work on emerging markets.

As previously noted, analytical work on general comparative financial development has been based on a small set of countries with deep financial markets and high per capita income.  In particular, under the influential work of Allen and Gale [2000], students of financial development have tended to focus on four countries as representative of  two types of systems: “bank-based” financial systems such as Germany and Japan where banks have played a leading role in savings mobilization, investment financing and risk management; “market-based” financial systems such as the UK and the US where securities markets share these functions with banks.

In the case of housing finance systems where work has started very much later, the same pattern on reliance on the instruments and institutions of a few high-income countries has been repeated. The pioneering comparative study on the efficiency of housing finance systems  by Diamond and Lea  [1992] compares five Western countries that have very high incomes and are fully urbanized: the UK, the US, Germany, France and Denmark. The second effort came a decade later from Mercer Oliver Wyman [2003]. This time the scope of the study is limited to eight European countries: Denmark, France, Germany, Italy, Portugal, Spain and the UK. The new insights provided by this 2003 study are again very welcome.  However, the issue of their direct policy suitability for emerging economies with incomplete financial systems deserves to be challenged.

In the absence of a readily available body of comparative work on emerging mortgage markets, there has been a strong “home bias” in policy advice. Because housing is a non-traded sector the demand for international agreement has been very low during the 20th Century. Discussions and advice have long had the tendency to reflect the single domestic country experience of participants –except in recently in Europe with the creation of the European Union, then of the Euro as single currency in 2001. Yet when governments of emerging economies seek advice, they often do not carefully examine the relevance of the most recent innovations in a very high-income deep financial market like the US to their current needs when US innovations of much earlier decades might be much more appropriate.

As Figure 6 shows, in the US the largest gain in financing home ownership preceded the development of mortgage securitization.  The historical record shows that behind the major strengthening and deepening of US housing markets between 1940 and 1960 were successful public policies and innovations to strengthen housing markets proper and the operations of retail mortgage lenders, as well as the development of different forms of public and private mortgage insurance. (See Tucillo and Goodman [1983])

Given these issues in mortgage market development, what do we know now about the evolving structure of financial market across the full income spectrum as an economy develops?


A significant step forward has been taken in 1999 with the completion of a new global database. This database uses bank-specific data and has aimed to construct indicators of the market structure and efficiency of commercial banks. This work represents several firsts: “…the first systematic compilation of data on the split of public versus private ownership in the banking sector… the first attempt to define and construct indicators of the size and activity of non-bank financial intermediaries, such as insurance companies, pension funds, and non-deposit money banks…the first to include indicators of the size of the primary equity markets and primary and secondary bond markets.” This new source provides data for periods ranging from 1960 to 1997 for 175 countries on 37 indicators, but the country coverage varies significantly for each indicators. (see Demirgürç-Kunt and Levine, or DKL [2001]).

From the viewpoint of mortgage market development, what is of particular interest is the information that might be gained from this new 1999 financial sector database on banking sector performance, non-bank intermediaries and bond market development across the full spectrum of country incomes, which takes us beyond the dominant emphasis on the dichotomy between banks and equity markets. This new database reveals significant patterns regarding the size and activity of financial intermediaries at various income levels. The database confirms previous insights into policy sequencing and desirable priority actions regarding the development of housing finance systems at various stages of financial development.

Five figures from DK L (2001) based on this new database provide an overview of dominant financial development patterns. These graphs summarize key features of the financial environment in which housing finance systems have to develop.

The new evidence from the 1999 World Bank database shows that primary or retail mortgage markets will depend initially on the performance of banking institutions that are dominant across a wide range of income levels except for the largest and highest-income emerging markets.

As the initially fragmented property rights of transition economies show, conditions in the housing markets themselves and the nature of the assets to be financed cannot be ignored. The evidence available supports the view that there is a virtuous circle of better finance encouraging the development of housing markets, which in turn deepens the development of mortgage finance system.

Comparative housing research since the 1980s has shown that during development market distortions tend to be much more severe on the supply side than on the demand side (Malpezzi and Mayo, 1985).  The exceptions are centrally planned economies where the distortions are severe on both sides of housing systems. In market economies, three leading causes of significant housing market distortions are institutional weaknesses regarding real estate property rights and land markets, market-averse urban planning regulations, and rent controls.  However imperfect its data might be, the only global survey of housing markets in existence provides important clues about the impact of housing market structure on the development prospects of housing finance systems.

Two indicators of housing market performance in Table show how the structure of housing markets is often a very important obstacle to the growth of mortgage markets in developing economies.  In particular, the high proportion of “unauthorized” housing units will drastically limit the possibility of develop every form of secured lending in some markets. Urban reforms to reduce the ratio of high housing prices compared to household purchasing power is often a prior condition to developing mortgage markets.


Since financial systems are predominantly bank-based at early stages of development priority must be given to the development of bank- based retail mortgage markets. Then the question becomes whether or not private banks are willing or able to lend for housing on a significant scale.

In previous work, I have suggested that a typology could consider six broad types of mortgage finance systems with very different development needs and strategic priorities (see Renaud [1999]):

Undeveloped mortgage finance systems where the per capita income is low, the economy is small and the overall financial system small and undeveloped as encountered in Sub-Saharan African, and small economies of Asia and Latin America, as well as many island economies.

The systems under construction or reconstruction in former centrally planned economies, the most important of which is China. Russia and Central and Eastern European countries also belong to this group. So does Vietnam, which has a large reservoir of future urban population.

The housing finance systems that are remaining underdeveloped because of the lingering legacy of direct government interventions in the financial system and reliance on public institutions for housing finance. Most countries of the Middle-East still belong in this category.

The housing finance systems that have suffered from repeated episodes of macroeconomic instability, as has been too frequently the case in Latin America, Turkey and the Philippines.

Then there are the housing finance systems that are generally sound and growing where macroeconomic management and financial sector policy have been supportive.  There are number of these cases in Asia such as Malaysia and Thailand.

Finally, there are the developed mortgage markets of high-income economies found in Europe, North America and the Pacific region.

This informal typology is reflected in the indicators of depth of mortgage markets presented in Figures 13A  and 13B where for the benefit of legibility the bars are uniformly scaled across regional groupings. These figures reports recent measures of the ratio of residential mortgage loan outstanding at the end of the year to national GDP that year. Some broad points can be made. First, even among the high income countries of the European Union housing finance depth varies greatly from a high ratio of 70% in Denmark to a low 10% in Italy in 2001. These differences are due to the quality of the institutional framework, policies and practices in both the housing markets and the mortgage system.

Across regions of the world, is it quite noticeable that countries of the East Asia region (as defined in World Bank practices) enjoy much deeper housing finance systems than either Latin America or the Middle-East.  Countries of South Asia, especially India that will contribute a major share of forthcoming urbanization have very shallow and undeveloped mortgage finance systems. Except for South Africa, all African financial systems presently lack the economies of scale and scope needed for a performing mortgage finance system, and remain at a seminal stage.

Systematic comparative work on mortgage market development in emerging economies is still at an embryonic stage. Yet current experience already suggests a series of observations regarding the likely development path of mortgage finance systems.

When promoting the transfer of a mortgage finance innovation to a developing economy,  attention needs to be paid to its overall financial conditions. These will differ widely beyond the three broad tiers of countries described in Part II, section 1. In addition to the economies and scale and scope differences across these three tiers of countries, on-going research also shows that five broad types of financial systems should be distinguished. Within these five types of financial groups, finer intra-group, and regional distinctions could further be made. (See World Bank [2001], p. 25-28):

  1.   Small low-income countries dominated by state-owned financial institutions
  2. Transition economies with weak rule of law
  3. A lower middle-income, bank-dominated country emerging from a crisis
  4. An upper middle-income country with a still shallow financial system
  5. Mature, deep financial systems

When it comes to mortgage finance, the evidence available and the accumulating field experience allows us to make ten observations regarding likely development paths:

  • Macroeconomic stability is an absolute prerequisite for the development and growth of private mortgage markets and sustainable long-term finance. Without macroeconomic stability only small, costly and significantly subsidized state housing finance programs can operate.  The experience of Mexico is a good example of successful macroeconomic reforms that have made possible the strong revival of private mortgage lending since the  year 2000.
  • A strong, long-term, persistent government commitment to financial reforms is essential to housing finance. Without such a commitment, the required legal and regulatory infrastructure is not likely to be built, or to be consistent across financial sectors, institutions, and instruments.
  • The restructuring of costly and unsustainable public housing programs and subsidies that undercut the supply of private mortgage finance is often a prior requirement to moving forward in mortgage finance reforms proper. Financial authorities and urban authorities must learn to work together for that purpose.
  • As already noted, finance is the derivate of the real sector. Correcting large distortions in the housing markets will be needed in countries where housing price-to-income ratios are high. Such structural improvements usually include stronger property rights, land titling and effective registration systems. In addition, a more elastic land supply and market responsive urban planning are part of the solutions.
  • Because financial systems typically evolve from being bank-based to developing a market-based component, the development of primary, retail mortgage markets comes first.
  • However, latecomers to mortgage finance do not have to repeat the historical sequence observed in the 1999 World Bank survey reported in Part III.  Depending on the scale and scope of their overall financial markets, such countries might instead pursue a two-pronged strategy of simultaneously strengthening their primary markets and developing new mortgage capital markets.
  • Sound primary mortgage markets means:

·         The standardization of documents and of loan underwriting practices

·         The standardization of the mortgage loan instruments themselves (ARM, FRM)

·         High quality loan underwriting, servicing and collection

·         Professional standards of property appraisal

  •   When it comes to developing the mortgage capital market, the three critical roles of the government are:

·         Insuring the quality and enforceability of the mortgage collateral;

·         Building a complete legal and regulatory framework coherent with the framework of the overall financial system;

·         Reducing uncertainty for market players throughout the entire process.

  •  Regarding the choice among types of mortgage-related securities to be encouraged, there is a natural sequencing from older, simpler mortgage bonds to more complex mortgage-backed securities (RMBS).  However, depending on the domestic financial context, RMBS might be better suited to the local banking environment. The five broad types of financial systems described above call attention to that possibility. Occam’s razor applies: simpler, bond-type mortgage-related instruments are normally better until market scale and scope has expanded sufficiently. (See Chiquier et al. [2004])
  •  Finally, in a nascent market, specialized lenders are often a good way to kick-start the mortgage finance system and to get the market going. However, as the financial system expands and liberalizes, these specialized lenders may come under competitive pressures. They may have to modify their business model, including joining large, diversified banking groups with large branching network and wider funding options. Such an evolution can be observed in Mexico. After a decade of rebuilding following the shutdown of the private mortgage finance system in the aftermath of the 1995 currency and banking crisis, large, independent mortgage finance companies (Sofoles) are being acquired by banking groups.

Financial factors and its impact on financial Institutions

Turkey had undertaken major economic reform in the 1990’s and it is in the process of introducing the mortgage system in Turkey in 2006. Many financial factors have affected the financial institutions. The financial factors that affected financial Institutions are the structure of banking, government regulatory policy, involvement of private and foreign banks and the creation of non-banks such as insurance companies and other specialized banks and the evolution of professional financial services other than traditional banking services to different customer segments. In addition the introduction of mortgage system also has created a primary and secondary market for mortgages to enable the mortgages to be affordable to low-income groups and to lengthen the terms of credit. As well the introduction also has made the mortgage market by the means of issuing mortgage backed securities and or mortgage bonds.

The above factors will be discussed in detail why they affected the financial Institutions and how the financial factors affected and shaped their operations and how financial regulations will affect further the financial services and competition and their banking and non-banking operational practices in the verge of introduction of mortgage system in Turkey. As well how government monetary and fiscal policy will be affected by the introduction of mortgage system so that the macroeconomic environment is stable to have an effective and efficient mortgage system and there fore to implement prudential regulation of financial Institutions in Turkey and affect financial Institutions services and practices, which enhances economic growth and stability, and to meet the macroeconomic goals and stable macroeconomic environment in a sustainable manner.

In this manner the credit expansion as a result of mortgage system in Turkey will affect the Financial Institutional structure and the services provided and its practices and procedures. As a result of supervisory framework to regulate the banking and non-banking sector the financial Institutional structure and practices and operations will be changed after the introduction of the mortgage system in Turkey.

This also highlights how the mortgage system introduction in Turkey has affected the government financial discipline in fiscal and monetary policy to keep inflation low so that the housing market and the banks can be certain that the mortgage loans are affordable and banks can extend loan periods to 30 years from the short terms periods now exist in Turkey for housing and real estate loans. There fore it can be argued the introduction of mortgage system has affected the financial Institutions of regulation particularly the financial management of fiscal policy to keep interest low and keep the fiscal budget under control and monetary policy, which encourages a stable macroeconomic environment to control inflation in Turkey, is more important than ever before. It can be said that the introduction of mortgage system will further deregulate the financial system and capital markets and also increase the complexity of financial products offered by banks and non-banks other than the traditional banking operations and in to more specialized financial services to a variety customer segments in Turkey than ever before in Turkeys financial system.

In the Capital Market Board of Turkey in an article “THE DRAFT LAW AMENDING THE LAWS RELATED TO HOUSING FINANCE SYSTEM” has identified as a result of efficient housing finance system the pre-condition is to reform the capital market Institutions and to have securitization of mortgage by allowing mortgage corporations to issue and trade market bonds backed by mortgage collateral and to have macroeconomic environment which is stable and the control of inflation.  The Capital market Board article as quoted above demonstrates the introduction of mortgage system in Turkey affects the financial system to become more deregulated and allow the development of capital markets which attracts foreign capital and foreign investment in the financial system of Turkey to enable the housing finance affordable not only to high income groups but also to low-income groups and keep the interest rates lower so that the credit terms are longer not shorter in the current housing finance system in Turkey. It also reinforces the arguments I have presented in page 4 and 5 that mortgage finance system increase the importance of fiscal and monetary policy as a financial factor affecting the Financial Institutional policies and practices particularly of government and to have a Institutional frame work to improve the efficiency of housing finance system and to have tax incentives and to keep low the transaction cost of lending by mortgage Institutions and regulation of these Institutions which enable the economy to have sustainable growth and control inflation. The Capital market Board article as quoted above in this page has the following statements presented which will substantiate my arguments in this page. The statement is as follows.

 “Establishing an efficient housing finance system requires a coordinated works in different areas. Housing finance system can be stated, mainly, as a mechanism which would transfer the funds to the home buyers, however the efficiency of the housing finance system depends on macroeconomic stability, in the first run, and easily accessible and secure title registration system, easiness in establishing and transferring liens, well functioning appraisal profession, effective foreclosure procedure, proper capital market institutions and instruments available for securitization of mortgages, minimum operational costs from lending to securitization process, and tax incentives provided by the government at least at the start-up period. Even all these preconditions are met; there may be a need for public intervention in order to trigger the system”. (http://www.cmb.gov.tr/housingfinance/mortgage_cmb_draft_law.pdf)

In Turkey to introduce the mortgage system and increase the term of the loan and to have adequate capital the reform of the banking sector and regulatory frame work as well the importance of controlling inflation and the development of Insurance Industry as well the development of market for mortgage securities has been highlighted as financial factors to be considered for the efficient working of the mortgage system in an article by DEMIR H et el “ Housing Finance in Turkey” which appeared in the International Federation of Surveyors as follows.

“The prior condition to build up a long-term mortgage credit system is to form the market conditions and to lower the inflation rate under 15%. Unless the market conditions are not formed, the solution of the problem is impossible even the government does all the responsibilities.

The global economy and financial system

The global economy and financial system have shown, over the last year or so, enormous resilience in the face of successive shocks. Taken as individual events, the continuing stock market correction, the attacks of 11 September, the war against terrorism, the failure of Enron, the collapse of Argentina's currency board and the conflict in the Middle East might each have been expected to have unpleasant economic side effects. Taken together, their cumulative impact could have been far more serious - interactions frequently generate outcomes greatly exceeding the sum of the parts. Moreover, these events came on top of a global economic downturn that, for a time, threatened to gather significant momentum.

Compared with what might have been expected, it is remarkable how well the system has coped. Far from continuing to contract, the global economy appears to have begun expanding again. And it is the United States that seems once more to be leading the way, in spite of its many perceived imbalances. The financial sector too has responded flexibly to these recent developments. Payment and settlement systems coped well, even with such an extreme event as the terrorist attack on the New York financial district itself. Credit has also generally continued to flow freely, albeit more expensively to those now judged to be less creditworthy. Explanations for this good performance would certainly include supportive macroeconomic policies, notably monetary policy. But we should also acknowledge the possibility that the many years of effort put into promoting financial stability have at last begun to bear fruit. In particular, the infrastructure underpinning the global financial system, and associated plans for continuity and backup, were vastly improved as a result of the attention they received prior to the turn of the millennium.

In spite of these very welcome developments, and the expectation that they are likely to continue, it would be premature to conclude that all must now be well. Some of the concerns raised above may yet be realised, and a number of last year's shocks may prove to have longer-lasting implications. One effect which is already all too evident has been a deep erosion of that sense of trust, in both market information and people, which fundamentally underpins a well functioning economy. In the Enron case, it became clear that the profit and debt figures were not at all what they seemed. This has led in turn to a growing distrust, not just of innovative accounting at other firms, but even of some of the accounting conventions themselves. These suspicions have already weighed heavily on the share prices of a number of companies, but could yet bear down further on overall market valuations. Moreover, the Enron developments called into serious question the professional competence and even ethical standards of many people in positions of great responsibility. Not one but a whole host of internal and external levels of governance failed. Conflicts of interest played a role at each level, but the common thread was the all too human reluctance to ask the right questions when the going was good.

In the case of Japan, the doubts have focused on the accuracy of current estimates of non-performing loans in the banking system, as well as on the reliability of market prices subject to government interventions of various sorts. In Argentina the sense of trust was also violated, not only by the depreciation and associated sovereign default, but by the particular way in which these events were handled. By choosing to rewrite legislation in ways that explicitly discriminated against creditors, the government raised fundamental questions about the applicability of the rule of law itself. In the light of all this, it will inevitably take some time before an appropriate degree of confidence and trust can be re-established.

Yet even here it is possible to see a silver lining around some of the economic clouds of last year. If, paradoxically, there may actually have been an excess of trust in recent years, the Enron affair has at least put paid to that. The Argentine experience also provides a salutary lesson about how the costs of failing to carry out needed policy changes can rise dramatically over time. And finally, it is notable that the Enron failure and the Argentine debt default were allowed to happen without the massive public sector intervention often seen in the past. It should now be crystal clear when confronting such troubled circumstances that the choice will no longer be between bailout and workout. Rather, the practical choice is between an orderly and a disorderly workout. Insofar as sovereign crises are concerned, this latter debate has arguably progressed further in the course of the last 12 months than in the last five years.

A down year for the global economy

The recent economic cycle has been unusual in several respects. The expansion in a number of industrial economies, but particularly in the United States, was underpinned by evidence supporting belief in a "new era" of higher productivity growth and associated increases in profits. Credit growth, asset prices and capital investment all rose rapidly, especially in those sectors thought likely to benefit the most from recent technological developments. When the economic downturn finally came, it too was unusual in that it was not primarily due to a classical tightening of monetary policy in the face of accelerating inflationary pressures. Rather, it was led by a sharp decline in profits in the United States reflecting limited pricing power and increases in employee compensation. In effect, the real gains in productivity ended up being appropriated by the household sector. Confronted with such circumstances, and further buffeted by rising energy prices, the corporate sector in the industrial economies liquidated inventories and cut capital investment on a massive scale in 2001.

The downturn was, however, attenuated by the extraordinary resilience of consumer spending. This was remarkable in that, globally, the consumer sector had become more exposed to the risks of a corporate downturn. There has been a marked expansion in the holdings of financial assets by households, not least in the form of defined contribution pension plans, which have lost no small part of their value since the spring of 2000. In many countries there has also been a shift towards employment contracts which make it easier to lay off workers and lower compensation in downturns. These contractionary influences seem to have been offset by continued increases in house prices in many countries, as well as the fact that the prices of many financial assets are still well above levels seen five or 10 years ago.

The synchronous downturn in the global economy and the apparent common recovery has been interpreted by some as evidence of increased globalization. In a profit-driven cycle, one would indeed expect Europe and North America to move more in tandem, particularly given the scale of transatlantic mergers and acquisitions over the last decade. Furthermore, as noted above, common shocks have been key features of recent events in the industrial countries. Nevertheless, before concluding that the world has fundamentally changed, it should be recalled that synchronous cycles were also common in the 1970s and 1980s. Moreover, the long-standing recession in Japan could for a time give the illusion of a synchronous downward movement even if other economies had turned down for completely independent reasons.

Economic developments in emerging markets were largely explicable in terms of the same contractionary forces affecting the industrial countries. However, the size of the impact varied significantly. The negative effect on East Asia was particularly evident given the heavy reliance of many countries on exports of IT-related products. Latin American economies, with the notable exception of Mexico, are more closed and felt the external forces less keenly. Many central European countries seemed almost immune to the slowdown, while growth in Russia was actually stronger than expected under the influence of structural reforms and continued high oil revenues.

At the same time, developments in emerging markets had many idiosyncratic features, some for the better and others for the worse. The former would certainly include the sustained rapid growth in China and the slower but still substantial expansion in India. Even in Indonesia there were tentative signs last year that the economy might be regaining strength. These fortunate developments provided material benefits to a vast number of people, many still desperately poor. At the other end of the spectrum, the economic crises affecting Turkey and Argentina were both very costly but they exhibited some differences as well as fundamental similarities.

In Argentina as well as Turkey, the fundamental problem of long standing was the government's fiscal position. Moreover, in both cases it was the way in which an overly rigid exchange rate regime interacted with a banking system vulnerable to exchange rate changes that actually triggered the crisis of confidence. This led to a flight of capital, both domestic and foreign. In the Turkish case an acceptable and essentially traditional policy framework was quickly agreed with the IMF. However, the Argentine case has proved much more intractable given the high degree of dollarisation, the size of the debt default and the conflicts between the various arms of the Argentine government. The erratic and disruptive way in which the government then intervened in the operations of the banking system, largely foreign-owned, effectively brought both the payment system and the economy to their knees.

Financial resilience in the face of shocks

With these dramatic events as backdrop, it is hardly surprising that the global economy experienced a cyclical slowdown in 2001. Nevertheless, the picture emerging late in the first half of 2002 is that the downturn was relatively mild and that a broad-based global recovery may already be under way. Such signs are clearest in North America but are also evident in East Asia and Europe, and have been accompanied by upward revisions to the consensus forecast. While inventory swings, particularly in the IT sector, have played a crucial role both on the way down and on the way up, there are early indications that final demand may also be picking up along with productivity and profits. It is also noteworthy that there was very limited contagion from the Turkish and Argentine shocks to other emerging market economies. Some explanations for this, as well as other positive developments in the period under review, are considered below.

One reason for the positive economic outturn was the resilience of the global financial system. First of all, the infrastructure of the system proved strong. The events of 11 September affected the US equity, fixed income and repo markets for a week or so, but the global system functioned effectively, even in the immediate aftermath of massive disruptions in a leading global financial centre. Similarly, after the collapse of Enron, one of the world's biggest energy traders, the energy market continued to function normally. And in spite of all the extraordinary events referred to, the legal integrity of a whole range of new financial instruments, including special purpose vehicles and credit risk transfer mechanisms, proved robust.

The reaction in individual financial markets was also consistent with a sober assessment of changing circumstances. There was no panic flight to liquidity like that seen after the LTCM and Russian crises in 1998. Major equity markets in North America and Europe continued their long decline up until autumn last year but, soon after the post-11 September plunge, began to rise again as economic prospects brightened. Moreover, the rally persisted into 2002 before stalling, at very high historical valuations, under the joint influence of the Enron revelations and increasingly gloomy news on the profits front. Most other markets on both sides of the Atlantic showed similar gyrations. They fell, rose and then fell again as optimism about the US economy waxed and waned, while divergent European prospects were largely ignored. The overall effect, however, was that nominal borrowing costs in corporate bond markets fell to historically low levels last September and has changed remarkably little since.

In some other markets there were clearer signs of stress. The US commercial paper market was most affected, with lower-tier credits being effectively frozen out and others being asked to pay higher rates of interest. The decline in outstanding non-financial commercial paper over the last year has been the steepest on record. Yet many firms were still able to fall back on renegotiated arrangements with their banks, even though banks were feeling increasingly uncomfortable in view of the credit losses they had already suffered in the downturn. The corporate bond market, however, was an even more willing provider of funds and bond issues rose to record levels. These long-duration bond issues, while more expensive than shorter-term paper, should help ease corporate liquidity concerns for some time.

Two other features of recent events also underline the resilience of the global financial system. The first was the extent to which consumers in many industrial countries gained greater access to consumer and mortgage credit. Moreover, they availed themselves of such credit to pay down more expensive debt as well as to increase consumer expenditures. While significantly less well advanced, a similar phenomenon has arisen in a number of large emerging market economies, including China, India, Korea and Mexico. In countries with initially low domestic saving rates, such developments had to be financed, in part at least, by inflows from abroad. In the United States in particular, government-sponsored mortgage agencies were extremely successful in selling bonds directly to foreigners.

The second remarkable aspect of recent financial events was also related to international capital flows. In global circumstances likely to increase investor risk aversion, external financing for countries with current account deficits might suddenly have proved harder to obtain. In fact, this was not the case. Among the industrial countries, the external funding requirements of the United States continued to be easily met. This was generally true for emerging market economies as well. To be sure, banks further reduced their cross-border lending. However, there had been a long-standing tendency for internationally active banks to rely increasingly on a domestic presence and domestic funding to extend credit in emerging markets. In contrast, most of those seeking funds in the international bond markets still had ready access. Sovereign spreads actually narrowed over the period under review for countries such as Korea and Mexico, deemed to have sound policies, although the opposite was true (and sometimes dramatically so) for countries like Turkey, Argentina and Venezuela. Moreover, foreign direct investment continued to flow into a number of favored countries, in particular Brazil, China and Mexico, while equity prices in a range of emerging market countries were also on the rise. In sum, the outcome was - thankfully - a far cry from the indiscriminate contagion that some feared would arise from the Turkish and Argentine crises.

Factors supporting the resilience of the global economy

Why were the global economy and financial system so resilient? Policy initiatives appear to provide at least part of the answer. Stimulative macroeconomic policies clearly helped sustain aggregate demand. Perhaps more speculatively, the measures taken to promote financial stability over the past few years may have begun to prove their effectiveness. And, albeit still more in the background, many countries have acted in recent years to free up labor and product markets and improve productivity. The benefits of this were always expected to include more stable growth, as well as faster growth on average.

The most obvious policy measure was the sharp monetary easing almost everywhere. While the lagged effects of earlier oil price increases remained a source of concern for some, underlying inflationary pressures were generally viewed as subdued. This gave monetary authorities substantial room for maneuver which, moreover, many exploited aggressively.

Nowhere was this more evident than in the United States, where the policy rate was cut forcefully and repeatedly during 2001, and has been maintained at a record low level since. One conditioning factor may have been the perception that a number of the traditional channels through which monetary policy works were not operating as expected. As short rates fell, long rates dipped but then rose again, and the effective value of the dollar also appreciated. Equity prices continued to weaken, although presumably less rapidly than if policy had not eased. Even while recognizing that some of these developments were also signs of the market's optimism about the future, the Federal Reserve clearly felt it had grounds for aggressive action. A second conditioning factor may have been lessons learned from the experience of Japan. There, with prices falling and nominal interest rates effectively at the zero lower bound, cumulative increases in real rates and debt deflation have become a real possibility. Moreover, a variety of other, less common monetary policy responses, including escalating levels of bank reserves, have so far failed to turn the Japanese situation around.

The ECB also cut its policy rate in response to the economic situation. The absolute reduction was, however, more limited in view of headline inflation which stayed stubbornly above target. In addition, for most of 2001, there was a rather more moderate deceleration of growth in the euro area than in the United States. The picture was similar in most of the inflation targeting industrial countries, as well as in many emerging market economies. In the latter, the spread of floating exchange rate regimes (albeit heavily managed in some cases) provided a new channel through which monetary easing might become effective. Of course, the extent to which this new freedom could be exploited depended very much on the credibility of the policy regimes in the countries in question. Broadly stated, and largely reflecting historical experience, central banks in Asia were less constrained than those in Latin America.

Simulative fiscal policies also helped support the global economy. As a general rule, countries with a better fiscal track record were able to do more, while those with a less satisfactory history of debt accumulation had to content themselves with less. The spectrum ranged from significant structural deficit increases in the United States to active restraint in the case of Japan. Countries in the euro area felt able to complement the flexibility of the Stability and Growth Pact with tax cuts without compromising their long-run commitment to a broadly neutral fiscal stance. A similarly diverse state of affairs prevailed in emerging markets. While many governments in Asia eased fiscal policy significantly, a number of Latin American countries were constrained by exchange rate pressures or legislation directed towards ensuring fiscal responsibility after years of laxity. Mexico, for example, although much affected by the sagging US economy, had to match declining tax receipts due to lower oil prices in 2001 by expenditure cuts.

Why did financial markets respond as effectively as they did in the period under review? Lower policy rates surely contributed to this. But, in addition, financial markets in many countries are now much more varied and flexible due to deregulation over many years. Corporations, particularly in North America and Europe, had access to alternative sources of funds when initial sources dried up in the course of last year. Households in many countries were also able to alter the timing of their lifetime consumption path by tapping new markets to raise funds. This was in part a welcome by-product of rising house prices and the greater availability of collateral. However, it also reflected the increased capacity of financial institutions to use risk transfer instruments to lay off the exposures arising from these new credits. Moreover, derivatives markets, in particular rapidly growing markets for the transfer of credit risk, also allowed many economic agents to share with others the ramifications of the various shocks to which they had recently been subjected.

More broadly, financing needs have in the recent past been met more through markets than through financial intermediaries such as banks. This has limited the likelihood of collateral damage from shocks through the payment system, though it clearly did not eliminate it. The terrorist attacks of 11 September might conceivably have led to a complete collapse of market functioning had not the Federal Reserve, and in lesser measure other central banks, intervened with ample injections of liquidity to ensure that payment obligations could be met. A closely related issue is why there was so little market contagion from the Turkish and Argentine crises. The principal reason must surely be the widespread adoption of floating exchange rate regimes. In addition, both crises built up over a rather lengthy period, allowing investors dedicated to emerging markets to reallocate their funds in a relatively orderly way. It also appears that, in the wake of earlier crises, there were far fewer highly leveraged investments in emerging market economies than before. This may have been related to the declining importance of large macro-directional hedge funds in recent years. But another important factor seems to have been the growing capacity of investors to discriminate between good and bad credits and to allocate funds accordingly.

This greater capacity to discriminate between borrowers reflects another fundamental change that has affected the behavior of financial institutions over the last few years, and improved the functioning of markets in consequence. Financial institutions generally appear to have become much more risk-conscious, particularly as regards the dangers posed by lending on commercial property. They have developed new and better methods of measuring risk and have made significant progress in implementing systems to manage risk effectively. In countries where they had been pricing risk more accurately for some time, their balance sheets were significantly better prepared to withstand the economic slowdown.

Some of the credit for this change in risk culture must go to the Basel Committee on Banking Supervision, and associated efforts by its counterparts in the insurance and securities sectors. While the Core Principles for Effective Banking Supervision will continue to be reviewed and revised, and the New Basel Capital Accord is not yet finalized, the interactive process of developing these standards has already been immensely helpful. The active participation of the IMF and the World Bank Group in assessing compliance with such standards in emerging markets, and assisting their governments in making needed improvements, has been no less valuable. And complementary steps have also been taken to strengthen both market functioning and market infrastructure. That being noted, a great deal of work is yet to be done to address the financial vulnerabilities that remain. This issue will be returned to in the Conclusion of this Report.

Other means to improve cooperation among officials with an interest in financial stability, both nationally and globally, were also explored last year. The G10 central bank Governors and their non-central bank supervisory counterparts have begun to interact more regularly than before. A major expected benefit is better mutual understanding of the merits of focusing not only on the health of individual institutions, but also on the extent to which the system as a whole might be exposed to common shocks. These discussions are also a useful complement to those taking place in the Financial Stability Forum, which has established a still wider international network of officials concerned with such issues. Last year, the FSF also began organizing regional meetings. One important purpose was to share views about vulnerabilities and the ways in which the adoption of international financial standards might help reduce them. A central idea behind the Forum's work has been that individual countries would derive enormous advantages from having efficient and stable domestic financial systems. It is this self-interest, rather than the need to contribute to some vague international effort, that is thought likely to provide the primary motivation for domestic financial reform. Nevertheless, the Forum is also working to improve the market's understanding of the importance of these standards so that it will, over time, increasingly reward the compliant and penalise the non-compliant.

Finally, and as paradoxical as it might seem in the light of the developments in Argentina, some progress was also made last year in establishing more orderly procedures for resolving sovereign liquidity crises. Indeed, the chaotic events in Argentina may well have contributed to this progress. After many years of disagreement between some of the major industrial countries, the most recent G7 and G10 communiqués indicate that a substantial degree of consensus now exists on how to move forward. While full agreement and implementation could well take years, and - as always - the devil is in the detail, there now appear to be greater grounds for optimism about achieving practical results than has been the case for some time.

The Turkish Mortgage Market

In the Mortgage Finance GAZETTE (2006) website in an article “ The Turkish Mortgage Market” it has highlighted many financial factors which affects the Institutions such as instruments of securitization of mortgages and the development of market Institutions, operational costs of lending and securitization, government support through tax incentives at least in the infancy period and as a result of the mortgage system in Turkey it must develop a well functioning and independent appraisal profession in Turkey. The following statements from the Mortgage Finance GAZETTE will demonstrate the financial factors as mentioned in this paragraph, which will affect the financial institutions for the efficient functioning of the Mortgage system in Turkey are as follows. “The efficiency of the proposed housing finance system depends on a variety of factors, including macroeconomic stability and implementation of adequate internal infrastructure, such as: well-functioning and independent appraisal profession effective and quicker foreclosure procedure capital market institutions and instruments for securitization of mortgages minimized operational costs in lending and securitization government support through tax incentives, at least during the infancy period”.

The introduction of mortgage system in Turkey and the financial factors affecting financial institutions are the development of secondary market institutions and issuing of securities and the evolution of insurance institutions in the financial system of Turkey as well private sector involvement in the financial system and management of risks arising from long-term mortgage finance and the government tax incentives in its introductory stages to help the system established in Turkey. In addition to reduce the cost of borrowing and have proper institutional regulatory structure to protect consumers, the Financial Institutions such as banks and non-banks will compete in the market and also improves the efficiency and effectiveness of financial Institutions as a result of mortgage system introduction in Turkey. In addition government must use fiscal and monetary policy as a financial factor to keep budget deficit under control to keep inflation low and the interest rates low to have an effective mortgage system and attract foreign capital on this market. That is mortgage system affects the financial management of the government and its institutions and reform in this area. The financial factors mentioned in page10 and 11 are evident from an article “Mortgage System coming soon” in the web site Mortgage Advisors as follows.

“Upon effectuation of the system, the authorized agencies and institutions lending Mortgage loans other than the existing banks and financial institutions will also carry out activities. The increased number of lenders and the resale ability of such loans granted will make a substantial contribution to continuity and sustainability of the long-term loan financing system. Besides, Mortgage will also play a pioneer role on some other issues in Turkey, which we are now suffering trouble. For example, it is expected that any house desirable to be included in this system meet some certain criteria. For the values and reliability of houses, some factors such as earthquake risk of the region where the house is located and the structural strength certificate of the building will play a determining role. Because, the lenders that provide long-term loans would wish to guarantee that the building physically remain strong until the repayments of loan are completed. The houses within the system will also be insured to minimize the risk. Similarly, the effectuation of Life Insurance for the borrowers is also on the agenda. By this way, it is aimed that in case of any health problem encountered by the borrower or of his/her death, such debt would not cause any burden on the part of his/her next of kins and that the lenders reduce their risk as well.”

As the schedule foreseen for enactment and operability of the Mortgage System approaches, a substantial competition on housing loans has started to be experienced among the banks. In fact, such accelerating competition in the banking sector may also be assessed as the preparatory tours for Mortgage System by the banks. Because, although the interest rates on monthly basis seem to have dropped for the time being, it is anticipated that the sector will undergo a substantial restructuring in the coming months considering that the interest rates targeted by the Mortgage System are to be at around 4% to 5% on yearly basis. Though the reduction in interest rates seems to increase the prices of houses for the time being, it is possible to anticipate reduction in such price hikes in the long-run.

In the First Initiative web site of  Turkish Capital market Board (2004) in the article  “Turkey: Secondary Mortgage Development” it has highlighted the in ability of the banks to be involved in house financing and the  lack of standardization within the title and appraisal system is a constrain to develop the Mortgage system in Turkey and emphasize the importance of development of a secondary market which will provide long-term finance to the banking sector and kick starting the mortgage market as a whole. The following statement provided by the article quoted in this page as follows validates the points raised in this page.

“The establishment of an appropriate secondary market will assist in developing a mechanism to provide long-term financing to the banking sector as well as kick-starting the mortgage market as a whole.”[11]

 “To date there have been a number of constraints to establishing a mortgage market, the main ones being macroeconomic conditions, the inability of the banks to fund housing credits from their deposit base, and the lack of standardization within the title and appraisal systems.” The Mortgage system introduction as a financial factor of providing mortgage products by leasing and finance companies will affect the competitive structure of the market and the number of different institutions in the financial sector as well as to regulate the non-banks to avoid regulatory arbitrage between the banks and non-banks in the financial system of Turkey. In an article by Capital Market Board (2005) “ Housing Financing in Turkey”  demonstrates the points As foreign banks are attracted to the banking sector of Turkey as it deregulates its financial system and foreign Investment increases steadily and the presence of foreign banks will increase competition and will increase the Turkey’s financial systems efficiency and its practices  and as a financial factor will affect the financial institutions to adopt technology and professional banking services rather than traditional banking services in the future. The foreign investment will increase given the confidence the foreign banks have on Turkish economy and its future prospects after the introduction of mortgage system in Turkey. As an example the presence of foreign banks the article “A Reformed and financed Turkey must not slip the EU’s grasp” in the banker web site is as follows can demonstrate foreign banks in Turkey and their confidence.

“For Turkey, the past 18 months has brought a plethora of foreign banks, with acquisitions by BNP Paribas, Fortis, Dexia, UniCredit and two from Greek banks, National Bank of Greece and EFG Eurobank, among others. Lured by the young and expanding market of 73 million people, foreign banks have jumped at the prospects offered by the 87.3% annual growth in retail lending and 183.6% annual growth in housing loans over the past four year. Also, with the housing loan/GDP ratio for Turkey at 0.6%, compared to 39.8% in the EU25, the potential is huge. But as bankers pile in to grasp the opportunities offered by a much reformed Turkey, the country’s road to EU membership faces increasing obstacles over growing European protectionism, Cyprus, French concerns over Armenia and human rights issues. Formal suspension of EU talks could be decided this year.”

“Bankers have acknowledged the reform process taking place in Turkey and have had the confidence to invest. Turkey’s EU negotiations were never thought to be easy but they cannot be allowed to collapse. As Citi and many European banks have demonstrated, Turkey represents its region’s future. The obstacles to EU membership, however complex, need to be overcome.” There fore as evidenced above if the Turkish economy  is stable in macroeconomic terms then the introduction of mortgage system will enhance foreign investment and will affect the financial Institutions in terms of its banking practices use of technology and the efficiency of the financial system due to increased competition as well as its risk management and the provision of specialized banking services rather than traditional banking services due to capital market development as a result of mortgage system in Turkey.

In Turkey the banks are the primary institutions in the financial sector in Turkey prior to liberalization process, which started in 1980’s.  As a result of liberalization process started in 1980’s the share of banks in relation to the alternative to banks have increased. For example in 1997 the share of banking assets is 60% and in 2002 it was 45% as Turkey took steps to develop capital markets and direct financing to households and corporate sector. The mortgage system introduction in Turkey will attract foreign capital and the development of capital market further and it will affect the structure of institutions in the financial sector and increasing number of non-bank institutions like mortgage and other credit institutions in Turkey compared to banks.

The liberalization process also will reduce the role of state Banks in the financial sector and the increase the role of private banks and non-bank institutions as result of capital market development when mortgage is introduced to the Turkeys housing credit system. The capital market institutions as a financial factor will definitely affect the structure of institutions and their practices in the financial sector after the introduction of mortgage system in Turkey as it is vital capital markets are developed to have an efficient functioning housing mortgage system in Turkey as discussed above.

There fore the financial factors such as tax incentives, risk management, reduction of cost of lending, increasing the terms of credit to 20-30 years, development of secondary mortgage market structure and Institutions. Financial regulation of banks and non-banks, fiscal discipline and privatization of state banks and involvement of private and foreign banks in the financial sector will definitely affect the Financial Institutional and regulatory framework and in this process will affect the practices and financial services provided by banks and non-bank institutions and also will increase the efficiency of the financial sector and contribute to macroeconomic stability to keep interest rates low as possible in Turkey as a result of introduction of mortgage system which is comparable to the mortgage system used in western countries but reflect the specific conditions of Turkeys socio-economic and political climate.

The Turkish Mortgage System

The Turkish residential mortgage market has grown significantly over the last few years driven by falling interest rates and competitors trying to gain market share. What are the current issues facing this market? How are housing policies affecting its performance? Who are the biggest lenders? What will be the size of the sector in the next five years? This report provides the answers.

Scope of this report

  • Covers the residential mortgage market
  • Provides market sizing data in terms of gross advances and balances outstanding
  • Provides competitor market share for the top five players in terms of balances outstanding. A short profile of the top players is also provided
  • Looks at housing policies and issues in the marketResearch and analysis highlights

Turkey currently does not have a fully developed mortgage market. However, it is expected that new legislation will be passed in mid-2006 creating a fully functioning market.

Turkey's principal economic problem has been extremely high levels of inflation. Following the 2001 economic crisis, a 3-year program aimed at combating inflation through a floating foreign exchange regime and tight monetary policy was implemented. The changes have had a significant impact on the rate of inflation in the following years.

Mortgage interest rates in Turkey are very high. However, these interest rates have been falling as the economy stabilizes. A typical annual interest rate at the end of 2004 was around 24 per cent, but this had fallen to around 13 per cent at the end of 2005.


Today, sheltering problem is one of the most important problems of human being as it was in the past. Mortgage is a system, which will make individual landowner by paying their house's installments under long term payment plants around the rent amounts, sometimes less than these amounts, as if they are paying monthly rent. In the Mortgage system a certain amount of the real estate value is paid in advance and then for the remaining part credit is obtained from the credit establishments under the maturity options 15-30 years and variable interest rates. In this way, the landlord has collected the value of the real estate in cash. The value of the house is determined by authorized experts. In this stage, real estate evaluation experts must enter the subject. Before the Mortgage system which will make the people of small income to be land owner and has become a popular subject in Turkey nowadays, the subject of real estate evaluation and related infrastructure which is extremely weak, must be taken up urgently and well-planned. Different Mortgage applications like the number of countries applying Mortgage have developed. Because every country's economic and administrative structure differs from each other. Consequently it is a necessity to develop a different solution and procedure for each country. What should be the results of this system, which has not legalized in Turkey yet, is a matter of curiosity. In this study, the importance of the system and real estate evaluation, forming the necessary infrastructure, evaluation criteria and legalization stages have been discussed, the place of such a social project in the development of the country is emphasized.


The choice of a development strategy for its mortgage market will always depend on what financial system a country currently has. As in the human body, the various parts of the financial system interact constantly whatever the age and strength of the individual under observation. Proposed new interventions much recognize this fact. National policy makers, private sector leaders, social pressure groups, or external advisers are not free from the requirement of first making an accurate diagnosis – taking the personal history -- of their housing finance system before deciding on priority interventions.  Moreover, interventions may be needed in both the housing markets and the mortgage market. The deeper our cumulative work of comparative mortgage finance work becomes, the better the chances of success will be.

It can be said that mortgage system is the major challenges for Turkey.

  • Regaining macroeconomic stability
  • High and volatile interest rates reduce affordability and increase risk
  • Improving legal system and lending infrastructur
  • Testing and further strengthening the foreclosure regim
  • Improving the housing authorization process
  • Improving the construction period financing process
  • Expanding funding options
  • Banks have a funding (interest rate, maturity) mismatch and need capital market and hedging instruments
  • New funding instruments require liquidity, standardization
  • Need for educating and expanding the investor base
  • Expanding loan options
  • importance of TL lending
  • Instruments can be tailored to borrower need – different interest, amortization patterns, and longer terms to improve affordability (Lea 2006).


  • Açlar, A. and Çagdas, V., 2002, Ta??nmaz (Gayrimenkul) De?erlemesi, TMMOB-HKMO,
  • ALLEN, Franklin and Douglas GALE [2000]. Comparing Financial Systems, Cambridge MA: MIT Press, 507 pp.
  • ANGEL, Shlomo [2000]. Housing Policy Matters. A Global Analysis. Oxford University Press, 418 pp.Ankara,Turkey.
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Factors affecting financial institutions. (2018, Jan 08). Retrieved from https://phdessay.com/factors-affecting-financial-institutions/

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