Uzbekistan : Mortgage Market Sector Development Program

Finance / Housing finance

1. The program is aligned with the following impact: living standards improved for the population of Uzbekistan. The program will have the following outcome: availability of affordable market-based residential mortgage credit increased. The outcome will be achieved by establishing the premise for improved access to long-term market-based funding and enhanced development of competitive housing finance products, as well as reforming the inefficient housing subsidy framework and some of its programs.

2. The program will have three outputs. The multitranche PBL will primarily support reforms under outputs 1 and 2. The PBL comprises 13 policy actions under tranche 1 and 14 policy actions under tranche 2. The FIL will focus on delivering output 3 of the program.

3. Output 1: Policy, regulatory, and legal framework for the mortgage finance industry strengthened. The government will revise and strengthen the existing housing policy and subsidy framework, which is presently distorting the financial system (i.e., government housing programs are provided at below-market rates, crowding out market funding and pricing). Activities include review of the existing, and establishment of better targeted, subsidy programs that reach lower-income households. Some of the changes under tranche 1 of the PBL are aimed at reducing excessive subsidies and their regressive nature. Policy actions under tranche 2 of the PBL will further deepen these reforms to enhance the fiscal sustainability and effectiveness of pro-poor targeting. The transition, which the UMRC will facilitate, toward stronger private sector participation in the development of the housing sector will be supported by (i) introducing a new category of financial institutions specializing in mortgage refinancing activities, (ii) mandating the Central Bank of Uzbekistan (CBU) to supervise and regulate this new category of financial institutions, and (iii) developing new regulations on mortgage lending to induce sound lending practices by banks.

4. Output 2: Housing finance strategy and subsidy framework strengthened. Tranche 1 of the PBL will establish the institutional mechanisms required to effectively implement and rationalize the government's housing subsidy framework. The government will establish the HAU to coordinate all existing housing policies and subsidy programs. In the initial phase, the HAU will take stock of the existing government housing programs and redefine the eligibility criteria for beneficiaries, review the housing policy framework, and agree on a road map that sets out priorities for the required legal and policy reforms. Ultimately, the HAU will become a single point of contact for all housing programs and subsidy schemes, with the objectives of reducing the excessive burden on the public budget and improving efficiency and sustainability. The HAU will also increase coverage by developing innovative and new housing finance solutions and instruments (such as the up-front and one-time subsidy schemes for low-income beneficiaries, and rental programs in the housing sector).

5. The following actions will be carried out by the government under tranche 2 of the PBL to facilitate implementation of outputs 1 and 2: (i) introduction of a pilot program of income-based up-front housing subsidies for low-income families and preparation of a feasibility study for a new government-sponsored housing assistance scheme; (ii) development of a comprehensive housing and mortgage market database; (iii) eventual transformation of the HAU into an independent housing agency; (iv) preparation and approval of a new system for the collection and timely dissemination of statistical data and information on the housing sector, which will ultimately lead to the establishment of a house price index; (v) review and amendment of the current prudential and regulatory framework governing housing finance and mortgage lending in line with international norms; and (vi) comprehensive review of the housing sector (demand and supply sides) to identify areas and initiatives to promote greater competition by introducing international best practices. A feasibility study will also look into the future roles and relevance of the two dominant state-owned real estate developers.

6. Output 3: The establishment and operationalization of the mortgage refinancing company supported with long-term funding. Under this output (solely addressed by the FIL), ADB will provide long-term funding to the proposed UMRC to make long-term local currency resources available to banks to fund residential mortgage and housing improvement loans. The UMRC will facilitate the provision of mortgage loans at an interest rate close to market rates (with an average loan maturity of 10 years), and address the demand for housing improvement loans, which are currently unavailable in the market. The UMRC will address a fundamental market constraint that is preventing banks from expanding their housing finance portfolios, by better matching their assets and liabilities. The UMRC will provide loans to participating financial institutions (PFIs) that are secured by eligible mortgage loans, based on criteria that will assess product design, market-based pricing, underwriting practices, loan documentation, and performance. This will help to professionalize the overall housing finance industry and address the risks associated with broadening access to housing finance across new borrower segments. Eligibility criteria will also target end-beneficiaries that are currently underserved by the banking sector. In the medium to long term, the UMRC will support more exponential sector growth by using new debt instruments such as corporate bonds, covered bonds, and/or mortgage-backed securities to mobilize long-term funds from institutional investors.

1. Macroeconomic context. Since 2017, Uzbekistan has undertaken critical reforms, which have sustained a gross domestic product (GDP) growth above 5% in 2018. The country moved to a more liberal exchange rate and trade regime in 2017 and is undertaking major fiscal reforms. Substantive progress has also been achieved through ongoing structural and institutional reforms. The government is keen to continue its reform agenda, but it remains challenging. To sustain high growth and to make the private sector the primary driver of growth, the government has prioritized the restructuring of state-owned enterprises (SOEs), public finance management reforms, including ad hoc transfers from the state budget to SOEs, and finance sector development.

2. Sector development context. Access to affordable and long-term mortgage finance is needed to meet the growing housing demand, which is the result of population growth and years of underinvestment in the housing sector. Uzbekistan needs to produce 145,000 new housing units per year until 2040 to keep up with new household formation and replace old housing stock, with most new housing needed in urban areas. This figure is well above current production figures; the housing shortfall is therefore increasing annually despite the government's involvement to address it. In the past, the government initiated a number of housing subsidy programs mostly administered by state-owned commercial banks to improve the housing conditions in the country. However, the inefficiently structured and targeted subsidies are costly for the government and are not conducive to the development of market-based solutions by focusing solely on a limited number of households and products.

3. Core development problem. The government acknowledges that it lacks a comprehensive housing policy and subsidies framework. The existing housing finance programs are not effectively coordinated in terms of design, targeting, and use of subsidies, resulting in inefficient use of limited fiscal resources. The government also recognizes the need to gradually replace or phase out the existing programs and move to a market-based mortgage finance mechanism in addressing the housing needs of the population.

4. Low mortgage finance intermediation by banks dominated by state housing programs. The mortgage loan portfolio of Uzbek banks has increased steadily during 20132018, as reflected by the high compound annual growth rate of all bank mortgage loan portfolios of 31.4% and growth in the total gross loan portfolio of banks of 36.8% during this period. As of the end of 2018, the total mortgage loan portfolio had grown to SUM13.8 trillion. However, these figures still only represent 8.3% of banks' total loans outstanding and 3.4% of the GDP. Since 2007, most state housing programs have been mainly delivered by public banks. Six public banks issued 92% of all mortgage loans under the government's rural and urban housing programs (i.e. at subsidized rates). As a result, of the 39,556 mortgage loans issued in 2018, 75% by number, and 72% by volume, of loans were issued under the various state housing programs.

5. Lack of access to long-term funding and underdeveloped capital markets. All commercial banks are constrained by the lack of access to long-term funding (beyond 1 year). This results in banks' aversion to fund residential mortgages and leads to limited experience and insufficient internal capacity to properly design, analyze, price, and service mortgage loans. The capital market in the country is underdeveloped and illiquid. There is no active bond market to mobilize long-term financing from institutional investors, such as pension funds or insurance companies. Despite the sizable mortgage loan portfolio in public banks, these mortgage loans cannot be used by the banks for the issuance of corporate bonds or mortgage-backed securities because of the highly subsidized interest rates. New instruments such as long-term saving plans for households are also absent.

6. The proposed sector development program (SDP) aims to develop a market-based residential mortgage market by (i) designing and implementing a new housing policy, reforming housing subsidies, and reviewing the legal and regulatory framework; (ii) strengthening the institutional framework to administer housing policy and subsidies by establishing a Housing Assistance Unit (HAU) in the Ministry of Finance (MOF); and (iii) making long-term fixed-rate local currency funds available to banks to enable them to expand their range of residential mortgage loan products through the establishment of the Uzbekistan Mortgage Refinancing Company (UMRC).

7. Consistency with Asian Development Bank strategy and country strategy. The program is consistent with the Asian Development Bank (ADB) country partnership strategy for Uzbekistan, 20192023, which supports inclusive and sustainable economic growth through financial market development, access to finance, private sector development, and domestic resource mobilization. The program is included in ADB's country operations business plan for Uzbekistan, 20192021, and will be the first SDP in the country. In late 2017, ADB provided knowledge support TA to conduct detailed diagnostics of the housing finance sector, which led to a comprehensive government reform program. The program supports key operational priorities of ADB's Strategy 2030 such as making cities more livable, addressing remaining poverty and reducing inequalities, accelerating progress in gender equality and strengthening governance and institutional capacity.

8. Government's reform agenda. Based on ADB's advice and preparatory work, the government prepared a comprehensive presidential decree to reform the mortgage finance sector, which was signed on 13 May 2019. The decree establishes a strategic road map for the development of the mortgage market, including reforms to the existing housing policy and subsidies framework, over the period of 20192021. The government plans to gradually reduce its direct role in providing long-term funding for residential mortgage finance, remove interest rate subsidies and other distortions in the finance sector, reform the regressive subsidy framework, and establish efficient administrative mechanisms. Over time, the government plans to enable the operations of new institutions and to replace the current inefficient and costly subsidy programs with transparent and efficient subsidies to make residential mortgages more affordable to low- and middle-income families.

9. Rationale for a sector development program. The SDP modality is justified because the sector requires both a policy reform component and an investment component (supported by the FIL), which are interlinked. The PBL will focus on reforms that are necessary for creating the enabling environment for an effective and efficient mortgage finance market. The FIL will help establish a new type of financial institution (i.e., the UMRC) with private sector participation and make long-term funds available to banks. Initially, the UMRC will use ADB resources and subsequently access the capital market by issuing bonds (i.e., once the domestic capital markets are sufficiently developed). Therefore, the program will ensure that (i) reforms to improve market intermediation are pursued continuously, (ii) government housing policies and subsidy programs are streamlined to effectively support low- and middle-income borrowers, and (iii) much-needed long-term financing to banks is provided to expand the range of market-based mortgage products. These measures will enable banks to access long-term funding, promote competition, and remove market inefficiencies and distortions.

Living standards improved for the population of Uzbekistan

Availability of affordable market-based residential mortgage credit increased

Policy, regulatory, and legal framework for the mortgage finance industry strengthened (under the policy-based loan)

Housing finance strategy and subsidy framework strengthened (under policy-based loan)

The establishment and operationalization of the mortgage refinancing company supported with long-term funding (under the financial intermediation loan)