The financing of housing development, like many other development issues faced by African countries, is quite challenging. This is mainly due to the lack of adequate conditions or resources to facilitate such financing. In fact, the housing finance market in Africa is exposed to a number of risks. Diamond and Lea (1995) classify these risks under six categories: (1) credit risk arising from the fact that the borrowers may fail to pay back their loans; (2) liquidity risk stemming from maturity mismatch; (3) cash flow risk—which includes interest rate, prepayment, inflation, and exchange rate risks—which increases uncertainty about cash flows over time as the credit may be worth more or less over time; (4) agency risk or information asymmetry risk (moral hazard or adverse selection type of risks) that a divergence of interests will cause an intermediary to behave in a manner other than expected; (5) systemic risk, or the risk that a crisis at one institution or in a part of the system will affect the whole system; and (6) political risk, which refers to uncertainty about adverse government action that can trigger the other risks. In Africa, these risks are present in varying degrees. The management and mitigation of such risks are key elements that the finance system factors into the design and pricing of housing finance products, which ultimately affect the availability and supply of long-term capital for affordable housing. These risks are reflected by a very challenging environment characterized by weak legal frameworks and enforcement of property rights, by information asymmetry and credit risk, and by low levels of financial intermediation and a lack of long-term funding. These characteristics are examined in the following subsections.
1.6.1 Weak Legal Framework and Enforcement of Property Rights
Strong protections for privately held property are a prerequisite for attracting private capital to affordable housing. In most African countries, it is difficult to “crowd in” private investment due to weak legal and regulatory frameworks, which result in high payoffs for rent-seeking behavior. The facts that property rights are not always well defined and not strongly enforced constitute high risks that scare away scarce private investments. Reportedly, in many countries, the ability to use property—including land—as collateral to secure a loan is often constrained by legal uncertainties. Moreover, extensive foreclosure processes and related high costs are additional factors pushing away private investors. This is true in housing finance systems around the continent, where the principal asset at stake is land or a property sitting on that land, under a land tenure regime that is inadequate and does not promote strong property rights (see Chap. 4). This basically prevents the housing finance system from going “down market” and catering to low-income households, with which those risks are higher.
1.6.2 Information Asymmetry and Credit Risk
If one is concerned with allocating resources in an optimal fashion, information is key. Information asymmetry, or the lack of data—whether through moral hazard, adverse selection, or non-verifiability—could prevent society from achieving a first-best allocation of resources because of the additional costs that such asymmetry entails (Laffont and Martimort 2002).Footnote 3 These constitute transaction costs, which are challenging and very difficult to manage (Akerlof 1970; Spence 1974; Williamson 1975; Rothschild and Stiglitz 1976). Without adequate incentive mechanisms, investors and financial institutions cannot effectively price and manage risks. As a result, investors may have to incur some additional transaction costs due to the information gap. This risky situation is prevalent in many African countries, where information is imperfect and credit history information on individuals and firms is often not available. As a result, in Africa, as in other emerging markets, commercial banks shy away from lending to households that earn low and informal income.
What is more, this aversion of credit risk by the conventional banking sector does not seem to take into account the fact that the informal sector dominates Africa’s economy. In sub-Saharan Africa, according to the African Development Bank (AfDB 2013), 55 percent of the economic output derives from the informal sector and 80 percent of the labor force is employed in it. In South Africa, for instance, the size of the informal economy is estimated to be R 157 billion (US$12.5 billion), according to the Institute of Economic Research on Innovation in South Africa. However, as a reflection of commercial banks’ inexperience with putting in place the right incentive mechanisms, including underwriting processes tailored to risky clients, such banks continue to ignore this market segment while keeping lending on a tight leash. This has undoubtedly affected the development of mortgage markets in some African countries. The evidence from selected countries seems to point to an inverse relationship between the size of the informal economy and the depth of mortgage markets. In South Africa and Namibia, the countries with the most developed mortgage markets, the informal sector accounts for 33 percent and 44 percent of economic activities, respectively. Conversely, in countries where the informal economy dominates, such as Mali (82 percent), Côte d’Ivoire (78 percent), Tanzania, and Zambia (76 percent each), the mortgage market is very shallow.
1.6.3 Credit Markets and Macroeconomic Volatility
In many African countries, the capital markets remain shallow and are not a significant source of financing for long-term housing investments. They are dominated by bond markets (Fig. 1.3), which are highly driven by treasury bills. This reflects the share of government debt, which sometimes crowds out commercial banks, thus limiting the availability of adequate funding instruments. In addition, the contractual savings industry (insurance companies, pension funds, etc.) is not sufficiently developed. As such, this source of long-term institutional capital remains untapped. Furthermore, the few existing financial instruments are inadequate to address the long-term housing financing need.
Consequently, most housing loans in the continent are funded through short-term deposits. This can be done up to a certain extent, depending on the stability of deposits, the existence of deposit guarantee schemes, or the degree of political and social stability. These conditions do not always exist, and in the majority of countries, the lack of long-term financing is a significant roadblock to the development of housing finance. In some countries, such as those that are members of the West Africa Economic and Monetary Union (WAEMU) and the Central African Economic and Monetary Community (CEMAC), for instance, term transformation regulations that link long-term assets to long-term resources further constrain the provision of medium- and long-term credit for housing. This phenomenon translates to short loan tenors, which increases the costs of mortgages, thereby pricing out many potential borrowers as the repayment period is spread over a shorter time period.
Besides, in many African countries, the level of financial intermediation is reported to still be low, with the ratio of credit to the economy over GDP barely reaching 18 percent, implying limited involvement of the financial system in financing the economy. This is a reflection of the inadequate financing instruments and the weak finance markets, as explained above. Macroeconomic stability is a key feature for the development of the housing finance system and requires sound management of inflation and interest rates to avoid economic volatility. Unfortunately, both high inflation rates and rising interest rates are widespread in many African countries, which inherently affect housing affordability. Double-digit interest rates on residential mortgages and housing loans are the norm in many countries, with a few exceptions in countries such as Morocco, Tunisia, and South Africa. These high lending rates are often associated with high inflation and currency depreciation, which reflect to some extent the low development of the housing finance system on the continent. Figure 1.4 captures average interest rates for mortgages in selected countries. In many countries, interest rates are variable, with Morocco being the only exception as mortgage interest rates are fixed.
High inflation and interest rates have continuously plagued mortgage lending in both developed and developing economies. Primary mortgage lenders in Kenya, Nigeria, Tanzania, and many other countries identify high interest rates as the principal obstacle to mortgage market development efforts. In the absence of generally accepted interest rate benchmarks, rate changes are based on the internal cost of funds, a nontransparent approach that nonetheless allows for the smoothing out of ample fluctuations—to the point that loans are commonly perceived as being fixed rate (e.g., in WAEMU and CEMAC countries).