Financial Sector Development in Africa: Opportunities ... - World Bank

134 Walley
Eurobond market to fund some of their balance sheet growth. These
plans have been put on hold in the wake of the crisis.
The bigger impact coming out of the crisis, and the one on which this
section will focus, is seen in the lessons that have been learned for future
development. The collapse in the U.S. subprime mortgage market led to a
fundamental reexamination of housing finance systems and their regulation.
This process remains ongoing, but some lessons are already apparent:
• Asset-based loan underwriting should be avoided. Mortgage lending
should be done with the focus on the borrower’s ability and willingness
to repay the loan, not merely on the basis of collateral. Asset-based
lending creates distorted incentives to keep on lending as long as asset
prices are rising. To some extent this is the genesis of the “asset bubbles”
seen in many developed markets. The core banking principles of underwriting
a loan based on a borrower’s capacity to repay should prevail.
Collateral is posted as a safety net that can help lower the levels of loss
in case of a default, improve a borrower’s willingness to repay, and
thereby reduce the loan rate.
• There is a need for balanced funding models. Over-reliance on a single
source of funding can lead to exposure, to funds drying up, or to changes
in the cost of funds. This has been shown to be true for lenders relying
on mortgage-backed securities as a principal source of funding; examples
include Northern Rock in the United Kingdom and Countrywide in the
United States. This is also true of lenders relying on other capital market
instruments, such as short-term debt in the Eurobond market. When this
source of funds dried up, it created severe funding difficulties for many
European and central Asian economies, most notably Kazakhstan.
• Monoline lenders are vulnerable. The dangers of over-reliance on a single
source of funding is nowhere clearer than in the case of specialized
mortgage lenders, which have been especially vulnerable during the crisis.
The risk is twofold and comes both from the single source of funding
and from the concentration risk of having such a focused line of business.
In many cases, real estate lending was subject to overinflated property
markets and stretched affordability. This model has run into
difficulties in the United States, Mexico, and the United Kingdom. The
crisis does not necessarily spell the end for this model, but it is likely to
reemerge in a slightly different form. For instance, specialist lenders in
Kenya, Egypt, and Nigeria are all being bought by banks or created as