Government involvement in mortgage markets varies across countries, and it is likely that this explains at least some of the cross-country variation in housing finance, including the types of mortgage contracts available to borrowers, rates of home ownership, and the financing of mortgage lenders. However, it has been difficult to disentangle the effects of government regulation from other possible determinants using cross-country evidence, as this can be contaminated by unobserved differences across countries.
We adopt an alternative approach in this paper, tracing the effects of mortgage regulation over time within a single country, India. This type of time-series analysis has been difficult to undertake in developed countries, as they tend to have fairly stable systems of financial regulation, so one rarely has the opportunity to track the effects of sharp regulatory changes. India underwent an economic liberalization in the early 1990s and subsequently experienced rapid economic growth that accelerated further in the 2000s. During this time the financial sector has become much larger and more sophisticated, but remains highly regulated, with a significantly nationalized banking sector. The provision of housing finance is particularly fast-changing – regulatory norms have moved frequently, albeit with a continuing emphasis on low-income housing finance. For these reasons, India makes an ideal laboratory in which to examine the effects of mortgage regulation.
The ideal environment for answering questions pertaining to mortgage finance must be coupled with good quality microeconomic data, either at the household level or the loan level. There is now a vast literature looking at such data in the US, but it is harder to find in less wealthy countries with rapidly changing financial systems. We are fortunate to have access to loan-level administrative data on over 1.2 million mortgages disbursed by an Indian mortgage provider between 1995 and 2010, and using these data we attempt to understand both the macroeconomic and microeconomic determinants of mortgage rate setting and delinquencies in relation to the changing details of government regulation. Simple plots using these data reveal a significant spike in payment delinquencies in the early 2000s, which remains even after we control for demographic information and loan characteristics in more sophisticated specifications. Moreover, we are unable to pinpoint any obvious macroeconomic causes of this event. However, regulatory changes encouraged mortgage lending at that time, which we regard as unusually compelling evidence for regulatory effects on mortgage defaults, especially in light of the fact that defaults are primarily concentrated in recent cohorts of mortgage issuance. There are also important changes to the regulatory definition of non-performing assets around the time of the decline in delinquencies following the spike, and we find that this change also impacted mortgage risk.
We also provide evidence on the influence of regulation from the cross-section of defaults and mortgage rates conditioned on various loan attributes. In particular, we find that priority-sector lending norms, which impose quantity restrictions on lending to targeted sections of the economy, including low-cost housing, distort the efficient markets relationship between mortgage rates and default risk, especially during the early period of the data, from 1995 to 1999.
Finally, we briefly explore the question of learning by the mortgage provider in this tumultuous regulatory environment. While definitive answers to this question are difficult given changes in aggregate default rates and unobservable factors driving defaults, we find some evidence consistent with learning. Overall, our paper contributes to the growing body of literature on the impacts of regulators and regulatory norms on risks in financial markets.