Financing 10 Million New Houses for Pakistanis: What is the State Bank doing?

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Executive Summary

• The latest State Bank of Pakistan (SBP) guidelines for housing finance retain provisions for banks to provide housing and construction finance to under-construction projects, with a key amendment — housing finance providers are no longer required to mitigate their risk by lending only to projects where they are already offering construction finance.
• While the motivations behind the policy are commendable, it is unlikely that the current iteration will significantly increase the supply of housing units, since the new requirements raise a host of new potential complications for builders and developers in the form of inter-bank coordination, documentation, ranking of charges etc.
• Since the SBP guidelines for housing finance consistently impose substantial costs and conditions on builders and developers, to facilitate access to housing finance through their under-construction projects, any effective policy response to the nationwide housing shortage must take their practices and concerns into consideration as well as those of the banks.

Background and Context

Since July 2020, the State Bank of Pakistan (SBP) has taken a series of steps to accelerate the construction of new houses to meet the widely-reported shortfall of ten million housing units across the country. These measures compelled banks to increase lending to the construction and housing sector as an augmentation to other steps taken by the Government of Pakistan to make it easy for citizens to buy housing units through mortgage financing.

While these decisions appear to be motivated by the right policy instincts and are aligned with the construction finance policy, there are several caveats to how these past measures are expected to play out. These implications were discussed in the Tabadlab First Response published in September 2021 – Central Bank as Real Estate Regulator: Can the SBP’s Latest Guidelines Help Meet the Housing Shortfall? A summary of past developments in this series is presented below:

• July 2020: SBP set lending targets for all banks to extend credit to construction and housing finance. Construction finance covers lending to builders and developers of various projects, while housing finance entails lending to end-users to purchase, construct, or renovate a home – whether a house or an apartment. SBP required banks to lend at least 5% of their total domestic private sector credit to construction or housing finance, by December 2021.
• October 2020: SBP took up the role of monitoring and disbursing the mark-up subsidy programme announced by the Government of Pakistan for buyers of housing units costing up to PKR 6 million (circular issued on October 12, 2020).^[i]
• November 2020: SBP relaxed the prudential regulation of accepting another liquid security or residential property to meet the prescribed 15% equity contribution of the borrower for units being financed.
• April 2021: SBP expanded the type of transactions that can be counted towards meeting the construction and housing finance target whereby banks could invest in or lend to Real Estate Investment Trust (REIT) management companies, invest in Sukuks and bonds issued by the Pakistan Mortgage Refinance Company, or lend to borrowers indirectly via microfinance banks. While this step would have helped banks meet the construction and housing finance target, the impact on housing stock was uncertain.
• As a result of these steps taken by the regulator, new construction and housing lending in FY 2021 totalled PKR 259 billion, an increase of 75% over FY 2020.^[ii]
• September 2021: SBP made a significant change to the regulatory landscape by allowing banks to provide housing finance to buyers in under-construction projects. While the circular referred to both low-rise and high-rise under-construction projects, it was mainly relevant to high-rise projects. The purpose of the housing finance during the construction phase, as envisaged by the SBP circular, was to enable the end-user to make periodic instalment payments to the builder while the project remained under construction.

The Latest Move

In the announcement made on February 25, 2022, SBP has removed the central pillar of the September 2021 guidelines – that housing finance providers hedge their risk by lending only to projects where they are already offering construction finance. Under the latest circular:

1. A bank can provide housing finance to purchasers in projects where builders and developers are not availing construction finance.
2. To mitigate the risk to the bank offering housing finance to purchasers in these projects, the builder must pledge the underlying land to the housing finance provider.
3. Later if another purchaser, or a group of purchasers, obtain housing finance from another bank – different than the bank providing housing financing to the initial purchasers – to secure its risk, the second bank should arrange an NOC from the first bank and enter a bilateral arrangement for collateral against land.
4. The builder, even when not availing construction finance, must also comply with those requirements of the SBP guidelines for construction financing applicable to builders who have availed construction finance.

Builders are required to obtain written consent from those purchasers that are not availing housing finance and submit the original copies of such letters to housing finance providers. This requirement existed in the previous guidelines but has been re-emphasized in the latest circular.

[i] State Bank of Pakistan. (2020, October 12). Markup Subsidy for Housing Finance https://www.sbp.org.pk/smefd/circulars/2020/C11.htm

[ii] Iqbal, Shahid. (2021, July 16). Housing, Construction Finance up 75pc in FY21: SBP. Dawn. https://www.dawn.com/news/1635289

To learn more about the implications of the revised SBP Construction Financing Guidelines, read and download the complete First Response.

 Header photo: G-8, Islamabad by Syed Fahim Haider.