The credit-risk implications of home ownership promotion: The effects of public subsidies and adjustable-rate loans

This study analyzes the credit risk of housing loans with a particular focus on mechanisms that may help disentangling the financial constraints of low-income borrowers: public support and access to adjustable-rate loans. Using a large database of French housing loans covering the years 2000–2010, we show the following: supplying loans with financial assistance helps financially constrained borrowers to absorb income shocks, adjustable-rate loans are riskier on average, and the combination of public support and adjustable rates can lead to a concentration of risk in the lender’s portfolio. The risk measurement methodology used in this paper extends the one-factor economic capital model underlying the Basel 2 regulatory credit-risk formulas. This portfolio approach leads to the credit risk of housing loans being handled as a portfolio management issue for the lender. From this perspective, our results also illustrate that the ability to promote access to homeownership to low-income borrowers may be determined by the lender’s capacity to identify diversification benefits at the portfolio level. Thus, risky borrowers may have a limited credit-risk level from the lender’s perspective, which facilitates the supply of housing finance.