Implementation of the Saudi Mortgage Law - Case Study Example

Implementation of the Saudi Mortgage Law Saudi Arabia remains the biggest local banking sector present in the whole of the GCC. It continues to record good economic performance annually with most companies having an increase in their profitability and assets. In the financial year 2013, the banking sector in Saudi Arabia registered a positive performance, which was propelled by the significant growth of the general economy. There has been higher capability among firms to supply housing finance, coupled with higher capital spending that was incorporated in the budget. It is a great improvement from the low margins recorded about three years back. All Saudi banks have faced the challenge of gradual disappearing Saudi Government Development Bonds (Allam Web). These bonds were being issued, formerly to finance the deficits of the 1900s. Their disappearance has contributed significantly to budget surpluses. The presence of these bonds is very important for the efficiency in the development of banks. Their presence helps banks to have sound and profitable liquid assets that facilitate the fulfilment of the internal liquidity needs. It also helps to improve the state of all the regulatory ratios. When interest rates went low, banks started suffering from the consequences of replacing the high yielding assets with the more profitable assets. These inefficiencies prompted the need for developing an Effective Mortgage Market in the KSA. Then, the Saudi Mortgage Law was instituted. It is the Saudi Mortgage Law finally approved in July 2012 by King Abdullah. The recent development by the Saudi Arabian federal government is meant to support home mortgages. It is the most recent step towards widening extending the western system of home financing homes in the Saudi Kingdom. The implementation costs are estimated to be about 1.3 billion, which is an equivalent of five billion Saudi riyals (Allam Web). The monetary Agency of Saudi Arabia is to initiate the fund via the government’s Public Investment Fund. The federal government of Saudi Arabia is putting up an agency that resembles the American system for Fannie Mae. The objective is to boost the total of obtainable mortgages. According to Brass (Web), the Saudi Arabian Monetary Agency Director Mr. Al-Mubarak once said, "We studied the successful experience in other countries in terms of the mortgage," during the conference. At the beginning of this year, the government of Saudi Arabia completed the campaigns for mortgage rules to control the money industry. The plans had been underway for over ten years. Today, the proportion of homes being bought in Saudi Arabia through mortgages is down to 3.5%. It is very different from the situation in UK, where 70% of all the home purchases is done through mortgages (Brass Web). In order to meet the expected increase in demand for home finance it is expected the government will allow non-banking financial institutions to offer mortgages as well as create a Government Sponsored Entity (GSE) type institution, similar to that of Freddie Mac and Fannie Mae in America. Certain elements of the law, however, are yet to be implemented. Fannie Mae and Freddie Mac refer to the government-sponsored enterprises (GSE) working to expand home ownership across the country. For several years now, the housing market has been booming, due to increased opportunity through entities like the two GSEs, pricing, and other factors (Brass Web). However, it began to cool in the last year and felt major shockwaves from a crashing subprime market sector. The effects in the greater financing and real estate industries and in the national economy are still being felt and will be for some time. Fannie Mae expanded home ownership for millions of families in the 1990s by reducing the down payment requirements. There were very many borrowers remaining, whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market. Regardless of the opinions of many concerning this issue of promotion of home ownership, it is quite clear that the Government Sponsored Enterprises’ style of subsidizing home ownership through unfunded government guarantees is not an effective approach. Academic research has cast serious doubts on the ability of the GSE guarantees to help low-income households, arguing that in fact they have mostly lowered mortgage payments for the rich. To the extent that housing subsidy programs must exist, we believe that they are better housed -- and in much smaller size – in the Federal Housing Administration (FHA) and/or some other agency within the Department of Housing and Urban Development (HUD). It would make their costs explicitly an on-balance sheet fiscal item, providing transparency to the taxpayer. Any future architecture of housing finance in America should contemplate that more housing credit and construction are not the answer to the current-day economic When the housing prices declined in 2007 and the tail risk that these institutions had predicted against materialized, they all experienced substantial stress (Syed Web). Commercial banks by virtue of their steady profitability (ROA) and less aggressive leverage suffered the least, but even amongst them the most leveraged and risky – Citigroup – eventually had to be bailed out. Investment banks and Fannie-Freddie fell off the cliff, both because of lower profitability (ROA). Subprime mortgages are those made to borrowers with credit scores that traditionally denoted a risk. Credit scores are awarded on a scale of 300-850. Prime borrowers are those with scores around and above 700. Those with scores below 620 have credit issues and are considered a risk by lenders. Based on a strong and growing stronger housing market in the last few years, lenders started looking at potential borrowers with low credit scores. These “subprime” borrowers were offered home loans at higher interest rates than those paid by prime borrowers. In 2005, the Federal Reserve started a sequence of 17 hikes in the short-term interest rate, rising from 1% to 5.25%. Most subprime loans are based on floating interest rates that change as the short-term interest rates change. From this series of hikes, then, many homeowners who received loans before or around this time are now facing 30-50% increases in their monthly payments. The problem came to a head in March as late payments on U.S. mortgages reached their highest level in over three years, particularly in subprime markets. It was an affirmation about what many in the industry had thought for long. The subprime market was struggling and was on the verge of failure. A major subprime lender called HSBC Holdings made a pronunciation in 2006 that bad debts surpassed $10.5 billion. Many more (smaller) companies kept been falling as time went by. Complications started with the excess issuance of subprime loans. During this time, many homeowners possessing such loans felt the pain of reset charges and expenses. Evasions and fore-closures increased. Unexpectedly, the mortgage-supported securities were no longer the strongholds of safety and steady returns as before. Investors were staying away, and the entire procedure of the secondary mortgage market slowed down, implying less money was available for loans. To the homeowners, the end was escalating cases of loan defaults and delinquencies. Bloomsbury (11) reveals that all the subprime loans constituted as much as 23% of the housing market in 2006. It was an opportune time for Freddie Mac and Fannie Mae, to make a significant move. These two were the best in the secondary mortgage market and the housing market generally. According to Brass (Web), whatever had arisen in the financial sector was not a mere creative arrangement of mortgage finance firms. It was a highly deformed marketplace with two types of systems; the LCFI King Kongs and GSE Godzillas. The two were supported by the government. They were rising at intense speed, with significant leverage. When the financial markets failed, leverage and risks that are crucial characters that aided greater shareholder returns (ROE) before kept declining. Developing a liquid secondary mortgage market in an economy is very important, as discussed below. Mortgage markets are those avenues where mortgage loans and servicing rights are purchased and traded between mortgage creators, mortgage securities, and investors. Secondary mortgage markets are usually very wide and liquid. The secondary mortgage loans are the newly formed mortgages that are traded by their creators into the secondary market. In such secondary markets, these mortgages are packaged into mortgage-backed securities and traded to the investors in the form of pension funds, insurance companies, and hedge funds. The secondary mortgage market assists in making credit equally available to all borrowers over geographical areas. Allem (Web) notes that almost half of all the new single-family mortgages created are financed in the secondary mortgage market. The secondary mortgage market is very imperative in the housing and lending market. The process avails extra cash to the lenders. It can lower mortgage rates and make homeownership reasonably priced. Regardless of where they were situated, mortgage creators, can access pools of capital. Homebuyers can hence have easier access to better mortgage financing, regardless of whether they reside in major cities or minor towns, According to Bloomsbury (6), the following are recommendations on the structure that KSA administration should effect to support the growth of the KSA mortgage market. The Macroeconomic rules should remain watchful for signs of overheating. Fiscal policy looks set to appropriately slow the pace of spending growth this year to help contain demand pressures. Macro-prudential policy structure appears relevant currently. Suppose symptoms of inflationary pressures emerge, the capital expenditure will be slowed. Otherwise, the macro-prudential policy will need to be strengthened. Saudi Arabia is incorporating measures to hold the growth in domestic energy demand and develop optional energy resources. Being a country with one of the highest levels of energy consumption per capita globally, the government is pursuing a number of policies to promote energy preservation and expand gas and solar energy. Measures to promote financial development together with reforms should be maintained to strengthen the financial sector regulation and supervision. Saudi Arabia remains one of the first nations to put into practice Basle III capital principles for the banking structure. The system remains well capitalized, liquid, and profitable. With the passage of the mortgage law, a regulatory and supervisory framework is appropriately being put in place for non-bank institutions entering the market. Works Cited Allam, Abeer. “Saudi Arabia approves first mortgage law.” Politics and Society. 2 July 2012. Retrieved from Brass, Kevin. “Saudi Arabia Launches $1.3 Billion Mortgage Fund.”World Property Journal. 21 March, 2013. Retrieved from Syed Hussain. Saudi’s Housing Market – The Home Stretch. Gulf Business.30 Nov 2013. Retrieved from Qfinance: the ultimate resource. By: Bloomsbury 2009. Read More