Implementation of the Saudi Mortgage Law Developing an Effective Mortgage Market in the KSA - Essay Example

Finance and Accounting Number: Paper: Table of Contents Introduction 3 Overview of Saudi Mortgage Law 3 Role played by two main GSE’s in the US 5 Importance of liquid secondary mortgage market in an economy 7 Recommendation 7 Conclusion 8 References 9 Introduction The real estate market in Saudi Arabia has encountered a huge slack as there was a rise in the house price. This rise had prevented the lower and middle income earners to purchase houses as they were unable to borrow money from the financial institutions against property, due to the restrictions imposed by the Shariah principle. Thus, there was an urgent requirement for regulations that could encourage the operation of mortgage market in Saudi Arabia. The Saudi Mortgage Law paved way for mortgage financing and allowed the individuals to opt for purchase of houses. The law defined that the financial rights will be handed over to the investor until the debt matures or any other rights that are possessed by Mortgage finance companies such as Saudi Fannie Mae. This company sells the right to another party. However, the regulation also clearly mentioned that under the Mortgage Financing Contract, authority of Mortgage Company will be transferred to others in secondary markets without obtaining any permission from the customers (SAMA, 2014b). The report highlights the technical details of the Saudi Mortgage law and its impact on the financial market of the country. It also gives emphasis on the role played by the government sponsored enterprises in the mortgage market of the US. Overview of Saudi Mortgage Law The Saudi Arabian real estate market has encountered a number of draft regulations, which originated after refinancing companies of the US such as Freddy Mac and Fannie Mae. The regulations relate to the government efforts for the development housing mortgage sector in Saudi Arabia. The regulation was needed as restrictions of Islamic Shariah law have made it difficult for the individuals to secure loan against property (Stubing, 2014; Al Rajhi Capital, 2013). In Saudi Arabia, the middle and lower income individuals had encountered difficulty as the land price had appreciated and there is a housing shortage. This led to the establishment of Saudi Arabia Mortgage Law by the government. Mortgage liquidity is a vital milestone for creating an effective and stable mortgage market (Chiquier, Hassler & Lea, 2004). The law established set of regulatory, legal and primary market provisions in order to encourage lending opportunities in Saudi Arabia. As mortgage industry will mature, greater access to secondary market can be obtained, which will rely solely on the liquidity centers. Through the regulation, the country takes its initial step in establishing the Islamic secondary mortgage market. The regulations are formulated in such a way that it can only be understood by the financial professionals. The law also paved way for reviving the secondary market of Sukuk and developing financial instruments such as Securitization. A local company is also developed for managing the refinancing facility in the mortgage market and this is a significant step in creating a robust secondary mortgage market in Saudi Arabia. The government owns majority of the stake in the company and 19% are offered to the public (AlKhnaifer, n.d.). Nevertheless, the public investment funds owns about 51% of the stake that belongs to Ministry of Finance and the remaining 30% is offered to private mortgage companies, which is settled with a capital amount of 2 billion riyals (AlKhnaifer, n.d.). According to the Saudi Mortgage Law, the clients first approach the mortgage finance companies in order to purchase a new house. A contract is formed between the two parties for a period of twenty years, when the client has to make a monthly payment in order to reach purchase amount. The finance company will also ensure that the client has the ability to pay back the amount by critically reviewing his/her cash inflows (AlKhnaifer, n.d.). Thereafter, companies such as Fennie Mae can make contract with the private mortgage company and purchase the financial rights by allowing a discount. Nonetheless, Fennie Mae will purchase the right only to re-sell to the investors. Saudi Fannie Mae facilitates flow of funds so as to offer liquidity to secondary market of the country. It also aims at providing a better opportunity to the mortgage companies to finance their beneficiaries in order to own the residential property. One such operation by Saudi Fannie Mae is Sukuk issuance and other financial securities or instruments. Saudi Fannie Mae ensures that the payments results in assets backing. This assures the company that the clients will make timely payments (SAMA, 2014a). The Saudi Mortgage law has increased the competition between the financing companies by emphasizing on establishment of new industry. Due to the absence of the secondary markets, the mortgage loans play an important role in holding the portfolio lender to the economy. In weak economies the borrowers do not get the privilege such as loan from lenders, but, entry of mortgage companies will abolish the local business and bring benefit to the borrowers. The secondary markets aim at increasing its efficiency by emphasizing on the specialization part of the lending functions, which reduces costs. The portfolio lenders are engaged in servicing loans even if they are not efficient. The secondary markets develop pressure to break the functions and assign prices accordingly. This helps in imposing discipline on the mortgage companies (SAMA, 2014b). Role played by two main GSE’s in the US During 2005, government of the US felt the need of establishing institutions that can facilitate flow of funds for housing loans globally. Under the Congressional Charter, Fannie Mae and Freddie Mac were established as the Government-Sponsored Enterprise (GSE). These institutions were established in order to fulfill the public mission and provide stable finance for the residential mortgages globally that includes both low and moderate income families (Congressional Budget Office, 2010). The two GSEs are permitted to borrow for funding their portfolio holdings at lower interest rates than offered by the private financial institutions. This posed comparable risks on the investors, those who believed in the credit guarantees of the two institutions. Yet the stakeholders of GSE are also deprived from some of the gains that are achieved from property deals. The main advantages of the federal support aided the institutions to grow rapidly and also reign in secondary market for offering right type of mortgages (Congressional Budget Office, 2010; Acharya, et al., 2011). The two GSEs were profitable after their inception until the economy of the US was affected by the financial crisis in 2008 (Congressional Budget Office, 2010). The housing prices dropped drastically; as a result the two GSEs suffered huge loss on the investments that they made. The situation worsened for the two when the rate of unemployment increased and it led to credit losses on the outstanding guarantees. These events impaired the capability of the two GSEs to offer low cost debt in order to fund the mortgage purchases in the US. However, doubts were raised regarding the capacity of the two GSEs whether they can compensate for the potential losses (Congressional Budget Office, 2010; Acharya, et al., 2011). Housing and Economic Recovery Act of 2008 (Public Law 110-289) was established by the Federal Housing Finance Agency in order to revive the business of finance companies like the two GSEs. It gave opportunity to Freddie Mac and Fannie Mae to receive unlimited capital through purchase of stocks. Hence, it maintained the solvency of the GSEs in 2012. This enactment also permitted the government to control the two institutions more effectively (Congressional Budget Office, 2010). The explicit federal guarantee for the two GSE continued to channel funds in mortgage market of the US and above that the private financial institutions remained uncertain. In 2009, the GSEs owned half of the outstanding mortgages in the US and they also rendered finance to about one-third of the new mortgage during that year (Congressional Budget Office, 2010; Acharya, et al., 2011). Importance of liquid secondary mortgage market in an economy Ginnie Mac played a significant role in the progress of secondary mortgage market, which was established during the time of Great depression. The Federal Reserve was developed in order to provide liquidity to the commercial banks with the help of Federal Reserve discount window. Federal Home Loan Banks were granted the authority for borrowing from US Treasury. Liquidity reduced effect of credit risk on the investors by providing them insurance against any default mortgage. Nevertheless, all mortgages are not insured, the applicants had to satisfy specific standards established by the higher authorities (Mcdowell, 2012; Kolatey, n. d.). Recommendation The mortgage market of Kingdom of Saudi Arabia (KSA) encountered a big change after the establishment of the Saudi Mortgage Law. It increased the liquidity of the secondary market and also gave an opportunity to lower and middle income group of the society to receive fund against property so that they can purchase new houses. Despite the advantages of the law there are few limitations regarding the legal structure. The structure is complicated and thus it cannot be understood by layman other than professionals. Thus, it is recommended that the government should amend the law so that the investors are aware of the process that takes place in the mortgage market. Hence, the law should be simplified so as to make it acceptable and comprehensible for the general crowd in Saudi Arabia. Conclusion The establishment of the new Saudi Mortgage Law not only gave way for mortgage market in the country, but also allowed the lower and middle income earners to purchase houses by lending fund from the financial institutions against property. The GSEs, Fannie Mae and Freddie Mac made way for injecting fund in the economy and helped the investors to acquire funds. Nonetheless, it also encountered huge challenge in the form of financial loss during the financial crisis, which affected the US economy during 2008. The situation was managed by Housing and Economic Recovery Act of 2008, which gave opportunity to the GSEs to acquire fund whenever required and in return revive the business from the great loss. Though the new law has the potential to bring in effective changes to the mortgage in Saudi Arabia, it cannot be understood by the layman and only the professionals have knowledge regarding the process of funding. References Acharya, V., Richardson, M., Nieuwerburgh, S. & White, L. (2011). Guaranteed to Fail. Retrieved from https://research.stlouisfed.org/conferences/gse/White.pdf Al Rajhi Capital. (2013). Saudi Mortgage law Planning for the long-term. Retrieved from http://www.alrajhi-capital.com/en/research/Market/Mortgage%20law_Mar%202013_Final.pdf AlKhnaifer, M. (no date). A look at the Secondary Mortgage Market. Retrieved from http://www.al-jazirah.com/2012/20121211/bf3.htm Chiquier, L., Hassler, O. & Lea, M. (2004). Mortgage Securities in Emerging Markets. Retrieved from http://elibrary.worldbank.org/doi/pdf/10.1596/1813-9450-3370 Congressional Budget Office. (2010). Fannie Mae, Freddie Mac, and the Federal Role in the Secondary Mortgage Market. Retrieved from http://www.cbo.gov/publication/21992 Kolatey, A. (no date). Ginnie Mae and the Secondary Mortgage Market: an Integral Part of the American Economic Engine. Retrieved from http://www.kalotay.com/sites/default/files/private/Fabozzi-Kalotay.pdf Mcdowell, A. (2012). Analysis - Saudi Reforms Economy, Benefits May Be Elusive. Retrieved from http://uk.reuters.com/article/2012/07/11/uk-saudi-economy-reform-idUKBRE86A0NT20120711 SAMA. (2014a). Finance Laws and Implementing Regulations. Retrieved from http://www.sama.gov.sa/sites/samaen/Finance/Pages/Laws.aspx/ SAMA. (2014b). Rules and regulations concerning the creation of the secondary market. Retrieved from www.sama.gov.sa: Stubing, D. (2014). Saudi Arabia’s Mortgage Law to Boost Markets. Retrieved from http://gulfbusiness.com/2014/02/saudi-arabia-mortgage-market-boost/#.VGBE8GcnaqY Read More