Securitization in Kuwait - Case Study Example

Securitization in Kuwait

Introduction

Securitization refers to the process whereby various types of assets are brought together with the sole intention of repackaging them into interest-yielding securities (International Monetary Fund Staff). The principal payments and the interests obtained from the assets are passed to the buyers of the securities. Securitization process began in the 1970’s when home mortgages were brought together by agencies backed by US government. It is imperative to assert that both the persistence and scale of attendant credit crisis implies that securitization if characterized by inadequate valuation methods, poor credit origination, as well as insufficient regulatory oversight can brutally hurt financial stability (Moffat). During securitization, an increase in the financial institution numbers result to the credit risks originating from balance sheets to be transferred to other institutions such as banks, hedge banks, as well as insurance companies (International Monetary Fund Staff). This is done since raising money through securitization is extremely easy and cheaper. This comes about from the fact that securitized assets are not expensive for banks to hold since financial regulators have varied standards for them compared to other underpinned assets (Development, O. F. E. C.O. A.).

In a society or region, economic activities play a central role in the survival of humankind. The mutual interactions between people living in the society and their economic activities are important. In a corporation, the success of one individual is measured by the effectiveness and activeness of the person in the financial world. Among other activities, securitization is one of the major economic systems that influence the society. Depending on how securitization is practiced, it can either be beneficial or detrimental to the society (International Monetary Fund Staff). The motive behind any business is success and accumulation of money, but how to acquire the success and money is a significant factor. This research paper focuses on securitization in Kuwait as an economic system and its effects. It will examine in a greater depth the securitization situation in Kuwait, the issuers of securitization, the barriers of securitization, as well as the strategy to employ so as to ensure that securitization is a success.

Discussion

Securitization can be viewed as a diversified and alternative source of finance based on credit risk transfer from issuers to investors (Development, O. F. E. C.O. A.). In a clearly refined set up, securitization portfolio is subdivided into numerous slices known as tranches. These tranches have varied levels of risks associated with them. Both losses and investment return are billed among the varied tranches according to their pre-eminence. The tranche with the least risk, for instance, has the first call on the earnings accrued by the underlying assets; whereas, the tranche with the most risk has the last claim to the revenue (International Monetary Fund Staff).

In a securitization transaction, an inventor can transfer credit as well as other risks linked with the assets pooled for securitization. This plays an instrumental role in providing the much needed liquidity in an inventor’s balance sheet; thus helping the inventor stir up its portfolio making room for new asset creation. In simple terms, securitization enables investors to improve their profits while remaining intact or advancing the investment quality. Securitization can help Kuwait’s borrowers with international assets in the sovereign ratings as well as the investment grade structure (Moffat).

Securitization plays an integral part in the rapid growth and expansion of the economy of Kuwait. Stakeholders in this industry are primarily the government of Kuwait and consumers of services. Securitization has been a vital step in fostering growth and expansion of various companies and the industry at large. For instance, securitization would pave the way for swift growth of the business corporations and industrial sector in entirety (Hernon & Metoyer-Duran 91). In most cases, Kuwait government often intervenes to rescue business corporations that are on loss-making path by encouraging securitization. A typical case in point is Kuwait Airways that apparently operated at a considerable loss amid heightened competition from rival companies in the region and two new local airlines. The securitization law will facilitate the process of reviving and transforming business corporations on a profit-making path. However, successful securitization would require a comprehensive audit of business corporations’ assets before the entire process becomes a reality (Hernon & Metoyer-Duran 95). Once an independent international audit firm has conducted the auditing process, existing and new investors will purchase some of the company’s shares in an attempt to raise capital and move the hapless corporation back to profit-making path (Ellis & Levy 50).

In order to understand the securitization process of Kuwait, this paper will tackle the economic situation in Kuwait by defining the main terms which we will use from time to time in this economic analysis. We will define recession and depression in order to put these matters in the right perspective. According to the National Bureau of Economic Research (NBER), recession is the period when business activities have reached its peak and a fall starts. This continues until the time when those business activities reach the bottom. In average, a recession lasts for one year. Depression on the other hand is a downturn in economic activity. A great example is the Great Depression of 1930. The term ‘recession’ was coined during this period in order to differentiate the event of 1930 from the smaller economic declines of 1910 and 1913 (Smiley 147). So we can lightly say that a depression can be said to be a recession that lasts longer and its business activity decline is larger.

Having defined both the recession and depression, we can point out the difference. The changes in GNP are the best test to use in getting the differences between the two terms. For a depression, the GNP declines by more than 10 per cent (Moffat 67). On the other hand a recession is an economic decline that is less severe. A number of world leaders have warmed of the looming economic crisis. The British Prime Minister, David Cameron made claims that the Eurozone is facing a recession. He said that during the G20 Summit in Brisbane. These warnings were prompted by prior warning by the Bank of England Governor Mark Carney who said that stagnation was facing many countries in Europe.

It is reported that the looming recession is expected to increase rates of unemployment and economic growth will slow down during this period. Danica Kirka of Associated Press wrote a great article on the threats facing the global economy. The problems of world economy seem to be multiplying at a fast rate. Moffat reports that recession will still happen despite the promises made by the G20 leaders to increase global output by $2 trillion for the next five years. Other countries such as Japan reported that they are already in recession. Japan has joined a long list of troubled economies. The US and UK have not officially joined the list. Their economies are growing at decent rates. Across the world China’s economic growth is also declining. Currently, the problem is squarely on the Eurozone court. Over 18 countries are struggling to stay afloat. The Eurozone economy is the second largest after that of United States.

Hernon & Metoyer-Duran (28) found that Kuwait had a Gross Domestic Product of $52,197. It is expected that this will increase by 3.3 per cent in the next five years. The state has its strengths in skilled manufacturing workers, low business costs and great healthcare hubs. This makes it the 7th largest economy in the Middle East/North of Africa region. The factories in this state are the leading in the production of appliances, plastics, fabricated metals and rubber. Kuwait is a leading state in the production of oil and gas. This is ascribed to the fact that it boasts of six percent of the world’s oil reserves. Gas and oil account for over sixty percent of the GDP and ninety five percent of the export incomes (NYMEX-U.S. Crude down on Weaker China Data, Libyan Oil Outlook). Kuwait’s economy is not likely to get into recession or depression because business is growing fast through private investments in Energy, Biohealth, advanced manufacturing, aerospace, logistics and polymers.

In a study by Hernon & Metoyer-Duran (56), it is reported by Kuwait’s two leading exports are gas and oil. The companies operating in Kuwait are known to export their products to over 210 countries globally. This constitutes six per cent of the world’s total consumption. Despite Kuwait’s good looking financial map, many families are struggling with financial insecurity. This is why over 44% of her residents are deep in financial insecurity. This is the latest information released by the Corporation for Enterprise Development. There are many households that have little or no cash reserves to cover emergencies when they arise. The corporation discovered that the state policies are doing little to remedy this situation. There are a large number of people who live below the official income poverty line which for a family with four members (Hernon & Metoyer-Duran 45).

Kuwait is ranked below average when it comes to income insecurity. This is what calls for policies from the government to protect residents from abusive economic practices. The national economy might be recovering from previous financial crisis. People in Kuwait are still struggling financially. The EITC initiative in Kuwait is very important because it is helping families own homes. Home is the foundation of success according to Jeff Diver, an Executive Director at Supports to Encourage Low-income Families (SELF). A research by Christina (223) found out that the economic terrain in Kuwait is slow and declining. This is worsened by a widening income and wealth inequality. The following key findings are the main points to the fact that Kuwait is facing a recession:

• College debt for students who graduate has increased by 78 per cent. In 2011, the debt was $27,150 and in 2012, it reached $29,400. When these student loans increase so do the default rates for those loans.
• Kuwait has experienced a reduced employee participation in retirement plans provided by employers. For the period 2007 -2012 this has reduced by 47 percent.

Kuwait is advised to empower its households to preserve their assets by creating programs and policies that help them to buy homes, make high education loans more affordable. There should be a general understanding that families need to succeed in order to curb financial insecurity. The government needs to made changes to its laws to make sure that the business corporations have budget rules and processes. According to Smiley (28), these rules will be handy in containing the looming economic crisis. According to a research by Christina (228), private enterprises should push for a need for tax reforms. There should be increased fairness in the tax system. The remedy is a two way process that calls for a revised budget process and widen the tax base to prevent the overdependence on income taxes. This will raise the burden on citizens.

Securitization in Kuwait can face challenges arising from political tensions. The ruling authorities have continued to take action on people, media as well as groups linked with dissent. Consequently, the ruling-family rivalries have the potential of spilling into the parliamentary arena and this may block advancement of key issues, securitization being one. The expectations of Kuwait running its first current deficit since 1992 is expected to take place in 2016 as a result of the decline in the oil prices. The decline in the oil prices is contributing to a deficit in the 2015/16 budget (Ellis & Levy 59).

Securitization is a term used to describe an economic system in which the centers of production, trade and industry are pooled together with the sole intention of repackaging them into interest-yielding securities. All business operations regarding production, distribution and management are entirely carried out by individuals and private sectors. In securitization, the government’s role is the provision of laws, both internally and externally and solving disputes through a court of justice in the case of any disagreements in business terms. Other business activities including price determination of goods and services are typically determined by parties involved in the transactions. The degree of capitalism varies from state to state depending on the laws and regulations of the country.

The existence of securitization varies according to the region or country’s economic policies. Securitization is paramount and influential in the economic systems. It is usually characterized by an accumulation of capital, competitive markets and an increase in wage labor. Other benefits of securitization include efficient control of the production process, increased variety availability due to non-governmental regulations and an improved quality of goods and services. Due to securitization, there is a possibility that consumer’s choice is emphasized as production and distribution sectors experience a reduction in production cost as a result of efficient control (Pettinger 22). These factors can positively influence the economic state of the country. For business corporations, utilizing securitization to make the earth a better place for other people is significant. The correct business plans and operations can benefit many people.

In securitization, the process of production and distribution is privately managed with minimal help from the state. Commodity prices are privately set and coordinated. Since the state does not interrupt in the process of production, the cost of production is minimized reducing the final product price. The quality of products is enhanced, and a variety of services are available to customers. Affordability of goods and services by customers is important since more consumers will have access to the commodities (Piketty 64).This is important in creating a mutual society thereby elevating people’s living standards and increasing the potential for business expansion.

Even though securitization is beneficial to the society when practiced ethically, there are potential side-effects of a securitized economic system. These effects include monopoly power, ignorance of social benefits such as environmental pollution and inequality in wealth distribution. Inequality in wealth distribution can lead to the formation of social classes and the likelihood of social injustices against the poor (Pettinger 89). Other harmful vices such as practicing securitization are detrimental to the poor. Practicing effective securitization practices can help reduce these forms of economic and social injustices in the society. Kuwait is one of those countries where the gap between the rich and poor is large. Therefore, if not carefully executed; securitization may only benefit the rich at the expense of the poor. Therefore, the government should play an important role in monitoring the way securitization is being conducted in Kuwait. That is the only surest way in which securitization will benefit a majority of the citizens in Kuwait.

Securitization and interest rates in Kuwait

Interest rates refer to the rate at which interest is paid by debtors for the use of funds borrowed from lenders. Interests are usually charged by lenders as a compensation for the loss the lenders incur when another party is using their asset. Assets securitized may be consumer goods, cash, and large assets such as buildings or vehicles (International Monetary Fund Staff). Interest is basically a leasing or rental charge imposed on the borrower for the use of the asset. In cases of large assets, such as buildings or vehicles; interest rates are normally referred to as lease rates. In cases where money is lend, the lender could have invested the funds in some income generating projects instead of lending them. Additionally, instead of lending massive assets; the lenders can use the assets themselves to generate income. Low-risk borrowers are normally charged low interest rates compared to high-risk borrowers (Development, O. F. E. C.O. A.).

High interest rates raise the Kuwait’s dinar value. Having a strong dinar has the effect of making Kuwait’s exports to be less competitive. On the other hand, the imports will increase, resulting to a reduction in the Aggregate demand in the economy (International Monetary Fund Staff). An increase in interest rate will also result to an increase in the borrowing cost. Interest paid on loans and credit cards are extremely expensive and with an upsurge, the consumers will be discouraged from saving and borrowing. On the other hand, people who have loans already will have a smaller amount of disposable income since they will be spending more on interest payments. The eventual outcome of this will be a reduction in consumption. Consequently, this will lead to a decline in the value of assets held by each household, thus; dampening the consumer spending in the form of the wealth effect. The overall outcome in this situation will be a failure of the securitization process.

Interest rate increment may also result to an upsurge in the cost of government debt interest payments (International Monetary Fund Staff). Kuwait’s government currently pays huge amounts of money pounds annually on its national debt. Therefore, an increase the government expenditure on interest payments would lead to high taxes in future. This will have an adverse in the economy since the heat will be felt by the consumers (International Monetary Fund Staff). When this happens, those who would have pooled their assets under securitization will feel the heat and may incur massive losses.

Lastly, it is important to note that an increase in interest rates will have a tremendous effect on the business and consumer confidence. This is ascribed to the fact that any rise in interest rates discourages any investment interests since it makes business firms and individual disinterested in taking out risky purchases or investment ventures (Development, O. F. E. C.O. A.). In this case, the government will lack areas to get its revenue in form of taxes imposed on goods and business entities. A reduction in tax will make it extremely difficult for the governme4nt to fully carry out its development agenda due to lack of sufficient funds. Therefore, a rise in interest if brought about by securitization may pose a great threat to the government.

Conclusion

In conclusion, securitization can be used to change the world as it is today. To make the globe a better place, ethical and social factors should be incorporated into the securitization form of economic systems in order to benefit all individuals involved in the business (International Monetary Fund Staff). Economic vices such as corruption that arises due to Free State business operations should be avoided. Quality of goods and services should be emphasized, and application of affordable costs on goods and services encouraged. Consumer interactions and customer relation should be put into consideration, and social-economic practices strengthened. Business owners should work in harmony bearing at heart the needs of fellow citizens. In this way, the society can be made a better place for virtually everybody. If Kuwait government carefully monitors the securitization process; then the economic process would be a benefit to its citizens.

Kuwait’s government should come with laws that promote securitization. These laws serve the purpose of encouraging investors to pool their assets together. In instances that the laws are stringent and do not encourage securitization, potential investors will invest their funds in other countries leaving Kuwait to lag behind inn economic growth. On the other hand, the laws should not be too lenient to give room for fraudsters to defraud potential investors of their assets (Moffat).

Consequently, the ruling family in Kuwait should desist from interfering with the parliamentary politics so as to ensure that the country enjoys political stability. In this way, there are many investors who will deposit their money with banks in Kuwait to enable the securitization process to be successful. Political stability is an essential aspect that is needed for economic growth (Moffat). However, if this is not done; then the infighting to control the oil rich regions will make the securitization a total flop. When this happens, the economic growth of the Persian Gulf country will slug behind and the poor will continue being poor while the rich will continue being rich. The overall outcome of these is the poor suffering more (Ellis & Levy 50).