Mushtak Parker Saudi Gazette LONDON – The approval of the Saudi Mortgage Law by the Council of Ministers earlier this month, which has been almost four years overdue, will not only be a game changer for the housing finance and real estate development market but could propel Islamic finance to the next level in the Kingdom. Islamic mortgage finance could have the same impact in consumer finance as Sukuk is having on the Saudi corporate sector as a fund-raising instrument. But according to Ajmal Bhatty, President and CEO, Tokio Marine Middle East Limited, which is in the process of establishing a Takaful (Islamic insurance) joint venture in Saudi Arabia with Alinma Bank, the Alinma Tokio Marine KSA, the adoption of a mortgage law could boost the mortgage Takaful industry in a big way, which could lead to further developments in mortgage securitization down the line as the market matures. “I think the introduction of the Saudi mortgage law is a major development for the housing market. I understand that more than 60 percent of households may need new units because of the young demography of the Kingdom. So there is a huge housing market for mortgage finance. And that opens up opportunities on the mortgage Takaful side as well. But it has to be handled properly with the right products and processes,” explained Bhatty to Saudi Gazette. International credit rating agency, Moody's Investors Service, in a statement also stressed that “the implementation of the mortgage law is credit positive for Saudi banks because we expect it to enhance their asset growth potential, strengthen the profitability of retail franchises and increase loan book diversification.” The regulation of the mortgage industry in the Kingdom will be the responsibility of the Saudi Arabian Monetary Agency (SAMA), the central bank. However, the introduction of a mortgage law is one thing, implementing such a law could be more difficult, especially also if the mortgage law alludes to Shariah-compliant (as it does) housing finance schemes and products. As such, the development of the mortgage finance industry in the Kingdom will be gradual despite pressure from above to expedite things given that the lack of housing is a major social issue in Saudi Arabia as it is in almost all countries of the world. Indeed, in the latest World Bank/International Monetary Fund (IMF) Financial Sector Assessment Report (FSAP) on the Kingdom titled “Saudi Arabia: Financial System Stability Assessment—Update” which was published in April this year, the IMF warned that the Kingdom faces the challenge of generating housing and employment for its young and growing population, a challenge that cannot be met only through specialized public credit institutions. “Support to housing finance has been traditionally provided by the Saudi Real Estate Development Fund (REDF). However, such institutions do not have the resources or operational capacity to meet the large demand, even though the government provided the REDF with SR40 billion in additional capital in early 2011. The government and SAMA are aware of these limitations, and they expect the banking system to play a much larger role in the current decade and beyond. A key challenge will be to ensure efficiency and financial soundness in housing finance as it expands," said the Fund. The law, according to Saudi banking sources, specifies that only companies authorized by SAMA - banks, mortgage companies, finance companies owned by real estate developers - will be allowed to extend housing finance. In addition, the Saudi Real Estate Development Fund (REDF) will continue to give loans for building housing units, of which there is a huge shortage, given the growing population of the Kingdom and the fact that 60 percent of the population is under 25 years of age. The REDF in its latest allocation last week approved another 11,666 loans worth SR5,833 million for the building of 14,000 housing units in various towns and provinces. The mortgage law is also Shariah-compliant not only in terms of the mortgage finance contract, but also in terms of the rights of the mortgagee. It comprises a package of five laws - mortgage registration law; execution law including foreclosure processes and proceedings; a financial leasing law; real estate finance law, and a finance company law. The five draft laws in the mortgage package would improve the housing finance framework in the Kingdom. Besides laying the foundation for an efficient mortgage system, the new laws will create a consumer protection framework, empower SAMA to regulate and supervise non-depository lenders, and establish a framework for the development of funding instruments (mortgage refinance facility, securitization, covered bonds). But as the World Bank/IMF ASAP Report stressed, "in view of the risks that are inherent to residential real estate lending, additional measures are needed to ensure the sound development of the (Saudi real estate) market. These include (i) new prudential norms (capital, provisioning) to support stronger creditor rights; (ii) setting up of a housing market observatory, including a price index; (iii) consumer protection norms; and (iv) regulatory facilitation of new products, including notably steps to strengthen the developer industry." Affordable housing - or the lack of it - is the fundamental challenge for all societies whether they are in industrialized, newly industrialized, emerging or least developed countries. Countries such as Saudi Arabia are realizing that housing is a national priority. King Abdullah last year even appointed the first Minister for Housing. As such the adoption of the mortgage law should also be seen in this context. The World Bank Group, especially its private sector funding arm, the International Finance Corporation (IFC), believes that "providing people with affordable housing helps foster stronger communities, neighborhood safety, and political stability. While housing affords people shelter, owning one's home also gives people a tangible asset, and a stake in their society. Development of a strong housing sector also contributes to job creation, entrepreneurship, and the growth of strong business and commercial services to support cities, communities and neighborhoods." Mortgage finance not surprisingly is one of the fastest growing investment areas and a "high priority' economic sector for the IFC across the globe. The business case for the Saudi mortgage finance market is implicit. Despite recent growth, housing finance portfolios in the Kingdom remain small. The REDF has historically been the main provider of housing finance, with a portfolio of SR78 billion, stable in recent years. According to the World Bank/IMF in its ASAP Report, the REDF facilitated access to housing, but is unable to meet a growing demand (with waits up to 18 years) and has adversely affected the development of commercial housing finance (for example, interest free loans for nationals). "In recent years, banks and other lenders such as mortgage finance companies rapidly grew their portfolios (at an annual rate of 22 percent from 2008 to 2010). Nonetheless, housing demand is not satisfied, with annual needs estimated at around 250,000 units over the medium term, compared to 80,000 permits delivered on a commercial basis. Housing demand will only increase further, reflecting the young and growing population and declining household size," the report noted. Housing loans currently constitute 3 percent of banks' loan portfolio, which is heavily dominated by low yielding corporate and government business. Housing loans account for around 2 percent of Saudi Arabia's GDP, compared with around 5-10 per cent of GDP in most other Gulf Cooperation Council (GCC) countries, according to the respective central banks and Moody's estimates. Saudi mortgage penetration is only 2 percent, albeit the Saudi government target is for 80 percent home ownership by Saudi citizens by the year 2024. Some of the challenges for the Saudi mortgage market and for the mortgage law are specific. Although one of the laws in the package talks about financial leasing (Ijara), does this mean that only Ijara-based mortgages will be available in the Saudi market? The other choices are Murabaha (fixed-rate mark-up); Al-Bai Bithaman Ajil (deferred payment), and Diminishing Musharaka (equity participation with a rental element). Similarly, no mortgage finance provider would finance a house without the requisite insurance for building and contents.
