Passing an important milestone

July 2 was no ordinary day in the annals of the Saudi financial sector. The new mortgage law, in the making for years, had been awaited with growing impatience as affordable housing moved toward the top of the policy agenda. Following the approval by the Council of Ministers of July 2, the relevant implementing regulations are expected to be issued by SAMA (Saudi Arabian Monetary Agency) within months. There is little doubt that the new law – or in fact a compendium of laws – is among the most important pieces of enabling legislation to have seen the light of day in the Kingdom over the past several years.
A thriving mortgage market is important for a whole host of reasons. What matters most in the Saudi context is its ability to boost access to housing, a crucial issue in a demographically dynamic economy with a chronic shortage of residential real estate. Home ownership in the Kingdom on any reasonable indicator is internationally fairly low and in practice beyond the aspirations of many young middle class professionals. One of the consequences has been persistent rental inflation which remains a key contributing factor to overall price rises. The currently extant facilities for mortgage finance have provided only partial solutions, although the Real Estate Development Fund has seen its resources boosted substantially in recent years. It has further increased its market presence through guarantee agreements with banks. While commercial banks have also embraced mortgage finance with growing enthusiasm, the relatively early stage of market development and incomplete regulatory provisions have large limited their lending to generally low risk, pre-screened customers. The impact on access to housing has thus been modest.
The mortgage law has a potential to transform this situation over time. Above all, it should lend an impetus to property development, especially in the middle income segment, as the increased availability of credit should boost demand by middle-income customers. Such individuals are likely to evolve into the backbone of the market going forward. Quite apart from boosting access to owner-occupied housing, the law should also boost house quality. A properly regulated mortgage industry creates an incentive to protect and presence the value of housing thereby boosting building standards and maintenance.
Mortgages are also important from the perspective of financial market development and hence a key plank in economic diversification and job creation. Overall mortgage lending in the Kingdom is in the neighborhood of 2 percent of GDP, an extremely modest figure by international standards that compares to 60-70 percent, even as much as 100 percent, in mature markets. The corresponding proportion even some GCC markets is now nearing 20 percent. Mortgages can, with time, constitute a transformative element in deepening financial intermediation in the Kingdom where overall bank credit still stands below 50 percent of GDP.
The law should also stimulate the emergence of new mortgage lenders as well as financial products such mortgage-backed securities and real estate funds. New institutions should in turn arise to structure and disseminate them. In many other markets, such instruments serve as important funding and investment vehicles. Other auxiliary activities will emerge in areas such as insurance and real estate brokerage. At the same time, by enabling people to acquire substantial assets, mortgages can create a collateral for further borrowing. Similarly, they should contribute to financial planning and broader financial literacy.
In spite of its impressive potential, the new law will not suddenly solve all the problems associated with the Saudi market, as much as it marks an important turn in the right direction. Building a thriving, sustainable mortgage market will require continued vigilance and proactive regulation. Such regulatory conservatism will in part be needed to manage potential mismatches between demand and supply, as well as other market distortions that could potentially generate market bubbles. The international experience has repeatedly shown how the correction of such imbalances can exact substantial financial and broader economic costs. Beyond this, ensuring broad-based access to housing is likely to continue to hinge critically on an active government role in housing development. Some type of social housing has constituted a key element in the development of all mature housing markets. However, the presence of a proper mortgage market and a thriving secondary property market may well make it possible for some social housing to be privatized, so as to further boost home ownership as time goes on.
Enabling legislation has an impressive track record of success in transforming and expanding the Saudi financial sector. By creating a well defined, comprehensive regulatory framework to support the development of a market and coupling this with adequate supervisory resources, the Saudi authorities have over the past decade ago successfully boosted financial intermediation while preventing destabilizing excesses. The financial sector remains well capitalized and stable. Landmark initiatives in this regard include the 2003 Capital Market Law and the 2005 Cooperative Insurance Companies Control Law. The former has played a key role in fostering the sustained development of the largest equity market in the region while the later gave rise to a well regulated insurance sector. The mortgage law now presents the prospect of another important milestone on the road to sustainable growth.
— Jarmo T. Kotilaine is chief economist at
the National Commercial Bank, Jeddah.