While banks throughout the developed world are cutting their lending in the aftermath of the sub-prime mortgage crisis in the US, in Saudi Arabia the situation is the reverse. Banks are eager to deepen their involvement in the mortgage market.

The population of Saudi Arabia has been growing at 2.5-3 per cent a year for several years, creating a steady increase in demand for properties. Booming hydrocarbons earnings since 2003 have not only given the kingdom the capital to spend on real estate – its revenue from oil exports alone is more than $1bn a day – but has also attracted a growing pool of foreign workers, putting further pressure on the housing market.

According to the latest real estate report by National Commercial Bank (NCB), published in July 2007, between 1992 and 2006, the kingdom’s population grew by 40 per cent, from 16.96 million to 23.7 million. Today it is estimated to be more than 27 million, and by 2020 NCB estimates it will grow to 33.7 million.

But housing finance currently accounts for just 1 per cent of bank lending, and the regulatory framework for mortgage lending is poorly developed. According to NCB, an estimated 44 per cent of Saudi Arabia’s housing stock is occupied on a rental basis.

Building relationships

The banking community is keen to develop the market. “When you start a housing loan, you have a relationship with the client that lasts for a very long time,” says Jean Marion, chief executive officer (CEO) of Banque Saudi Fransi. “There are a lot of other products that can be presented to them during that time.”

Riyadh has also recognised the importance of resolving the situation and two years ago it came up with a proposal for a new mortgage law. The draft law is now being considered by the Majlis al-Shura (ruling council). When the law comes into force, it will introduce a coherent basis for the provision of mortgage finance in the kingdom for the first time.

“The absence of a mortgage law has created a gap in the local market,” says Nader el-Husseini, a consultant in the Riyadh office of law firm Norton Rose. “There is massive liquidity in the kingdom that will be drawn to invest in real estate once the mortgage law is passed. At the moment, there is a housing and accommodation problem, with demand outstripping supply. Eventually the new law will allow banks and investors to make the necessary investment in real estate.”

“It is going to revitalise the way people purchase their homes in Saudi Arabia,” says Amgad Hussein, head of the Riyadh office of law firm Denton, Wilde & Sapte. “At the moment it is quite difficult for the average Saudi national to obtain a mortgage – it is quite costly and not efficient. Unless they can afford to buy their own land and build their own home, it is hard for them to become a homeowner.”

A form of Islamic mortgage lending does already exist in Saudi Arabia. To comply with sharia law on the charging of interest, a system is used under which banks buy the real estate and sell it back to their client at a profit over a period of 20-30 years. But the existing regulatory infrastructure for the market is inadequate, leaving banks to employ complex strategies that enable them to provide housing finance to their clients. For example, to get around the Banking Control Law, which prevents banks from holding the title deeds of real estate, they have adopted innovative practices such as using their CEO or another board member as the title holder of the property.

Regulatory restrictions

The new law is likely to include provisions through which banks can establish a separate mortgage business that is not subject to the provisions of the Banking Control Law.

“The mortgage law is crucial because it will organise the relationship between the different parties and create the legal infrastructure to engage in lending against homes,” says Abdul-kareem Abu al-Nasr, CEO of NCB. “The law will enable banks and financial players to recognise that they are protected. Then comes the entrance of large developers who can develop properties that lenders feel safe buying.”

The most eagerly anticipated element of the new legislation is the provision of guarantees to banks in the case of their clients defaulting on repayment. Whereas in the West banks can, as a last resort, repossess their clients’ homes, no such redress exists in Saudi Arabia under the current system.

“This is the most important change,” says El-Husseini. “There is an existing mortgage market in Saudi Arabia using regular loans for housing finance and it is already expanding. But the regulations on repossession in the new law will enable it to expand further. The bottom line is that the majority of Saudis do not own their houses, and that will definitely change.”

The exact terms of the new law are still uncertain. Several revisions have already been made to the original text since the law was proposed in 2006, and the draft legislation is subject to an ongoing process of review by the Majlis, the Finance Ministry and the king. Just how close this process is to completion is also unknown, with everyone in the industry seeming to have a different view of exactly what is happening. Most agree, though, that the law is still several months away from being enacted, and it could take even longer.

“It is still under discussion,” says Osama Aboghorara, chairman of the Majlis al-Shura’s committee for financial affairs, which is reviewing the law. “We are studying it with other [government] departments and getting feedback from [business] people who are interested in the law from our country and other countries. We expect to be presenting [our findings] to the Shura before the summertime.”

Aboghorara would not be drawn into predicting when the draft legislation will become law. “It is a huge system and we are still processing and studying,” he says. “We will pass it to the government and to the king and they will study it. I hope that we will finish it as soon as the people want us to.”

The protractedness of the debate on the legislation is due to the fact that it touches on particularly sensitive issues. Reconciling the repossession of property with the social tenets of Islam is a critical issue for those examining the proposed legislation. “It is one of the most difficult laws [to be addressed by the Shura council],” says Ihsan Ali Bu Hulaiga, also a member of the council. “The issues relating to repossession and eviction are making it difficult for the legislation to make progress.

“Banks might be able to go through the courts to get the rights to repossession but when it comes to actually evicting people, it is very delicate. It is forbidden in Islam to force families out of their homes. So how do you deal with it if they have defaulted?”

Even if the new law is passed successfully, the banking industry expects it will be some years before it has a significant impact on the market. “The mortgage law will not be the next stock market bonanza, with the banks building portfolios of billions [of riyals],” says Al-Nasr. “I think it will come gradually.”

The high indebtedness of the average Saudi national, restrictive mortgage borrowing limits and rising property prices are all expected to impede the growth of the mortgage market over the next five years.

“Banks already offer housing finance and if you use the take-up of that as an indicator, you can see that the market is not growing as fast as anticipated,” says John Sfakianakis, chief economist at Sabb. “Mortgage lending is only about 1 per cent of the balance sheets of Saudi’s 11 banks.

“Consumer borrowing may have reached a limit it cannot exceed without further legislative changes. And property prices are increasing month by month, which will be another challenge even if the new legislation is approved. In the short-to-medium term, we will probably not see enormous growth in the provision of housing finance.”

High land prices are another significant barrier to the development of the mortgage market. “The cost of raw land is an impediment,” says Al-Nasr. “The speculation driven by the liquidity in the market makes the economics difficult to understand. If you buy the land for billions of riyals, how can you develop anything that is economically feasible?”

It is a problem that will take time to overcome. “The phenomenon until recently was that the price of the land would go up but the home itself would decrease in value,” says Al-Nasr. “So that makes it very difficult to go and lend against the asset. This is because there are no building codes and no maintenance requirements, [while] the inclination to buy the land was greater. This will have to change but it will take time. I’m not seeing massive transformation yet.”