MEMORANDUM TO THE MINISTER OF FINANCE

 

BACKGROUND

Stakeholders have engaged in ongoing deliberation for
the need to broaden and deepen the capital market to promote Kenya as an
international financial hub. This cannot be achieved unless and until changes,
improvements and innovations are injected into the Kenyan capital market.

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Currently, the national exchange only trades in
traditional instruments i.e. bonds (treasury and corporate) and equities with a
recent introduction of ETFs. Corporate bonds listings have diminished with the
collapse of two issuing banks. Investors are yet to be compensated. There was
only one issue in 2017 and none in 2016.

 The activity in
the exchange is still low compared to other emerging market economies
identified as international financial hubs giving investor limited investment
options. The capital market faces the challenges of lack of diversified asset
universe and capital raising avenues. This has been attributed to limiting and bureaucratic
policies that inhibit innovation in new products and processes. Kenya recently
introduced trading of government bonds using mobile phones. A big leap and a
first. Despite the fete, the bond only attracted 102,700 investors in a
population of 45 million and less than USD 50M.

POLICY
PROPOSITION: DEVELOPMENT OF MORTGAGE SECURITIZATION MARKET AND REGULATIONS
(MORTGAGE BACKED SECURITIES)

Mortgage Backed Securities (MBS) are securities issued
from a pool of mortgages and are backed by cash flows received from homeowners through
interest and principal. Homeowners are bound to make payments over the life of
the mortgages. The lending institution sells off the mortgages to another entity
referred to as a Special Purpose Vehicle (SPV) which pools and structures them
to tradable securities sold in the capital market.

The Kenyan mortgage market faces two challenges. First
is the tying up of capital for the full tenor of the mortgage and second, the
introduction of interest rate capping on credit. By extension, banks are
offering lower returns on customer deposits which has led to massive withdraws
by customers who prefer lending to the government. Banks may not therefore have
large enough deposits to finance mortgage applications which has led to a
credit squeeze. Banks are the major issuers of mortgages in Kenya and as of
June 2017, there were approximately 24,000 mortgages in Kenya worth a USD 2B. These
challenges in addition to minimum capital requirements have created liquidity
conundrums proving unattractive to issue long-term loans. Banks have tightened
lending standards leading to lower overall loans issued.

The primary role of capital market is to raise long
term funding for companies, financial institutions and the government while
providing a platform for securities trading. By so doing, it stimulates
savings, increases investor’s wealth and accelerates economic growth. The
current universe of instruments in the Kenyan capital market fails to offer the
diversification benefits to borrowers and investors. It is for this reason that
the government considers the policy decision to develop mortgage securitization
market and regulations (Mortgage Backed Securities).

CASE FOR
DEVELOPING MBS TO THE KENYAN CAPITAL MARKET

There are no MBS currently issued in Kenya and their
introduction will offer a myriad of benefits to Kenya`s capital market. First,
MBS will improve capital formation by unlocking USD 2B of illiquid, rigid mortgages
held by banks into tradable securities leading to increased liquidity of banks and
more mortgage borrowers will have access to housing. Banks are also better able
to manage their balance sheet effectively hence reducing systemic risks and
freeing up capital.

Second, MBS will increase the asset universe in
Kenya`s capital market and enable issuers and investors to accomplish what is
not currently achieved with existing instruments, diversification. This helps
in capital formation and appeals to a larger pool of local and foreign investments
seeking to diversify returns. More instruments spurs activity in trade of
securities which helps deepen and widen the capital market to investors and
borrowers previously not reached.

Third, MBS helps increase the access of mortgages to
buyers by significantly reducing the cost of mortgages and more people can
access.

The risk of MBS quality will be mitigated by creating
robust regulatory framework by Capital Markets Authority (CMA), increased transparency
and awareness to encourage uptake.

For the MBS market to be effective, certain legal and regulatory
changes are needed. Amendments will be required to the Central Bank guidelines
to allow for securitization of mortgages.

With the need to raise additional funds to finance
growth plans and diversification, MBS will help meet fundamental economic demands
of issuers and investors and improve economic growth.

POLICY
RECOMMENDATION

To steer the Kenyan capital market closer to a deeper,
wider, liquid and inclusive financial system, the government should develop the
Mortgage Backed Securities market and regulations.

 

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