No free lunch: Strict conditions apply to the support offered by the new Financial Stability Law

As the global economy lurched into crisis in 2008, governments and central banks the world over acted to mitigate its deleterious effects, using a full array of traditional tools – such as monetary policy and open market measures – and more radical instruments, in the form of new regulation or legislation.

The traditional mechanisms utilised by Kuwait in response to the deteriorating global economy included liquidity injections through central bank operations and direct government deposits, and an easing of some liquidity requirements applied to banks, such as altering the loan-to-deposit ratio. However, the government also sought to support the financial sector with one of the most comprehensive pieces of legislation ever directed to it: the Law for the Strengthening of Financial Stability, known as the Financial Stability Law (FSL) or Decree Law 2 of 2009. Ratified by the National Assembly in May 2009, this wide-ranging piece of legislation has the three-fold aim of shoring up banks, productive sectors and troubled investment companies.

GOVERNMENT GUARANTEES: The first part of the law addresses the banks, outlining a mechanism by which the government can provide a guarantee for provisions and investment shortfalls against loans and investment portfolios that were established before December 31, 2008. However, this provision is far from a bailout. Banks cannot simply write off their bad assets and turn to the government’s guarantee, but must monitor debts and make demonstrable efforts to collect them. Moreover, from the end of 2011 banks must build provisions to cover their deficits at a rate of 8% of the shortfall per year. The government’s guarantee, therefore, decreases over time, and is intended to act as a mechanism by which local banks can be granted a period to make the required provisions themselves. Should a bank be unable to cover its deficit within the specified schedule, the law grants the Kuwait Investment Authority the ability to subscribe sufficient equity to cover the shortfall – a bailout of sorts, but one that repays the government with increased ownership.

The second part of the FSL represents an attempt to boost productive economic sectors. The government will provide a guarantee of up to 50% of new collateralised credit extended by local banks, provided the facilities have a maximum duration of five years and are not used to either speculate or trade in real estate and securities. As a lending stimulus in a time of scarce lending opportunity, the provision is of potential benefit to banks, although it is not a shortfall guarantee – losses will be covered only after collateral has been realised and applied to the entire loan.

LIQUIDITY: The third part of the FSL is designed to assist investment companies with liquidity problems, and describes, among other things, how those meeting specified solvency requirements will be provided with guarantees for up to 50% of new finance from local banks to settle obligations to local parties (but not banks) and reschedule debt to foreign banks. A further provision grants the Kuwait Investment Authority the ability to inject capital into investment companies and establishes the government’s right to subscribe for equity and even take over investment companies if the need is seen to be large enough.

The bank and investment company programmes set out in the FSL grant the Central Bank of Kuwait (CBK) and the government the ability to act aggressively in some cases, and will therefore only be of interest to companies facing otherwise insurmountable challenges.

The demanding eligibility requirements of the FSL also preclude those institutions facing insolvency or with insufficient capital in the eyes of the consulting firms appointed by the CBK to assess banks. This does not, however, render the new law irrelevant. At its launch it was described by the CBK’s governor as a preemptive and precautionary measure, and it offers a lifeline to companies with liquidity issues and acts as a potential spur to lending. It is an important element in the response to the credit crisis. However, a bailout it is not, and companies with severe solvency challenges will have to look beyond the government’s coffers for relief.