Digitalisation spurs business process optimisation in Saudi Arabia

Saudi Arabia’s banking sector is dynamic and competitive, comprised of domestic universal banks, foreign specialists and finance companies vying for market share. It is also a sector in the midst of significant and regulation-driven change, as the Kingdom’s leadership works to implement its long-term economic blueprint, outlined in detail in its Vision 2030 programme. Indeed, the financial sector is expected to play a major role in the Kingdom’s diversification initiatives.

This cross-sector economic transformation is fuelled by technology and innovation-driven process optimisation to create new opportunities. In the banking sector specifically, digitalisation is seen as the key to unlocking a new era of enhanced services, eased connectivity and enhanced financial inclusion. To accomplish this, several new players have entered the market in recent years, including three digital banks and a microfinance lender. The sector is also characterised by a fast-growing financial technology (fintech) sector, in which payment companies, lending platforms and other innovative solutions are being deployed or are under development. The Saudi Central Bank (SAMA) released notable regulatory changes that have spurred this activity, including the introduction of an open banking policy in January 2021 that promises to usher in an era of cooperation between traditional banks and entrepreneurial start-ups, and the licensing of the first digital banks in June 2021.

Structure

Of the 35 locally licensed banks operating in the country, 14 are either conventional or Islamic domestic banks, and 21 are foreign. Three of the domestic banks are digital only, and six of the foreign lenders have received licences but have yet to commence operations. There are also 48 licensed finance companies, seven of which are active only in real estate, and five of which do not extend credit but are instead service providers to the industry. SAMA has also awarded 16 licences to fintech companies providing payment services, digital insurance brokering and microfinance, the first offering of its kind in the country. Another 32 licensees are operating in a regulatory sandbox environment that was created by the central bank to test new digital solutions.

As of the end of 2020 three lenders accounted for 50% of the sector’s market share: National Commercial Bank (NCB), at 20.3%; Al Rajhi Bank, at 18.5%; and Riyadh Bank, at 11.2%. All are domestic lenders, and Al Rajhi is the country’s largest Islamic bank. NCB merged with Samba Financial Group to form Saudi National Bank in 2021, in a $15bn deal that may trigger more consolidation. The combined entity is poised for market leadership, according to a January 2022 report from ratings agency Fitch Ratings, with a market share of domestic assets at about 30%. It also had a leading market share of 21% in corporate banking and was the second-largest for retail lending, with a 29% share.

Consolidation of the banking sector into a smaller pool of larger lenders would make it more robust, reduce systemic risk and equip lenders with sizeable balance sheets required to invest in the digital future. SAMA, as the regulatory body, has long encouraged its licensees operating in financial services to consider mergers and acquisitions. This process is also under way in the insurance sector (see Insurance chapter).

Digitalisation

As of 2021 universal banks operated 1945 branches in the country, with Riyadh and its surroundings accounting for 30% of that figure. This number is down from 2014 in 2020, as more consumers have become comfortable with online services and fewer customers feel the need to visit brick-and-mortar locations. “As a result of the pandemic, consumer behaviour has changed. This is noticeable in the rise of cashless transactions, use of e-wallets and increased online spending from home,” Priyan Attygalle, CEO of American Express Saudi Arabia, told OBG.

The reduction in locations is not solely a result of digitalisation, but also because banks are working to relocate to enhance access and convenience for customers. Even with the Kingdom’s pursuit of its digital transformation, physical locations remain a key part of the offering, in particular for financial inclusion across the sector. Banks are now able to sell insurance products in partnership with insurers via bancassurance business models. This is seen as a practical option for consumers, particularly those who live in remote regions, as it helps to facilitate access to a full suite of financial services from one location.

Foreign banks in Saudi Arabia are not typically direct competitors with the domestic lenders that dominate the universal banking model. Instead, they are focused on providing finance to large projects and enhancing the Kingdom’s financial services connection to global peers and systems. Foreign banks hold less than 1% of total assets, and have been granted licences to ensure geographical diversity, with representation from China, the US, Japan, Pakistan and the UAE.

Oversight

The Banking Control Law of 1966 governs the sector, and SAMA regulates and supervises banks. Although recently rebranded as the Saudi Central Bank by the Saudi Central Bank Law of 2020, the institution has kept the acronym SAMA from the time in which it was formally titled the Saudi Arabian Monetary Authority. SAMA reports to the king but maintains financial and administrative independence from policymakers, in line with international best practices. Both SAMA and the wider Saudi government are seen as likely to offer support to the sector in difficult times, including liquidity injections as needed to preserve financial sector stability. “The Saudi authorities have the ability and willingness to provide support to domestic banks irrespective of size, franchise, funding structure and level of government ownership,” according to a January 2022 report published by Fitch Ratings.

Fahad Al Mubarak, the governor of the central bank, took office in January 2021 and is now serving his second term. He previously held the position from 2011 to 2016. Al Mubarak has also filled a variety of public sector economic leadership roles in the Kingdom and worked in the private sector.

In addition to banking regulation and the full range of roles and responsibilities typical to a central bank, SAMA is also the regulatory authority for insurance and payment companies, foreign exchange houses and two credit bureaus: Saudi Credit Bureau (SIMAH), in operation since 2004; and Bayan Credit Bureau, established in 2015. According to SAMA’s 2020 annual report SIMAH issued 12.3m credit reports for the retail sector during the year, down 36.7% from 2019, due to the Covid-19 pandemic; and 81,000 reports for the commercial sector, up 19.8% from the previous year.

SAMA also plays a key role in the Kingdom’s Vision 2030 plans. The Financial Sector Development Plan (FSDP) was created in 2017 to add specific details on projects and execution strategies to meet Vision 2030’s strategic objectives. Of the 41 initiatives in the FSDP, SAMA is responsible for 16 and as of mid-2022 completed 12. The plan includes targets for 2030 as well as mid-point years. For example, the overall aim for moving beyond cash is to execute 70% of all transactions over digital platforms by 2030, with an intermediate goal of 55% by 2021. That target was exceeded, as the share reached 57% for that year.

SAMA has facilitated this transition by issuing guidelines and rules to support the development of fintech and to facilitate digital transformation, such as those for digital banks; and technical requirements for digital financial intermediation, microfinance, debt-based crowdfunding, insurance aggregation and bancassurance. SAMA’s regulatory sandbox is another important aspect of the authority’s efforts to facilitate the digital transition and to meet the goals of Vision 2030. The sandbox hosts pilot projects for e-wallets and opening bank accounts online. SAMA has worked to position the regulatory sandbox, which ensures all relevant policies are understood and correctly implemented by fintech players, as one of the main drivers of innovation in the financial sector. In 2020 SAMA updated the standard real estate financing contracts for Islamic financing, which use the sharia-compliant ijara (leasing) and murabaha (cost-plus financing) financing structures.

In terms of digital banking, for example, updated rules specify the types of banking documents that must be made available and verifiable both electronically and on paper, including bank certificates, debt certificates and no-liability letters. SAMA also set rules for crowdfunding, and its General Secretariat of the Committees for Banking and Financial Disputes and Violations created the Banking and Financial Disputes Ombudsman Centre in January 2022 to offer alternative dispute resolution options aimed at lowering costs and expediting issues settlement.

Performance

The consolidated balance sheet for the sector showed SR3.3trn ($879.8bn) in total assets as of 2021, up from SR3trn ($800bn) in 2020. The 10.1% growth outpaced that of the previous year when assets expanded by 9.7%. The sector is close to meeting a goal in the FSDP of reaching SR3.5bn ($933m) in assets by 2025. The goal for 2030 is SR4.6bn ($1.2bn), compared with SR2.6bn ($693.2m) in 2019, the baseline year against which the FSDP measures growth.

Total bank deposits rose 8.2% in 2020 compared to 2019, amounting to SR1.9trn ($506.5bn). Demand deposits in 2020 comprised 66% of the total, an increase from 61.2% the previous year. Timed and savings deposits, meanwhile, accounted for 24.4%, down from 27.9% in 2019. The private sector contributed 78.1% of deposits, compared with 77.4% in 2019.

In 2021 the sector achieved a return on assets of 1.8%, up from 1.5% in 2020. The return on equity rose to 10.8%, compared to 8.6% over the same period. The ten publicly listed lenders on the Saudi stock exchange, which must report earnings, recorded a 59.6% increase in net profits in 2021, climbing to SR48.7bn ($13bn) from SR30.5bn ($8.1bn) in 2020.

In the Islamic segment, the value of sharia-compliant financing reached $430bn in the second half of 2021, with deposits amounting to $433bn. That accounted for just over half of all sharia-compliant assets in the Kingdom, including insurance, investment and sukuk (Islamic bonds). The last of these services were valued at about $800bn by the Islamic Financial Services Board in its annual report for 2021. Saudi Arabia’s total of Islamic finance assets comprises about 28% of the global total.

Liquidity & Solvency

Saudi Arabia’s banking sector is well-capitalised and expected to remain stable in the event of any potential crisis, thanks to a capital adequacy ratio that exceeds the recommended threshold. As of the end of 2020 the ratio stood at 20.3%, and the figure has been between 19.5% and 20.4% since 2016. Under the Basel III banking standards adopted as a result of the 2007-08 global financial crisis, the minimum recommended ratio is 8%. Other stability indicators remained positive throughout 2021, including the ratio of non-performing loans to gross loans, at 1.9%, down from 2.2% in 2020.

The Basel III framework provides a range of standards and practices to ensure banks’ stability, and regulators worldwide have mandated adoption for their banks at varying paces. SAMA had planned to issue final standards for the last phases of implementation in 2022 but has followed the guidelines of the Basel Committee on Banking Supervision in deferring implementation to 2023. The delay was suggested to give banks and regulators greater flexibility in responding to developments arising from the pandemic.

Saudiisation

Local participation in the workforce, is a crucial performance metric in Saudi Arabia, since knowledge and skills transfer to the populace is one of the country’s policy priorities. The Saudiisation rate, as it is often called, was 94.8% in the banking sector in 2020, down 2.4% from 2019. Foreign banks in particular, are meant to play a role in skills transfer. State-owned energy company Saudi Aramco joined forces with foreign and domestic banks and other multinational consultancies in April 2021 to launch the Altamayyuz Finance and Accounting Excellence Academy in Riyadh. This training institution was established to further build on the capabilities of the top finance and accounting graduates of the country. Participating institutions include Saudi National Bank, Technical and Vocational Training Corporation, Citi Bank, Deloitte, EY, Goldman Sachs, HSBC, JP Morgan, KPMG and Morgan Stanley.

Lending

With Saudi Arabia moving into a post-pandemic economy, lending is expected to continue on a growth track above 10% per annum. In 2020 bank claims in the public and private sectors rose by 14.5% to SR2.3trn ($613.2bn), outpacing the 10.4% growth in 2019. Loans to the private sector totalled SR1.7trn ($453.2bn), an increase from SR1.5trn ($400bn) from the previous year. The pace of lending expansion was faster for sharia-compliant lenders in that same period, at 17.9%. The most popular lending structures were murabaha, tawwaruq (to buy a commodity on credit and sell it to a third-party at spot value) and ijara. The overall goal of the FSDP is to boost credit to the private sector to SR2.1bn ($560m) by 2025, from a baseline-year measurement of SR1.5bn ($400m) in 2019.

The growth in lending has also come with an extension in maturities. Long-term credit rose to SR971.3bn ($259bn) as of the end of September 2021, a 70% increase from September 2019. Short-term credit grew 13% in the same period. Further expansion is expected to come from market segments led by residential mortgages, a priority under Vision 2030, followed by corporate lending and public sector lending.

SAMA figures indicate that between 2016 and 2022 mortgage financing has increased 17 times over, helped by consumer demand, as well as a favourable regulatory and legal environment, including a tax cut from 15% to 5% for retail property buyers. The outstanding balance of real estate loans grew 33% in 2021, including a 41.5% jump in loans to individuals. This is an area of lending in which finance companies are also active, as retail mortgages outpaced auto finance and personal finance as the most popular line of activity, accounting for 32.3% of total loans as of March 2022.

The Kingdom’s Vision 2030 economic blueprint highlights homeownership as a goal, targeting a 70% ownership rate by the plan’s end date. As of 2020 the rate exceeded 60%, up from 47% in 2016 at the plan’s start date. For portfolio investors, mortgage-backed securities are a useful investment vehicle, created by the Public Investment Fund (PIF) – the Kingdom’s sovereign wealth fund – in 2019 through a subsidiary called the Saudi Real Estate Refinance Company.

Small Business Credit

Credit to small- and medium-sized enterprises (SMEs) grew by 8.2% in 2021, rising to SR203.3bn ($54.2bn) from SR182.2bn ($48.6bn) in 2019. Finance companies are more exposed to the sector than universal banks, as SMEs accounted for 2% of their total credit in the year, compared with 7.8% for the banks. Overall lending to this group has almost doubled since 2018, thanks to policy interventions in the banking sector. SME financing is another area of focus in Vision 2030, with a 2025 target of an 11% increase in the share of SME financing by banks. By 2030 the aim is to boost the share to 20%, from a baseline-year measurement of 5.7% in 2019.

The state’s SME Financing Guarantee Programme, known as Kafalah, is offered through the Saudi Industrial Development Fund. It provides loan guarantees to lenders willing to extend credit to SMEs, and in 2020 underpinned financing worth SR12.3bn ($3.3bn), up from SR4.8bn ($1.3bn) in 2019. SMEs are also expected to benefit from the digitalisation under way in the sector and encouraged by Vision 2030, as banks expect that small businesses can be better reached and served through digital channels.

Financial Inclusion

Boosting the availability of mortgages for households and loans for SMEs is part of a wider effort to increase financial inclusion in the Kingdom – an area the FSDP identifies as needing attention in order to close a gap between the Kingdom and peer countries. The percentage of adults with a bank account was 71% in 2018, according to the FSDP, compared with rates above 90% in similarly developed markets at that time. Women and low-income citizens were in particular at risk of non-inclusion, with inclusion rates of 58.8% and 64%, respectively.

According to a 2017 survey conducted by the OECD, Saudi adults scored lower than those in any other G20 country in terms of financial literacy. Further domestic research underscored the need for citizen education on financial planning, in particular.

Broadly, however, technology is seen as the solution to this problem. The percentage of adults who have used at least one fintech solution was 74% in 2021, higher than the share of those who have a bank account, according to a survey by Fintech Saudi, a joint venture of SAMA and the Capital Market Authority, and whose mission is to help develop fintech in the country. The survey tallied responses from 2297 respondents from all ages and regions of the country, as well as 237 businesses. The survey also found that the majority of Saudis used cash at least once a week, although overall usage was in decline. Respondents reported a diminishing reliance on bank branches as 20% had visited one in the previous month, and 35% said they could not remember their last visit. Some 93% of customers conduct their banking activities primarily over digital platforms. Respondents reported a desire to use fintech solutions for payments, investment and savings, but this was not driven by a dissatisfaction with existing options. A total of 84% of respondents said they were satisfied with existing services. “Customers trust traditional banks to store their savings. As long as banks can adapt to the digital landscape and adopt secure innovations, they will continue to be the partner of choice for serious and sophisticated investors and savers,” Abdullah Al Khalifa, CEO of Alinma Bank, told OBG.

The Saudi fintech industry has grown from 10 companies in 2018 to 82 in 2021, according to Fintech Saudi, and investment levels are on the rise as well. In 2021 more than $12.9m was invested in seed and pre-seed stage fintech companies, more than double the figure from 2020. Payment technologies accounted for 93% of the total. Having comprehensive options for cashless transactions is a key element of the FSDP and Vision 2030, and an important early step to unlocking the broad potential of fintech. For overall venture capital investment in fintech, the first nine months of 2021 saw a total deal value of $157.2m, up from $7.8m compared to the same period in 2020.

Fintech Saudi’s survey found that payment and currency exchange companies comprise 32% of Saudi fintechs, and this mirrors early-stage interest from the market. E-commerce transactions in the first quarter of 2021 were up 95% from the first quarter of 2020, for example. Lending and finance has emerged as a secondary sector, at 19% of the total. Other areas of focus include personal finance and treasury management contributing 13%, business tools accounting for 12%, and private fundraising at 10%.

Digital Banking

SAMA licensed the first two digital-only lenders in July of 2021, stc Bank and Saudi Digital Bank. stc Bank is an outgrowth of stc Pay, a payment platform created by national telecom provider stc that achieved unicorn status in 2020. This milestone was met after Western Union, the global money-transfer service, invested $200m in the platform in exchange for a 15% stake, implying a valuation of the company at $1.3bn. stc’s experience with digital remittances, money transfers and other online payment services has put it in an advantageous position to evolve into banking. The new lender began operations with SR2.5bn ($666.5m) in capital in June 2021. Saudi Digital Bank, with SR1.5bn ($400m) in capital, was formed by led by Abdul Rahman Saad Al-Rashid Company, a Saudi conglomerate with interest in sectors including investment, real estate and construction. In early February 2022 SAMA awarded a third licence to D360 Bank, backed by a consortium that includes the PIF and Derayah Financial Group, the Riyadh-based financial services firm.

Customers will be able to use digital banks to open accounts, use debit and credit cards, loan money and invest. This may appeal to clients in rural areas, as the 97% internet penetration rate for this segment exceeds the traditional banking penetration rate of 72%. Additionally, SMEs could find a smoother path to credit through digital systems.

Open Banking

The next significant technological change for the banking sector is likely to be open banking, in which banks enable customers to share their financial data with third parties, in authorised and controlled settings using application programming interfaces (APIs). This is expected to empower thirdparty fintechs to create innovative and customised services and the platforms to integrate them. Account holders would be able to access a single dashboard tracking all of their financial relationships.

Open banking will lower the barriers to entry for fintech start-ups and is expected to boost competition and innovation in the sector, according to the FSDP. Embracing open banking will mean following in the footsteps of the EU, whose revised Payment Services Directive came into force in January 2018, and whose General Data Protection Regulation, issued in May 2018, provides customers with the choice of how much personal data to share with companies. By enabling financial institutions to promote the expansion of the private sector even further, open banking assists the Kingdom in achieving the objectives of Vision 2030.

SAMA announced its open banking initiative in January 2021, and it is expected to take effect in the second half of 2022, requiring licensees to be ready for a new era in regulatory compliance. The Saudi banking sector is in a position to successfully leverage open banking for several reasons, according to consultancy PwC. To start, the relatively small number of banks means that adoption could be a fairly quick and smooth experience for customers. The existing and robust payment infrastructure is also an asset, the consultancy said. “Collaboration among all players — banks, payment service providers and the Saudi Central Bank — will be critical to accelerating the process and ensuring the best implementation of open banking,” PwC indicated in a June 2021 strategy report.

For banks, the new era brings a mandate to do things in ways that may require an adjustment period and an updated outlook on whether fintech providers are competitors or partners. However, over time there could be at least three main benefits to open banking for traditional lenders, according to a report by the London-based consultancy Abacus Cambridge Partners: an acceleration in financial innovation, new revenue streams by monetising APIs and improved services leading to enhanced brand loyalty.

Outlook

The pace of change is accelerating in Saudi Arabia’s financial services sector, as the Kingdom’s leadership pursues a wide-ranging socio-economic reform agenda including increasing financing to SMEs, digitalisation and open banking. This is a challenge for licensees, but one they have proved capable of meeting by surpassing early-stage targets such as the 2021 goal for non-cash transactions. This transformation is also presenting new opportunities to develop and diversify the national economy, thanks in part to the investment that local banks are drawing, innovations in the pipeline and the new revenue streams soon to be available.