More to come: Prudent choices have enabled the sector to mature and build long-term potential

The past year has been a positive one for the Kingdom’s banking sector. With asset growth and profitability continuing the upward trend that has buoyed the industry over recent years, the shifts brought about by the 2008-09 global financial crisis are beginning to pay dividends in the form of increasingly diverse revenue streams and a wider customer base. An under-banked population and robust economy make for an interesting market as far as the nation’s lenders are concerned – targeting new economic segments, deploying cost-saving technology and improving service levels across the board are the principal means by which they intend to capitalise on the favourable market conditions.

BUILDING AN INDUSTRY: The development of the sector has been both rapid and eventful. Prior to the formalisation of the banking framework in the early 1950s, Saudi Arabia’s financial system consisted of a network of local money exchangers and a handful of foreign banks which catered to a relatively small business community. However, the oil revenues that had begun to flow earlier in the century soon set in motion the economic transformation which has established the nation as the regional economic powerhouse that it is today, and as business grew in the Kingdom’s urban centres it was decided that the increased flows of capital in the country warranted the creation of a central bank.

Two royal decrees issued in 1952 established this institution, the Saudi Arabian Monetary Agency (SAMA), which continues in its role as regulator of the banking sector to this day. In its 60-year history, SAMA has overseen several noteworthy changes, starting in the years immediately following its creation, when it set about licensing a host of local and foreign institutions that brought new services and products to both retail and commercial customers. Among these were the National Commercial Bank (NCB) and Riyad Bank (RB), which remain key players today. During the 1960s SAMA was faced with its first significant structural challenge – a series of bad loans issued by Al Watany Bank – which resulted in the bank’s collapse and incorporation within RB. The fault lines exposed during this episode were addressed by SAMA in its development of the 1966 Banking Control Law, which continues to serve as the regulatory backbone of the Saudi banking sector to this day. The law represented a significant regulatory advance in the Kingdom and required banks to maintain rigorous liquidity, capital adequacy and reserve ratios, and granted SAMA a broad array of licensing and supervisory responsibilities.

CONSOLIDATION: The 1970s saw a rapid expansion of the sector, driven by increasing oil revenues and a maturing economy. By 1980 the Kingdom was home to 12 banks, 10 of which were either fully or partly foreign-owned, according to the Bank for International Settlements. Notwithstanding, the sector had to overcome a number of hurdles. The decline in oil prices during the 1980s, for example, saw nonperforming loans rise to as high as 20% of all extended credit. However, the sector still continued to grow thereafter. A number of important players entered the market at this stage, including Saudi Investment Bank (SAIB) in 1984 and Al Rajhi Banking and Investment Corporation in 1988. The sector’s expansion continued throughout the 1990s and 2000s, when the oil industry entered a more sustained period of development and the non-oil oil sector began to exert itself more prominently.

By the early 2000s an increasingly confident SAMA began to open the market to majority foreign-owned commercial banks, a decision that overturned a 1975 requirement that all banks should be majority-owned by a local partner. Licensing for these international institutions began in 2004, and resulted in global brands such as Deutsche Bank, BNP Paribas and JP Morgan setting up shop in the Kingdom.

KEY PLAYERS: After decades of growth and consolidation, the Saudi banking sector is currently made up of 12 commercially licensed domestic banks. The largest of these in terms of assets is the NCB, which had total assets of SR377.3bn ($100.6bn) as of December 31, 2013, according to the bank’s financial statements. As of year-end 2013, total assets among the rest of the “big five” include Al Rajhi Bank with SR279.9bn ($74.6bn), RB with SR205.2bn ($54.71bn), Samba Financial Group (Samba) with SR205bn ($54.65bn), and SABB (formerly known as the Saudi British Bank) with SR177.3bn ($47.27bn). Other key operators include Banque Saudi Fransi (BSF) and Saudi Hollandi Bank (SHB), both of which maintain an extensive network of branches.

Saudi Arabia’s locally licensed banks have widened their focus from their initial concentration on the corporate and institutional segments to seek revenue in the increasingly important retail and small and medium-sized enterprise (SME) arenas (see analysis). At the same time, local players are also competing with foreign banks for deposits and lending opportunities, which have been available in the market since its earliest stages. Indeed, SHB, acted as the nation’s de facto central bank prior to SAMA’s establishment. In 1952, SHB handed over responsibilities to become an ordinary private sector player, and, in doing so, established a model for foreign participation in the sector.

While early foreign entrants to the market were compelled to incorporate with local partners and seek a licence as a national bank, since 2004 foreign banks have freely been able to open branches in the country. BNP Paribas and JP Morgan were the first to gain a market foothold under the new regime and, as of 2014, have been joined by a further 10 regional and global institutions, including the National Bank of Kuwait, Emirates Bank and Deutsche Bank.

Liberalisation of the regulations governing capital markets in the Kingdom has, since 2005, brought about an influx of investment banks to the sector. These institutions – which numbered around 100 at the time of writing – are licensed separately from foreign commercial banks and their activities are overseen by the Capital Markets Authority rather than SAMA. In addition to regional institutions, a number of global giants have also established a presence in the country to serve the investment community, including UBS and Goldman Sachs.

Although the arrival of global banking players has diversified the sector both in terms of the capital base and service provision, a relatively small number of operators still continue to dominate core banking activities in the Kingdom. According to a recent report by Aljazira Capital, the top five banks in terms of lending – all of them locally licensed – commanded some 65.6% of the market in 2012.

REGULATION: SAMA’s open stance to hosting international operators in recent years reflects a more general liberalisation of the economy that gathered momentum following the Kingdom’s accession to the World Trade Organisation in 2005.

However, the central bank’s development of the sector has been cautious and incremental, characteristics which have earned it a reputation as one of the most prudent regulators in the region.

In the wake of the 2008 global financial crisis, SAMA remains vigilant against external shocks and speculative interest. Indeed, the ownership structure of locally licensed commercial banks is limited to a 40% foreign share, while foreign commercial banks operating within its jurisdiction are limited to a maximum 60% foreign share. Moreover, the degree of domestic liquidity that can be invested overseas is restricted by the requirement that 20% of a bank’s liabilities be held in liquid assets.

The conservative norms historically established by SAMA mean that the sector is well placed to implement international codes of practice. To this end, the average capital adequacy ratio of 18.7%, as of December 2013, according to Aljazira Capital, is well above the Basel III requirement of 10.5%.

A side effect of SAMA’s close supervision of its licensed banks, however, is the increased burden of compliance. “We have a very professional and well-regulated sector, and the regulator and the banks are proud of this,” John Macedo, chief financial officer at SHB, told OBG. This challenge is mitigated by the strong channels of communication that exist between regulator and regulated, the efficacy of which was demonstrated most recently when SAMA agreed to delay the implementation of new guidelines concerning loan classification and provisioning after consulting with lenders.

ISLAMIC BANKS: A notable feature of the Kingdom’s banking sector is that no distinction is made by either the regulator or licensed banks between Islamic and conventional institutions.

Theoretically, all banking activity undertaken in the country is sharia-compliant – a result of the fact that the country’s legal system is largely uncodified and is instead based on the interpretation of sharia law. No local bank is identified as an Islamic operator and there is no formal test of sharia compliance in terms of a bank’s services and products.

While the creation of the Banking Dispute and Settlement Committee has made the task of outlining what activities are permissible within SAMA’s jurisdiction more structured, the lack of sharia regulation has resulted in a degree of uncertainty regarding acceptable practices in some cases. As a result, the possibility that the government could set up a sharia committee that will oversee the entire financial service sector has been broadly welcomed by the industry (see Islamic Financial Services chapter).

SECTOR PERFORMANCE: SAMA’s regulatory oversight of the domestic banking industry has enabled the Kingdom to emerge from the 2008-09 global economic crisis relatively unscathed. Total assets held by the sector have grown steadily over recent years. An OBG analysis of the 2013 financial year shows that the sector’s aggregate assets expanded by 9.2% over 2012 to reach SR1.87trn ($498.4bn). Deposits continued to accumulate throughout the credit crunch and into 2014, posting a compound annual growth rate (CAGR) of 12% between 2007 and 2012, according to Bank AlJazira.

The low interest rates that have persisted since 2008 have, however, altered the structure of the sector’s deposit base, with time deposits that once made up 51.6% of the total, in 2006, now accounting for around 35%, as customers abandon bank deposits as a source of interest accrual, shifting their capital towards demand deposits.

The Kingdom’s banks have also shown sustained profitability in recent years. Both interest and non-interest income rose steadily between 2011 and 2013, and the aggregate net income of SR37.8bn ($10.1bn) for 2013 was 7% over 2012.

The single biggest net income growth for 2013 was posted by SAIB, which reported a 41% year-on-year (y-o-y) expansion, followed by BSF (37%) and Bank AlJazira (30.2%). In terms of absolute net income standings, NCB led the sector for the year, reporting a net income of some SR7.99bn ($2.13bn), and was closely followed by Al Rajhi Bank with SR7.44bn ($1.98bn) and Samba with SR4.5bn ($1.2bn).

LENDING: Another encouraging sign for the industry is that bank lending in the Kingdom has shown particularly robust growth in recent years. A number of factors have combined to bring about this uptick, notably fewer concerns regarding asset quality in the wake of the 2008-09 global economic crisis, a rebound in GDP growth from 1.8% in 2009 to nearly 8% over the period between 2010 and 2012 (see Economy chapter), a high rate of government spending, and renewed private sector appetite.

Taken together, these developments have all played a part in boosting the sector’s aggregate loan book. Retail lending, which, according to Aljazira Capital, increased its share of total loans from around 21% in 2008 to 30.5% in 2012, has also played a significant part in this significant growth, fuelled by higher disposable incomes among the populace and a continuing drive by the government to place more Saudi nationals in the workforce.

On the corporate side, meanwhile, the slowdown in credit extension in 2009, which took place against a backdrop of a number of cancelled projects and economic uncertainty, has given way to a much more buoyant lending environment.

While the recovery in corporate loan growth has been overshadowed by the sector’s focus on the retail side of the loan book, credit extended to the segment nonetheless increased by some 14.5% y-oy in 2012. The last 12 months saw a continuation of the upward trend in both corporate and retail lending. According to an OBG analysis of the published financial statements of locally licensed banks, aggregate lending jumped by 16.45% in 2013, for a total of SR1.03trn ($274.5bn). The biggest single increase was provided by SAIB, which grew its loan book by some 39.69%, followed by Bank AlJazira (29.60%) and Bank Albilad (28.26%), respectively.

In terms of absolute lending standings, four of the sector’s “big five” retained their dominant market position. Based on net loans and advances, NCB led the pack as of December 31, 2013 with SR187.7bn ($50bn), followed by Al Rajhi Bank with SR186.8bn ($49.8bn), RB with SR131.2bn ($35bn) and Samba with SR113.5bn ($30.3bn). Other key lenders for the year included BSF with SR111.3bn ($29.7bn) and SABB with SR106.1bn ($28.3bn).

GROWTH PROSPECTS: A fast-growing population and a vibrant economy mean that the potential for further expansion in the banking sector is high. The more challenging economic environment ushered in by the 2008 global economic crisis encouraged banks to revisit their strategies, a direct result of which is the greater contribution of the retail segment to lenders’ balance sheets.

“Retail banking will be an increasingly important source of revenue. With rapid demographic growth, a young population, a developing bancassurance sector, and relatively low mortgage penetration rates, all the drivers are there to establish a strong baseline for growth,” Bernd van Linder, managing director and CEO of SHB, told OBG.

The retail side of the loan book is likely to receive a further fillip with the implementation of a mortgage law. Real estate finance by banks to individuals more than doubled between 2008 and 2013, according to data from SAMA, and yet – as the IMF pointed out in its 2013 Article IV Consultation with Saudi Arabia – home loans still represent only around 5% of total lending. The new law, actually five separate pieces of legislation, is expected to result in significant growth in the amount of credit extended to this segment, not just by the established lenders but by also by a new breed of dedicated mortgage providers that is currently undergoing the licensing process overseen by SAMA (see analysis).

REMITTANCES: Another segment that has the potential to generate significant future growth is international remittances. Thanks largely to the substantial expatriate workforce in Saudi Arabia, remittance growth has continued since 2004 and reached a new high of SR107.4bn ($28.63bn) in 2012. This helped to make the Kingdom the second-largest source of outgoing remittance flows in the world in 2012, after the US, according to the World Bank. Given the high volumes and well-developed market, many of Saudi Arabia’s banks have begun offering international money transfer services, a segment that has often been dominated by dedicated operators such as Western Union. Although efforts to reduce the numbers of expatriate workers may negatively affect the market, many operators agree that the segment has a positive outlook (see analysis).

SMALL & MEDIUM BUSINESSES: SMEs, too, represent a channel to increased revenue. Some 90% of Saudi businesses are thought to fall into the SME category, and yet according to the International Finance Corporation, only 2% of the aggregate Saudi loan book is derived from SME lending. Recognising the importance of SMEs to the Kingdom’s future economic growth, the government has sought to encourage lending to SMEs through the creation of a loan guarantee initiative.

The Kafala programme (see analysis) was set up in 2006 and has become the primary means through which the Kingdom’s banks have connected with this area of the market. Continued investment in the initiative by the government has allowed for a total of 7280 loan guarantees to be granted, for a combined value of SR3.59bn ($957m), from 2006 to year-end 2013 (see analysis).

At the corporate level, trade finance continues to present new opportunities, as both imports and exports rise on the back of the economy’s recovered momentum. SAMA data shows that the value of letters of credit settled and bills received have been steadily growing, and, as with other markets, banks are starting to invest in cost saving and service enhancing automated trade finance platforms.

Meanwhile, the project pipeline that has traditionally driven corporate banking growth has returned to its previous healthy flow – with some SR102bn ($27.2bn) worth of contracts awarded in the first six months of 2013 alone – and the continued expansion of sectors such as energy, industry, infrastructure, petrochemicals, utilities and real estate promises a stable source of revenue in the long term.

MARKET TRENDS: As the Kingdom’s banks seek to diversify their sources of revenue and secure a share of a competitive market, technology is also playing an important role (see analysis). E-banking legislation introduced in 2011 has greatly enhanced the ability of banks to interact with their customers, with online services now ubiquitous and mobile applications increasingly common.

This technology shift is being driven not just by the cost savings it offers to financial institutions, but also by the demand arising from a tech-savvy population. To this end, the number of Saudi residents connected to high-speed internet continues to expand thanks to growing investment in infrastructure and the widespread adoption of smartphones.

Total subscriptions to broadband – both in the home and mobile – rose by 30% y-o-y between 2011 and 2012, giving the country an overall broadband penetration rate of 41.6%. Banks are also investing in a new model of automated teller machine, which offers advanced, non-traditional self-service options and, in some cases, the ability to communicate directly with a live agent (see analysis).

OUTLOOK: Despite the expansion of the Saudi banking sector in recent years, market fundamentals suggest that there is room for further growth. As per data from Bloomberg and Aljazira Capital, banking deposits in Saudi Arabia stand at around 46% of GDP, compared to 89% in the UAE and 127% in Bahrain, respectively. Similarly, an asset-to-GDP ratio of 64% reveals significant under-penetration of the banking segment. Even within the conservative regulatory regime established by SAMA, the Kingdom’s banks have plenty of room for manoeuvre. Indeed, the sector’s loan-to-deposit ratio of 76.1% in 2012 remains well within the 85% limit established by the central bank and compares favourably to regional average of 86.1%. This excess capacity, combined with increasing demand from both the corporate and retail segments, bodes well for the future.