Saudi Arabia's banking sector enters a challenging 2020 with strong fundamentals

Saudi Arabia is home to more than 27% of the GCC’s total banking assets, and is the region’s second-largest banking industry in terms of assets and the largest in terms of market capitalisation. Having achieved promising profit growth in 2019, the sector entered 2020 ready to capitalise on the opportunities presented by the Kingdom’s ambitious development strategy. Vision 2030 provides a roadmap for the development of financial services in the country and a raft of lending opportunities in key sectors such as infrastructure, health, education and entertainment. However, declining oil prices and the effects of the global Covid-19 pandemic in early 2020 will make for a challenging year for the domestic banking industry. The government’s announcement of a series of measures to mitigate the impact of the crisis has therefore been welcomed by market participants.

History 

Saudi Arabia has one of the oldest banking industries in the region, dating back to the early part of the 20th century. Initially populated by a network of local money exchangers and a small number of foreign banks, the sector rapidly expanded in the years following the Second World War, prompting the authorities to consider the establishment of a central bank. The Saudi Arabian Monetary Authority (SAMA) was created in 1952 by two royal decrees to fill this role, and continues to oversee the banking industry to this day. In the years immediately following its creation SAMA licensed a large number of local and foreign institutions, which brought new services and products to both retail and commercial customers in the Kingdom. This period saw some of today’s key players enter the market, including National Commercial Bank (NCB) and Riyad Bank.

The central bank experienced its first serious challenge when a number of large, non-performing loans (NPLs) made by Al Watany Bank in the 1960s resulted in the first collapse of a major domestic financial institution. This led to an overhaul of the regulatory framework governing the banking sector, the culmination of which was the 1966 Banking Control Law, which still forms the legislative backbone of the sector. The new law set rigorous liquidity, capital adequacy and reserve requirements for the Kingdom’s lenders, and granted SAMA a raft of licensing and supervisory powers.

By 1980 Saudi Arabia was home to 12 banks, 10 of which were partially foreign owned. The sector continued to expand over the following decade, during which time a number of major players entered the market, including the Saudi Investment Bank in 1984 and the Al Rajhi Banking and Investment Corporation in 1988. In the 1990s the broader base of the Saudi economy reduced some of the systemic risk associated with volatile oil prices, and by the early 2000s an increasingly confident SAMA began to open the market to majority foreign-owned investment banks, a decision that overturned a 1975 requirement that all lenders be majority owned by a local partner.

Licensing for these international institutions was first issued in 2004, and over succeeding years global players such as Germany’s Deutsche Bank, France’s BNP Paribas and the US’ JPM organ entered the Saudi market for the first time.

Domestic Players

As of the first quarter of 2020 Saudi Arabia’s banking sector comprised 13 locally licensed banks, five of which held total assets worth more than SR200bn ($53.2bn). With over SR507bn ($135.2bn) in assets, NCB is both the largest and oldest bank in Saudi Arabia, and as such plays a central role in the country’s economy. Its position as a catalyst for growth was further cemented in 1999, when the government acquired a majority stake in the institution through its sovereign wealth fund, the Public Investment Fund (PIF). The Kingdom’s second-largest bank, Al Rajhi, is one of the largest Islamic banks in the world, and at the beginning of 2020 claimed assets worth nearly SR384.1bn ($102.4bn). Founded in 1957, it is the leading institution in the sharia-compliant segment that also includes Alinma Bank, Bank Albilad, and Bank AlJazira – which altogether account for around one-quarter of total banking sector assets. The third-largest bank, Riyad Bank, is another early market entrant, having been founded in 1957. At the start of 2020 it posted total assets of SR265.8bn ($70.9bn). In December 2018 the bank revealed that it was engaged in merger talks with NCB, with which it shares a common shareholder in the PIF. However, in December 2019 both lenders announced that the negotiations had ended without any agreement.

The Kingdom’s fourth-largest lender, SABB, secured its place among the country’s top-five banks after a successful merger with Alawwal Bank in June 2019. Previously known as Saudi Hollandi Bank, Alawwal Bank had been active in the Kingdom since the 1920s. It assisted with the creation of Saudi Arabia’s first currency and payment for the nation’s first oil export. SABB, meanwhile, has been a key participant in the banking industry for almost 70 years and is an associate of the HSBC Group. As of December 2019 the total assets of the new merged entity stood at SR265.5bn ($70.8bn).

The fifth-largest lender is Samba Bank, with total assets of SR255.6bn ($68.1bn) as of early 2020. Established in 1955, it is most notable for leading the introduction of the first ATMs and payment cards, and its expansion into foreign markets such as Pakistan, the UK and Dubai. In September 2019 the bank entered the debt market for the first time since 2006, staging a $1bn bond sale at a fixed coupon rate of 2.75%. Samba Bank is currently the only bank in the Kingdom to have an outstanding bond on the international market, but the popularity of the sale – which was 3.7 times oversubscribed – paves the way for other domestic lenders to follow.

Foreign Presence

In recent decades the regulatory framework governing the Kingdom’s banking sector has undergone a series of changes designed to make it more attractive to foreign institutions. Prior to 2004 international market entrants were required to incorporate with Saudi partners in order to obtain a licence to operate in the Kingdom. Some of the market’s largest players are the result of this joint-venture model, including SABB, which is 40% owned by HSBC; Samba Financial Group, which Norway’s Norges Bank, the UK’s Ashmore Investment, and US firms JPM organ and T Rowe Price have small interests in; and Banque Saudi Fransi, which is 14.9% owned by French group Crédit Agricole.

After the local partner requirement was removed, the Kingdom’s banking industry saw a new influx of foreign institutions. BNP Paribas and JPM organ Chase were the first market entrants under the revised framework. As of March 2020 they had been joined by 18 other regional and global institutions, including First Abu Dhabi Bank, Emirates NBD, National Bank of Kuwait and Deutsche Bank.

A further phase of market liberalisation took place in 2005, which allowed for an expansion of foreign-owned investment banks and financial houses. These institutions, of which there were around 100 as of March 2020, are licensed by the Capital Market Authority (CMA) rather than the central bank. They include some of the world’s largest investment banks, including Goldman Sachs, UBS and Credit Suisse, and emerging markets investment specialist Ashmore. These institutions carry out a broad range of activities, from investment fund management and custody arrangements, to deal arranging and underwriting, with the CMA issuing licences as appropriate and necessary.

New Entrants

The merger of Alawwal Bank and SABB in 2019 was the most significant recent structural change to the Kingdom’s banking sector, and formed part of a wider trend of mergers and acquisitions across the GCC. Saudi Arabia, however, has fewer banks per capita than many of its neighbours, and therefore it is not pursuing the same consolidation agenda as many Gulf regulators.

In 2019 SAMA also approved two new banking licences for Credit Suisse and Standard Chartered Bank. In the fourth quarter of that year Fahad Alshathri, deputy governor of supervision at SAMA, revealed that despite the consolidation trend across the region, there is still room for more banks in the Kingdom and the regulator was processing applications for three new banking licences – two traditional and one digital bank. “Today the number of banks operating in the Kingdom of Saudi Arabia is still not enough to fully serve the national market,” Saadoun Al Saadoun, CEO of Saudi Financial Support Services Company, told OBG. “There are promising opportunities for entities willing to invest in innovative and new ways of doing business in the Kingdom.”

The regulator is also speeding up the application process for banks seeking licences to operate in the Kingdom. As a result, the licences that SAMA issued in 2019 took less than a month to gain approval, making the Kingdom an attractive location for banks looking to enter the market in the future.

Performance

Saudi Arabia’s banking industry has faced a number of challenges in recent years. The decline in oil prices in late 2014 brought to an end a period of double-digit growth that the sector had experienced for many years. The necessary fiscal reform that followed led to uncertainty regarding growth opportunities and, in some cases, delayed payments to contractors for government projects. In 2015 the effects of lower oil prices brought aggregate asset growth to a modest 3.4% over the year, totalling SR2.2trn ($586.5bn). By 2017 asset growth had slowed further, to 0.4%, while the sector’s net loans showed a contraction of 1.1% for the year. In 2018 the positive effects of firming oil prices, which reached their highest point since late 2014, were offset by reductions in energy subsidies and companies adopting a wait-and-see approach with regard to expansion plans, resulting in fewer lending opportunities. However, by 2019 the continued stabilisation of oil prices, combined with the acceleration of major infrastructure projects under Vision 2030, brought more positive results.

The total assets of Saudi Arabia’s five largest banks grew by 16% in 2019 to reach SR1.7trn ($453.2bn). Their combined loans and advances, meanwhile, expanded by 15% to SR1trn ($266.6bn). The top-five lenders posted an impressive 30% growth in profits, totalling SR34bn ($9.1bn), up from SR26.2bn ($7bn) in 2018. While the Kingdom’s banking sector as a whole posted single-digit growth, its 7.4% increase in profits in 2019 was still a promising sign.

However, looking ahead, the Covid-19 pandemic and the concomitant fall in oil prices in the first quarter of 2020 will certainly weigh on growth. As of April 2020 the full economic impact was not yet clear, but the Kingdom was quick to respond with a series of measures designed to mitigate the worst of its effects, including a SR50bn ($13.3bn) investment package for banks and micro-, small and medium-sized enterprises (MSMEs).

Lending

The contraction of the sector’s aggregate loan book by 1% in 2017 marked a departure from the Kingdom’s usual pattern of annual credit expansion, and was the first time this trend had been reversed in 11 years. Since then, however, the industry has returned to its normal trajectory. Lending growth was strong in 2019, with the first three quarters of the year showing an average expansion of 5.5%, according to the “Saudi Arabia: Macroeconomic Forecast 2020-24” report published by Samba Bank in February 2020. The report also found that banks showed a willingness to take on more risk in 2019, with long-term lending representing 41% of net sector loans, up from 35% in 2018.

Lending to the corporate sector has traditionally been the preferred route to margin for the Kingdom’s larger financial institutions, and competition for major deals remains strong. Entering 2020 corporate lending divisions are recovering from a recent phase of credit contraction in the segment, a rare scenario that has only occurred three times since 1999. The segment’s return to growth was led by a recovery in mining and construction activity, driven in part by the infrastructure pipeline established under Vision 2030. Structured finance agreements for mega-projects in areas such as tourism, entertainment and hospitality have also provided lending opportunities for the Kingdom’s larger players (see Tourism & Entertainment chapter).

While these deals are generally awarded based on price and reputation, the desire to secure and retain corporate clients is driving innovation in products and services tailored to this segment. Segments such as business-to-business (B2B) payments and dividend distribution have been a competitive battleground for some time, and in 2019 new services such as flexible hedging strategies for corporate clients began to appear in the local market.

Lending to businesses in Saudi Arabia remains skewed towards the top end of the market. While credit extended to small and medium-sized enterprises (SMEs) rose by 8% in 2019, this gain was made from a low base. SME credit accounted for around 7.2% of Saudi Arabia’s total private sector loan portfolio and 5% of total loans. However, this figure is a significant increase on the estimated 2-3% share of the loan book that SME credit claimed prior to the launch of Vision 2030 in 2016. As the government continues to support the development of local SMEs, this lending segment is well positioned for further growth in the years ahead.

The retail credit market, meanwhile, recovered faster than corporate lending and steadily expanded from the end of 2017. In 2018 the segment recorded growth of 6.3%, driven largely by real estate and personal loans. Competition for lending opportunities in the retail segment is strong, and the increasingly sophisticated customer base continues to demand new incentives and benefits from its banking partners. As a result, most of the Kingdom’s larger banks offer loyalty programmes, awarding redeemable points for activities such as card usage, registration for online banking platforms and settlement of bill payments using ATMs. Mobile banking and digital services represents another competitive arena for Saudi Arabia’s lenders. This segment became particularly important in early 2020 as SAMA instructed banks to limit the number of working branches that do not offer online services amid the Covid-19 crisis.

Mortgage Growth

The emergence of real estate lending as a major driver of retail credit growth is a direct result of regulatory changes designed to increase the homeownership ratio among nationals from 47% in 2018 to 70% by 2030. The Kingdom was expected to achieve its target of 60% by the end of 2020, local media reported in March that year, although Covid-19 and declining oil prices are likely to slow the pace of construction projects and short-term demand for housing.

Major retail banks are working alongside the Ministry of Housing and the real estate sector to meet these ambitious targets, most notably through a state-backed housing programme that encourages lenders to allocate more funding to the mortgage segment. Mortgage lending also received a boost from SAMA’s decision to raise the loan-to-value limit for real estate loans in January 2018.

“Home loans in Saudi Arabia increased dramatically over the course of 2018 and 2019, as mortgage finance companies and commercial banks benefitted from subsidised financing designed to increase homeownership,” Fabrice Susini, CEO of the Saudi Real Estate Refinance Company (SRC), told OBG. According to SAMA, real estate lending by banks grew by 168% in 2019 to reach SR27bn ($7.2bn).

The SRC, which is owned by the government through the PIF, provides funding for banks and finance companies to offer more affordable housing loans. This funding takes the form of direct loans or portfolio acquisitions that are combined into mortgage-backed securities and sold to investors. The company aims to refinance 20% of the Kingdom’s mortgage market, which is forecast to grow to SR500bn ($133.3bn) in 2020 and SR800bn ($213.3bn) by 2030. The government is supporting the expansion of the SRC’s activities by guaranteeing its SR11bn ($2.9bn) sukuk (Islamic bond) programme. In March 2019 the company became the first non-sovereign issuer in the Kingdom to issue a riyal-denominated, fixed-rate instrument across several tranches, with five-, seven- and 10-year tenors.

The Saudi Real Estate Development Fund (REDF) also provides a number of mortgage subsidies through banks. Its programmes include a guarantee worth 5% of the property’s value as part of the required down payment, with a maximum limit of SR500,000 ($133,300) in most cases, although this is determined by family size and income. In certain cases, for example if a household has a monthly income below SR14,000 ($3730), the REDF could subsidise the entire down payment, which is usually around 10% for first-time homeowners.

Increased Visibility

Saudi banks are able to make efficient, risk-assessed lending decisions with the support of an increasingly capable credit information segment. The Saudi Credit Bureau was established in 2003 to collect, analyse and provide detailed credit information on individuals and local institutions. It has expanded to offer a range of services including behaviour monitoring, risk-management consulting, over-the-counter derivatives trade repository services and analytical modelling services to give greater insight into portfolios and customer behaviour. In 2015 a second credit bureau, Bayan, was established, which acts primarily as a platform for B2B data. It is working alongside SAMA, the General Authority for SMEs (Monsha’at), the Ministry of Commerce and Investment, and several other institutions to develop a digital database that uses artificial intelligence and blockchain to provide information on companies’ financial standing based on the common reporting standard.

Sector players are confident that the use of such technologies will make institutions more efficient. “Automated machine learning is changing the banking industry for good, particularly in the field of lending for entrepreneurs and SMEs,” Paul Melotto, CEO of Al Raedah Finance, told OBG. “Automation allows professional to have a better understanding of their customers’ profile and needs, and therefore offer more tailored services.”

However, more still needs to be done to prevent gaps in market data and lower the cost and risk of extending credit to all areas of the economy. “Moving forward, a key challenge within the Kingdom’s financial sector is the accessibility of financial information,” Ahmed Al Majed, CEO of Bayan, told OBG. “However, through collaborative initiatives between key players in the banking sector, increasing the accessibility of information is both necessary and achievable under Vision 2030.”

Regulation

The sector’s evolving regulatory landscape has had a significant effect on performance. The 1966 Banking Control Law set out the statutory requirements on banks and established the activities that can or cannot be carried out in the Kingdom. This framework governs all banks nationwide, both Islamic and conventional, and SAMA makes no licensing distinction on the grounds of sharia compliance.

In recent years, the central bank has guided the implementation of the sector’s reform agenda as agreed by the Financial Stability Board under the auspices of the G20 in the wake of the 2007/08 global financial crisis. The most significant regulatory change experienced by the sector since 2017, however, was the introduction of the International Financial Reporting Standard (IFRS) 9 at the start of 2018, which established stricter rules for banks when calculating their potential impairments. Instead of reviewing banks’ past performance to determine their provisions against impairment, losses from an impaired asset are projected over the following 12 months.

SAMA’s strategic direction is also determined by the Financial Sector Development Programme (FSDP), one of the key pillars of Vision 2030. The programme established a number of targets for the end of 2020, including increasing SME financing, mortgage lending and non-cash transactions.

“In line with Vision 2030’s objective of modernising the country’s payment infrastructure, increasing the number of cashless transactions per year is a high priority within the FSDP,” Ziad Al Yousef, managing director of Saudi Payments, told OBG.

Covid-19 Response

While the FSDP provides a roadmap for the sector’s long-term growth, in the shorter term it faces a number of challenges arising from the global outbreak of Covid-19 in early 2020. However, the central bank was quick to implement a number of measures to offset the economic impact of the virus. In March SAMA launched the Private Sector Financing Support Programme as part of its mandate to strengthen financial stability and bolster the government’s efforts to support private businesses affected by the pandemic.

The programme plans to deploy SR50bn ($13.3bn) in loan guarantees, allowing for deferred payments and direct funding for lending. Funding will also be available to cover the payment of fees normally charged by payment service providers. Targeted assistance will similarly be offered to companies adversely affected by precautionary measures taken in the cities of Makkah and Medina.

SAMA also provided support for bank customers by introducing a series of measures, including funding to enable companies to maintain employment levels; support for bank customers who have become unemployed as a result of the pandemic; restructured loans without additional fees; the removal of charges for accounts falling below minimum balance limits; changes to interest rates and credit card fees; and refunds for currency exchange fees for customers who have cancelled travel plans.

Sector Stability

Despite the challenges faced in the first quarter of 2020, the Kingdom’s banking industry enters this period of uncertainty with a solid base. Historically, credit growth has outpaced the country’s economic output, leading to concerns regarding excess leverage in the banking system. However, during the most recent period of economic prosperity beginning in 2017, bank credit expanded at a slightly slower rate than GDP. At the end of 2019 the sector’s loan-to-deposit ratio stood at 77.1%, compared to 80% in 2015, suggesting that there is potential for sustainable credit growth.

As of the third quarter of 2019 the sector’s aggregate NPL level stood at a healthy 1.9%, according to SAMA. NPLs in the corporate segment have increased in recent years, but remain at a comfortable level, reaching 2.4% by the last quarter of 2018. Retail NPLs, meanwhile, remain extremely low as this segment is largely secured by salary assignment.

The banking sector also showed strong capital adequacy with a regulatory Tier-1 capital to riskweighted assets ratio of 18.1%, comfortably in excess of Basel III requirements.

Digital Banking

In recent years the Kingdom has taken steps to develop the digital banking segment. “Traditionally Saudi Arabia has been a cash-based society; however, with the rise of new platforms and a young, tech-savvy population, we are seeing an increase in the use of digital payment systems,” Bashar Khalil Baidas, CEO and founder of Digital Cash International, told OBG.

The social effects of Covid-19, such as restricted mobility and the rise of remote working, has made the Kingdom’s drive to develop a digital economy even more important. In March 2020 the central bank asked the nation’s financial institutions to encourage customers to carry out transactions using online or mobile banking, having already requested that its own staff work remotely.

One of SAMA’s main objectives under the FSDP is to increase the proportion of transactions conducted electronically from 18% in 2016 to 28% by the end of 2020. The central bank has already established the foundations for a digital banking segment, issuing guidelines for online-only banks that were updated in February 2020 to include the minimum requirements to obtain a licence.

Fintech

At the same time, the Kingdom’s banks are beginning to direct significant amounts of capital towards the financial technology (fintech) segment. In October 2019 Riyad Bank announced the launch of its Digital Partnerships Programme and its association with a SR100m ($26.7m) venture capital fund, making it the first bank in Saudi Arabia to establish such a fund to invest in fintech. The bank has also formed partnerships with technology start-ups and entrepreneurs to support the development of digital services and new banking products. In November 2019 SABB and HSBC became the first institutions in the Kingdom to conduct an international trade transaction using blockchain technology. The transaction involved the shipment of homogenised aluminium billets from Aluminium Bahrain to Saudi Arabia’s Altaiseer Aluminium Corporation using a letter of credit issued on a blockchain-based platform. This deal is expected to improve the way that local companies conduct international trade, making the process more efficient, secure and transparent.

Meanwhile, in the retail segment, Al Rajhi Bank introduced a series of updates to its mobile app, including a facility that allows customers to add beneficiaries via their mobile phone numbers. According to the bank’s 2019 annual report, more than 50% of its new accounts are opened digitally and the majority of customer transactions are carried out using online or mobile platforms.

Looking ahead, sector players argue that digital banking will reshape the way that physical branches operate. “Banks are continuing to invest in innovation to strengthen their digital strategies and expand their digital offering,” Faisal Al Saggaf, CEO of NCB, told OBG. “While banks will continue to expand physical networks in order to extend their reach, branches are likely to be smaller and run more efficiently, aided by technology.”

Underpinning these developments is the Kingdom’s rapidly evolving digital payments infrastructure. SWIFT’s global payment initiative (gpi) was first introduced in 2017 with the aim of making cross-border payments more transparent and traceable. In October 2019 SABB became the first bank in the MENA region to offer the SWIFT gpi for Corporates service, which was first launched in July that year. This development is helping to ensure that corporate clients in the Kingdom are able to conduct international payments at the same speed as domestic transactions, with processing times reduced from days to hours or even minutes.

The Kingdom’s digital transactions infrastructure is overseen by Saudi Payments, a wholly owned subsidiary of SAMA that is charged with ensuring that both banks and fintech companies provide a secure payment system. Its recent developments include the launch of Esal in June 2019, a B2B invoicing platform designed to make the payment process more transparent and efficient. As of March 2020 there were four electronic wallets licensed in the Kingdom: local firms STC Pay, Halalah and BayanPay, and major global platform Apple Pay.

However, as the segment continues to expand, new players are likely to enter the Saudi market. “In 2019 the Kingdom’s e-commerce market expanded by 50% and e-payment transactions increased by over 100%. In the coming years, we expect these figures to grow exponentially and at an even faster rate,” Muhannad Ebwini, CEO of online payment solutions company HyperPay, told OBG.

Outlook

The Kingdom’s banking sector started 2020 on a promising note, with lending to the private sector increasing by 8.5% y-o-y in January, supported by the rapid growth of non-oil sectors in the third quarter of 2019. However, falling oil prices and the disruptive effects of the global Covid-19 pandemic are likely to undermine asset growth over the course of the year. Nevertheless, the Kingdom’s banks have previously demonstrated the ability to remain profitable despite difficulties, largely due to their strong franchises and relatively advantageous market structure, with 13 local banks serving a population of over 30m people. Looking to the longer term, banks are likely to venture beyond the highly competitive corporate and retail segments and develop their offering in underserved areas of the market, such as SME lending and microfinance.