Pledged to structural change

In Saudi Arabia, the two main financial regulatory authorities, the Saudi Arabian Monetary Authority (SAMA) and the Capital Market Authority (CMA), have been doing their bit, supporting financial institutions and tightening up the regulatory environment, seeking international investors, at the same time as broadening corporate funding options with the formation of Sukuk and bond markets.

The long-established central bank, SAMA has responsibility for issuing the kingdom’s currency, supervising commercial banks, managing monetary policy and generally ensuring the soundness of the financial system.

That would be a demanding list anywhere in the world. In Saudi Arabia there is the additional challenge of managing the rapid expansion of financial markets. In the space of five years, for example, the combined total assets of the commercial banks have risen by about 240 per cent, to 1,302 billion riyals (Dh1,275 billion) at year-end 2008. While the current global economic troubles stalled such growth, latest quarterly data marked the resumption of a rising trend, distinct from the rest of the region.

The Saudi banking sector comprises 20 banks — 12 domestic and eight foreign. In addition, the government has established five specialised credit institutions to fund development projects in specific sectors. The number of foreign banks is set to increase. The Japanese giant Nomura has this year launched an investment banking operation, and others have obtained licences.

In recent years Saudi banks have performed well on the back of the economic boom, the growth of Islamic finance, as well as benefiting from the surge of trading activity on the Saudi stock market, as fees and commission from brokerage services boosted income. More is to come for both domestic and foreign banks in what is still a relatively under-banked market in the largest economy in the Gulf, with a rapidly growing population.
In addition to basic demographics and greater market penetration, future growth is expected from the expansion of the mortgage market, with an important new law pending, also investment banking, project finance and asset management.
 

SAMA has had praise from international bodies for its performance. Moody’s commented on its prudence and “strong authority”. The rating agency’s assumption is that the Saudi authorities would do anything in their power to prevent a banking default by any of the Saudi banks, despite there being no pre-defined methodology of bank support. Standard & Poor’s notes the banking sector’s resilience, and that the leading financial institutions maintain sound financial positions. Banks have benefited from not having not been embroiled in the global mortgage-related crisis.

Yet, Saudi Arabia’s banks have not completely evaded the economic downturn. Among first-half results, the majority have increased provisions for loan losses. National Commercial Bank, the largest by assets, reported second-quarter provisions for loan losses worth 425 million riyals, more than a sevenfold increase year-on-year. Most of the other banks reported similar increases.

Reputational risk

Of significant concern for the banks has been that two of Saudi Arabia’s largest family-owned groups, Algosaibi and Saad, have had to restructure debts. The level of bank exposure, both international and regional, is a matter of debate, and some lenders have expressed some concern about the level of transparency. But the general feeling is that SAMA, which froze the companies’ accounts, will do the necessary to control the reputational risk to the kingdom’s banking system.

Deutsche Bank opines, “We believe that the banking system is weathering the global crisis fairly well. Despite the rise in non-performing loans (NPLs) we expect the sector to comfortably maintain a tier-1 ratio well above 10 per cent over the next two years, and the banking system to remain profitable.”

As well as banking, regulators have conspicuously cracked down on dubious practices on the stock market. Formed in 2004, the CMA has taken a firm hand on insider trading, inter alia.

The Saudi market (known as the Tadawul), the largest exchange in the Arab world, has had a volatile few years, recording 100 per cent gains each year from 2003 to 2005, followed by a dramatic slump in 2006, 50 per cent rise in 2007 and equally significant fall in 2008. Besides the trials of a market reaching for maturity, such movements are not uncommon in underdeveloped markets. At time of writing the index was up 21.2 per cent in 2009.

The CMA has stepped up the pace of change over the past year or so. Since the end of 2007 GCC nationals have been allowed to invest directly in Saudi equities. In August last year international investors became allowed to buy local equities, albeit through swap agreements with local companies, giving them indirect ownership. Further developments are in the offing, for example possibly the introduction of instruments such as options and futures, and exchange-traded funds.

Opening up the Tadawul to foreign institutional investors could go some way to reducing the market’s volatility, caused by the dominance of retail investors. Efforts have been made to join a global benchmark’s emerging-markets index to promote that objective.
With the growth potential on offer, Saudi Arabia’s financial sector would appear to have everything to gain by ensuring that it complies with international best practices, as is very much the plan.