Saudi financial system in an era of change

It's been a tough year in the international financial system, but few, if any, Saudi financial institutions had direct exposure to the US subprime market fiasco.

Saudi bank foreign asset holdings were about $43 billion in September 2007, but nearly all were in low-risk, US treasury-type investments and not in subprime loans. However, as all markets are interlinked, it is not inconceivable that the Saudi banks could in the long term be affected through higher cost of borrowing for their corporations, or the postponement of some international debt issues or even reduction in the size of such new placements.

However, the woes in international financial markets might induce more Saudi investors to repatriate funds to safer havens in terms of returns and the Saudi banks continue to report increase in their deposits.

As such, their ability to fund Saudi or regional projects on a co-financing basis, will not be affected by the global credit crunch.

What could affect them is a perceptible and sharp recession in the US that will lead to lower demand for Saudi oil and petrochemical exports, leading to domestic tightening of credit allocation to non-prime borrowers.

Indeed, times have in any case changed in the system.

The domestic banking sector has seen a 180-degree turnaround in a short period of time, from the era of enforced "Saudisation" of foreign bank branches pre-World Trade Organisation ( WTO ) accession in 2005, to more freedom for foreign bank entry post- WTO accession. This brings with it both threats and opportunities to existing Saudi banks.

Islamic banking

Opportunities lie in focusing in niche market areas such as Islamic banking and consumer and mortgage financing, while the threat comes from their relatively smaller capital base compared to the new foreign bank entrants. This might cause a rethink in potential Saudi bank mergers.

In Saudi Arabia there have been some bank mergers since the establishment of the the country's banking system, as well as quiet government intervention to support some institutions. Today the government is a part-owner of Riyad Bank and the National Commercial Bank, and both these institutions are solidly performing, with a relatively strong and independent management and internal process and controls.

At the same time some of the smaller banks merged into one entity during the era of Saudisation of the foreign bank branches took place in the late 1970s.

WTO accession has ensured that foreign banks and other financial players are given equal opportunities to enter the Saudi fin-ancial market, and Saudi banks will face competitive pressure from regional and international banks, whether these have a presence in the Kingdom or not, nor whether they operate under their own brand name or through a local joint-venture.

More freedom

Paradoxically, while Saudi bank capitalisation might be one of the highest in the world, they are undercapitalised domestically when it comes to participating in large-scale loan projects on an individual basis.

They now enter such loans through bank syndications. Mergers might be an option, but this might reduce competition and encourage monopolistic pricing for consumers.

What might evolve is a search for synergy and complementary services, with mergers for banks that do not offer a full range of products.

Islamic financing and mortgage financing is one area which could see some Saudi banks discuss possible strategic alliances and mergers to safeguard themselves from increased foreign competition.

Such "mergers" might add value if it complements the strengths of both sides.

Already some Saudi banks are making forays beyond the region, and Al Rajhi Bank's acquisitions of Islamic institutions in Malaysia indicates an Asian potential, with China and Indian expansion or joint ventures being other possibilities, given the Kingdom's strategic trade linkages with Asia and the Far East.

Whatever options are considered, the outlook for Saudi banking is certainly not one of maintaining the current status quo.

(To be continued)

- The author is visiting associate professor at King Fahd University of Petroleum and Minerals, Riyadh.