Trust and confidence are universal core prerequisites for successful banking. Both have been in relatively short supply in recent years. The global financial crisis has torn apart many banking sectors along with their respective economies and the resulting lack of confidence has proven to be extremely destructive.
Saudi Arabia, the world's largest oil exporter, while not totally isolated from the crisis has managed to stay relatively well insulated, avoiding much of its damaging impact. The country's traditional conservatism along with the policy focus by the Saudi Arabian Monetary Agency (SAMA) on counter-cyclicality in the boom years of 2003-08 provided a robust cushion against any possible downturn.
The counter-cyclical strategy in the good times not only enabled debt to be significantly reduced to a mere 16.3% of gross domestic product (GDP) in 2009 but also allowed banks to massively boost capital to a handsome capital adequacy ratio of 16.6% at end 2009, providing important stability to the economy.
SAMA vice-governor Abdulrahman Al-Hamidy stresses that prudent counter-cyclicality has paid off, but while the country's economic fundamentals look healthier than most of its G-20 colleagues and also its neighbours in the region, 2009 proved more challenging than expected.
After achieving strong growth of 4.3% in 2008 and having significant structural defences in place, the outlook for 2009 was reasonably bullish despite the decline in oil prices and production. But then an unexpected shock hit in May. A bitter public feud emerged between two of the kingdom's best-known and respected business conglomerates, the Saad Group, run by billionaire owner Maan Al-Sanea, and the long-established Ahmad Hamad Algosaibi and Brothers (AHAB). The dispute concerns allegations by AHAB of massive fraud against the owner of the Saad Group that could amount to $10bn and has led to litigation in New York and elsewhere. Mr Al-Sanea and Saad Group strongly deny the allegations. The feud is made more complex because Mr al-Sanea previously worked for AHAB and married into the Algosaibi family.
Lending paralysis
With both groups in default on billions of dollars-worth of debt and estimated to owe more than 100 regional and international banks about $20bn, the dispute has raised alarm bells in financial sectors across the globe and particularly in Saudi Arabia, where Saudi banks are estimated to have an exposure to the two groups of $5bn to $7bn. Not only are there concerns about the positions of other family conglomerates, although no major problems have emerged, but the surprise defaults have frightened bankers, both local and international, into a form of lending paralysis.
Extreme caution has set in as bankers naturally re-evaluate their exposures and lending policies. This event has triggered a sea change in banking in the country and probably for the better. As Dr Robert Eid, chief executive of Arab National Bank, explains: "Lending was growing at 30%-plus levels in recent years which was probably too high. We are now getting back to sustainable lending levels."
Since the Saad/AHAB crisis emerged last May, banks in the country have become decidedly reticent to lend, and regional as well as international banks have likewise shown a similar reluctance to lend, scared by the uncertainty surrounding the dispute and doubts over its final resolution as well as other global considerations.
According to aggregate lending figures provided by SAMA, total loans by the 12 Saudi banks fell in 2009 by 1.1% to SR779bn ($208bn) from SR788bn in 2008, the first annual decline in lending by Saudi banks since 1990. This decline contrasts with the 28% growth in 2008 and more than tripling of banking lending since 2003. Trust and confidence were badly hit along with other adverse consequences.
A complex picture
The Saad/AHAB dispute has highlighted not only the complexity of the two conglomerates' global activities but also the difficulties of resolving collateral and complex legal issues covering various jurisdictions and a huge number of institutions. It has also forced local banks on to the back foot with increased provisioning, delayed the recovery in the economy due to stricter lending policies and the downturn in bank credit, and has also stymied growth.
While most analysts had been forecasting growth declines of between 1% and 2% for 2009 (compared to 4.3% increase in 2008) in Saudi Arabia, the overall economy proved unexpectedly resilient and managed to achieve real GDP growth of 0.15%, becoming one of a handful of countries globally to escape a recession.
However, almost a year after the Saad/AHAB dispute emerged in May last year, the issue remains shrouded in secrecy and complexity and is still unresolved. Also international banks have expressed concerns that they have been sidelined by settlement deals negotiated separately with local banks.
So what is likely to happen? In discussions with SAMA, the banking regulator is adamant that the two groups are family businesses and not financial institutions and therefore are not licensed or regulated by it. SAMA is also aware that banks have set off against collateral held in relation to loans to the conglomerates but also stresses that it, as regulator, does not manage relationships with bank customers and hence has no direct role with the two groups. SAMA has an excellent reputation as a conservative regulator and is playing an increasing role in G-20 and international regulatory discussions, but this dispute and its resolution are seen to be well beyond its remit.
In traditional opaque Saudi style, a committee formed by the 'highest authority in the kingdom' has been set up to look into the dispute, but it is not clear how this high-level government committee will operate and what it can achieve, especially in relation to debts outside Saudi Arabia. The two groups are active across the globe involving many international institutions and jurisdictions beyond the country. While some bankers hope the so-called committee will settle the dispute by the end of the year or even earlier, it remains a damaging mess. With international banks increasingly frustrated and pointing fingers at the Saudi authorities to no effect, there appears no simple way out of this family squabble.
Meanwhile, the 12 Saudi banks significantly increased loan loss provisions in the fourth quarter of 2009 largely as a result, it is understood, of their exposures to the Saad and AHAB groups. The banks' fourth-quarter provisions are reported to total SR4.7bn or 43% of the total 2009 provisions. How much more in provisions banks will need to take in the Saad/AHAB saga remains to be seen but the dispute has clearly had a damaging impact on Saudi banks and also on the economy in 2009.
Saudi Arabian banking system: Aggregates (SR billion)
The outlook for 2010
Despite the difficult global economic environment and the adverse impact of unexpected events, such as the Saad/AHAB dispute, the core fundamentals of the economy remain strong, especially in relation to oil and key indicators such as debt levels and the budget. However, much will depend on how banks and the private sector react to variable factors in the overall economic environment since the government has already indicated its willingness to use its financial clout to keep vital infrastructure projects on track and to stimulate the economy where necessary.
In analysing the prospects for recovery, John Sfakianakis, chief economist at Banque Saudi Fransi, says: "Lack of credit availability is the principal reason why economic recoveries tend to be much slower and more protracted than normal. Policy-makers in Saudi Arabia have long recognised this danger and they have done their bit to facilitate liquidity and lending. Banks and the private sector have to do their part."
Mr Sfakianakis believes that banks wanted to start 2010 with a clean slate and hence took sharply increased provisions in the fourth quarter and also encouraged private borrowers to close pending credit facilities. Most analysts agree that there has been both a reluctance to lend as well as a certain reticence to borrow or a lack of both supply and demand for credit. But in his February report, Mr Sfakianakis says this is changing. "In our view, banks' reluctance to extend new loans has reached a trough and they will begin to lend."
The crucial issue is boosting private sector involvement in non-oil sectors and reversing the slide in private sector growth in 2009, which slowed to 2.5% following a healthy 4.8% growth in 2008 and even higher expansion in previous years. Private sector expansion at a significant rate is critical to create desperately needed new jobs in a rapidly expanding population of 25.5 million at the end of 2009 with a high official male unemployment rate of 8.5%.
Saudi Arabia: Key data
Public spending
While there is consensus on the need for the private sector to shoulder more of the burden, the government is amply demonstrating its willingness to keep public spending at historically high levels, as shown by its recent budget. Government spending will provide the main stimulus to the economy in 2010 with total expenditure budgeted at SR540bn, 14% above 2009 budgeted expenditure. Revenues are projected at SR470bn resulting in a deficit of SR70bn, compared to an actual SR45bn deficit in 2009.
Paul Gamble, head of research at Riyadh-based investment bank Jadwa Investment, says: "This is the largest ever deficit the kingdom has budgeted for in nominal terms and the highest as a per cent of GDP since 2003." Jadwa, however, forecasts a budget surplus of SR15bn in 2010 as the oil price is expected to be about $70 a barrel instead of the $50 a barrel used in the budget calculation, thus leading to oil revenues of SR538bn and non-oil revenues at SR80bn. Jadwa forecasts spending to be in excess of budget at SR603bn following the trend of the past 10 years where spending has averaged 21% greater than budget.
The 2010 budget allocates a quarter of the SR540bn in spending or SR137.6bn to education and manpower, emphasising the government's priority on investing in Saudi citizens. The budget makes allocations for new universities in Dammam, Al-Kharj, Majmaa and Shaqra, 1200 new schools, the establishment of new technical colleges and vocational institutes as well as the completion of the campuses of existing universities such as the massive new $11.5bn Princess Nora Bint Abdulrahman University for Women in Riyadh. The Princess Nora University is a huge project started last year which will have a capacity for 26,000 female students.
The 2010 budget also includes SR260bn for investment projects, a 16% increase over the 2009 budget. The government is determined to not let major projects slip and is willing to step in in some form to maintain momentum. A recent report by Banque Saudi Fransi noted: "In January, the government called on Saudi Aramco to build the proposed 250,000- to 400,000-barrels-per-day Jizan refinery, initially slated as an independent project, after the project tender attracted only two bids from local oil companies with no interest from global players. With state backing, the refinery is more likely to achieve a 2015 target start date."
The 2010 budget also saw SR48.3bn allocated to specialised credit institutions including PIF, SIDF, the Real Estate Development Fund, Saudi Credit and Saving Bank, Agricultural Development Fund and Government Lending Program, a 20% higher allocation than 2009 and five times more than 2005. Increasing emphasis has been put on the role of PIF and other state agencies to ensure infrastructure projects keep on target.
Construction stimulus
Meanwhile, the state's Public Pension Agency (PPA) is developing the huge SR29bn King Abdullah Financial District (KAFD) project in Riyadh, as pictured on the cover of this supplement. Described as Riyadh's equivalent to London's Canary Wharf, this mega-project to re-locate the capital's financial community to north Riyadh is now well under construction with bankers suggesting that all of Dubai's cranes have now shifted to Riyadh for the KAFD and the Princess Nora University for Women projects.
But while the Capital Markets Authority (CMA) and Tadawul (stock exchange) have committed to large buildings at KAFD, along with Samba bank, bankers have expressed concerns as to who will occupy the huge amount of office space being created. "It's a grandiose plan but who is going to fill it and at what price? There appears to be much more supply than demand," says one banker.
Looking ahead, growth is expected to be achieved by improved performance from both the oil and non-oil sectors. With the oil price forecast by analysts to be comfortable in the $70 to $80 range, the fundamentals look solid and overall economic growth is forecast to rise to 3.8% this year from 0.15% in 2009.
Muhammad Al-Jasser, governor of SAMA
Lending resumption
Having survived the challenges of 2009 and altered their strategies, the banks look set to resume lending this year, bringing with it a rebound in the private sector but not a return to pre-crisis lending growth levels.
Although the banks were hit hard by the Saad/AHAB defaults, it is important to note that the banking sector remains strong and profitable. As the aggregate figures amply demonstrate, lending may have slowed but the banks remain very liquid, strongly capitalised and highly profitable by relative international standards. Hence they are in a strong position to take advantage of the opportunities that will emerge.
The aggregate liquidity ratio rose to 34.3% at the end of 2009 compared to 29% at end 2008, while the capital adequacy ratio of the banks rose to a very acceptable 16.6%, up from 15.7% at end 2008. Meanwhile, aggregate net income at end 2009, despite increased provisioning, remained the same as the previous year at SR26bn, providing a healthy average return on assets of 1.9%, down slightly on the 2.01% achieved in 2008.
But while the banks are structurally sound and high government spending and low interest rates provide a good platform for growth, analysts are convinced that a revival of confidence is needed and that this will take time. Nevertheless, Muhammad Al-Jasser, governor of SAMA, is bullish about a recovery in bank lending this year, with private sector bank credit already edging up 0.2% in January. "The financial system did not suffer any damage throughout the crisis and banks are well positioned to lend in 2010 as the global recovery takes hold. [Lending growth] should pick up in 2010," Al-Jasser noted at a meeting of the Bank for International Settlements in Basel in March.
Cautious optimism
Meanwhile, the National Commercial Bank, in association with Dun & Bradstreet South Asia Middle East, has released its Business Optimism Index for Saudi Arabia for the first quarter of 2010, indicating broad improvement in Saudi business sentiments and that economic recovery is on track. "Findings reveal that sentiments have continued to improve in Q1 2010 across all major sectors of the Saudi economy. In the non-hydrocarbon sector, firms are increasingly optimistic regarding the volume of sales and new orders outlook, indicating demand is continuing to strengthen. Expectations have also firmed, for a third consecutive quarter, regarding the level of selling prices with 43% of respondents expecting increases during Q1."
Looking at other developments this year some positive movement seems at hand. More than 50 initial public offerings have been announced for 2010 with improved prospects for raising capital through the equity and sukuk markets. The March announcement that the Dar Al-Arkan Real Estate Development Company had successfully redeemed its inaugural $600m sukuk issued in March 2007 further bolstered confidence in the market.
While analysts believe there will be little finance forthcoming from foreign banks who have been unsettled by the handling of the Saad/AHAB dispute and the debt standstill at Dubai World, the local banks are well placed to participate in the expected rebound. Saudi Arabia and its banks look set for reasonable growth in 2010 after a challenging 2009, but while the economic fundamentals are sound, trust and confidence still have a lot of room for improvement.