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Middle EastMarch 7 2005

New dynamics bolster banking

Stephen Timewell looks behind the booming profits in the Saudi banking sector at the factors that are driving growth and the new product lines that are beginning to come onto the market.
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The banking boom hit new heights in 2004 as profits rocketed to record levels on the back of a growing economy, expanding consumer lending and increasing market confidence. And the boom is unlikely to fizzle out soon.

The launch of the Capital Market Authority (CMA) in mid-2004 represents an important milestone in the development of the Saudi capital market and this year should see the intensification of flotations, a broadening of investment banking activities and, following the new capital market law, an expansion of insurance products. For banks, the strong economy based on strong oil revenues provides a solid foundation for growth but the new opportunities stemming from new legislation, consumer lending and investment banking add a new growth dynamic.

Unprecedented profits

According to Fahd Al-Mufarrij at the Saudi Arabian Monetary Agency (Sama), the 10 Saudi commercial banks produced aggregate net profits of more than SR17bn ($4.5bn), almost 40% higher than the SR12.2bn achieved in 2003. The majority of their profits came from core businesses with total bank credit up 36.6% for the first 11 months of 2004 and total deposits up 20.6% over the same period.

The IMF executive directors, in commenting on the latest Article IV Consultation, welcomed the conclusion of the Financial Sector Assessment Program that the “Saudi banking system is stable, profitable and well supervised”. They also welcomed the recent establishment of the CMA under the capital market law, which they said “will help strengthen management and operations of the stock market”. The IMF supported the development of secondary bond markets, which, it said, would contribute to financial deepening and enhance the growth-promoting role of the financial sector.

Consumer borrowing up

One of the key profit drivers for banks in 2004 was the growth in consumer finance, which contributed significantly to the high overall growth in credit. Consumers are beginning to borrow and, although growth rates seem high, the sector is starting from a low base. In the past, the lack of meaningful collateral restricted banks’ activities but the recent concerted use of salary assignments has opened up this fresh new area, making credit easier for borrowers and secure for the banks – a win-win situation.

The authorities are mindful of an explosion in the consumer sector and have restricted the salary assignment to banks to a third of salary. But the surge in consumer lending has only just begun and Samba Financial Group CEO Eisa Al-Eisa believes that debt levels are still well below international levels at 12% of GDP and the market has enormous potential.

Non-conventional trend

An important aspect of this market has been the dramatic shift to the use of Islamic finance – what some prefer to describe as a shift from conventional to non-conventional financing. In recent years, banks such as Al Jazeera Bank have become entirely Islamic and from the beginning of this year, the country’s biggest bank, National Commercial Bank, is offering only Islamic or non-conventional finance in retail.

Other banks are heading in that direction in retail. Bankers suggest that 75% of the retail lending market is already Islamic and increasing. Banks in the kingdom have benefited for many years from the tradition of non-interest bearing deposits, which are, in effect, Islamic and account for more than 40% of deposits.

Bankers say that the growing shift to non-conventional products is a response to customer demand; and officials say that banks are merely tailors providing the type of financial products that customers want within the approved guidelines.

Although the subject of Islamic finance can be a sensitive issue in the kingdom, bankers are keen to make sure that they cater for customer preferences and do not lose market share; and officials are keen to ensure that the banking system is stable and efficient. As one put it: “Risk has no religion.”

Banks have found innovative ways to provide Sharia-compliant consumer loans that satisfy the need for delivery of a genuine commodity. Arab National Bank, for example, offers Al Tawarooq Al Mubarak AlMahali, a local tawarooq (securitisation) finance done through a tie-up with a large local commodity dealer that has an extensive network across the country.

The commodity is steel bars used in construction. Customers purchase the commodity owned by the bank and are issued with a commodity certificate. They can take delivery of the commodity (steel bars) at any of the dealer outlets spread across the country. Alternatively, they can choose to sell the commodity back to the commodity dealer without appointing the bank as the agent. This mechanism is seen therefore as a truly Islamic finance product and has been very successful for ANB. Other banks have developed similar tawarooq structures that have helped to revolutionise the market.

Islamic lease

Just as consumer finance is booming and will be further improved by the effective use of credit bureaux, bankers are optimistic about the growth of a housing or mortgage market that does not exist at present because of concerns about the legal environment – shorthand for the ability to repossess.

Saudi British Bank (SBB) has developed an Islamic lease and managing director, Geoff Calvert, acknowledges the concerns but also sees the huge potential in housing finance. “We have taken the view that the risk is acceptable and are establishing a small $100m portfolio.”

Riyad Bank already offers a limited mortgage product and ANB was due to introduce a home lending product in February.

As consumer lending has emerged and housing finance promises even more, corporate finance has far from disappeared. Increased government spending, especially on infrastructure, has provided a bonanza for many large corporates. Banks are also developing the ability to tackle another area of huge potential: the small and medium enterprise sector, which is one of the fastest growing in the economy.

Additionally, the new insurance law provides banks with huge opportunities to get more closely involved in all areas of insurance, an unexplored product area in the kingdom. At present, many banks are establishing joint ventures with international insurance companies. Riyad Bank, for example, is setting up with its long standing insurance partner Royal Sun Alliance. Riyad CEO Talal Al Qudaibi believes that insurance will be “a huge area of growth”.

And, given the role of the CMA, investment banking is yet another area where banks are just beginning to provide much needed services to a market with an almost insatiable demand (see page 15).

Dawn of a new era

With a variety of new product areas beginning to reach fruition, 2004 bank results can be regarded not just as record profits reflecting record oil revenues, but also as the start of a financial era in which oil is significant but not the only driver behind the financial sector. The aggregate SR17bn in bank profits in 2004 reflects this new diversity and all the banks shared in significantly improved profits and returns.

Not surprisingly, the country’s biggest bank, National Commercial Bank, posted the largest profits at SR3.53bn, a 17.2% increase over the previous year and a healthy 29.3% return on average equity. It also increased its shareholders’ equity to SR13.8bn, a staggering 33.3% rise, which included a SR1.5bn addition to general reserves. The bank, which is controlled by the government pension fund, is expected to be privatised in the next year. No timing for the eagerly awaited flotation has been announced.

Samba Financial Group (formerly Saudi American Bank) also produced record profits. After a dip in 2003, under its new ownership structure, Samba produced a massive 74% rise in net income to SR2.5bn in 2004 and a much improved 27.3% return on equity (RoE). It amply demonstrated that the exit of Citigroup from the bank in 2003 had no significant impact on its performance.

Arab National Bank continued its impressive growth record with a 52% increase in profits to SR1167m in 2004. Profits have almost tripled in the past five years and RoE has more than doubled, to 26.6%, under CEO Nemeh Sabbagh. Loan loss provisioning has been considerably strengthened with coverage now amounting to a high 182%.

Profits at SBB, whose new personal lending is all Islamic, rose by 30% to SR1636m. Customer deposits and loans rose by 23.8% and 21.1% respectively.

“Operating revenues, especially non-funds income, had a very good year benefiting from a buoyant economy and equity market,” says Mr Calvert.

Riyad Bank passed the SR2bn profit mark with a 26% rise in profits and a 22.2% RoE. Mr Al Qudaibi highlights the bank’s 61% increase in fee income to SR612m, stemming from its active trading services, and 20% share of the mutual funds market.

Saudi Hollandi Bank produced record net profits of SR743m, a 24% increase on the previous year. Managing director Peter Baltussen stressed the solid growth across all the main business segments, adding: “We increased our paid-up capital from SR945m to SR1260m in March 2004 and increased our Tier II capital by successfully issuing subordinated notes of SR700m in December 2004, a transaction which was a first in the Saudi market.”

Al Rajhi Banking & Investment Corp, the country’s fourth largest bank, faces growing competition in its traditional strength of Islamic banking products, but continues to benefit from its huge network of more than 380 branches. Unlike most other Saudi banks, Al Rajhi is looking into new opportunities abroad and has been granted a licence to open in Malaysia. CEO Abdullah Sulaiman Al Rajhi believes that Malaysia represents an interesting opportunity. Feasibility studies are being prepared.

Regional competition

Looking ahead, banks face many new opportunities that are expected to translate into further profits growth of 20%-30%. But they also face new competition not only in investment banking, but also from the growing band of regional banks.

Besides Bahrain’s Gulf International Bank, which has branches in Riyadh and Jeddah, the UAE’s Emirates Bank International has been operating since last October, National Bank of Kuwait is set to open in Jeddah in the second quarter and Oman’s BankMuscat and National Bank of Bahrain are due to open this year. And the new Al Bilad Bank is due to open in the next few weeks.

There will be almost double the number of licensed banks by year end but a lot more to compete for.

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