Saudi Al Rajhi

With a new open banking initiative planned for the first half of 2022, Saudi institutions are beginning to ramp up their digital offerings in the retail and SME banking arena. 

In what has always been predominantly a corporate banking landscape, Saudi Arabian retail banking has raised its profile of late. And two of the country’s largest banks, including the retail market runner-up, recently merged into one. As with so much in the country’s current economic life, both phenomena can be traced back to Vision 2030.

Saudi Arabia’s crown prince Mohammad bin Salman, son of and heir apparent to reigning King Salman bin Abdulaziz, is the effective ruler of the country and has articulated his comprehensive agenda for change in the Vision 2030 programme.

An important part of these plans is the Housing Vision Realisation programme, which aims to boost home ownership, make housing more affordable and raise local satisfaction. As with most elements of Vision 2030, an overarching objective is to create jobs and strengthen the economy.

Housing market boom

The goal is for 70% of Saudi citizens to own their own homes by 2030. Banks clearly have a role to play in achieving this goal, and the government has introduced subsidies and guarantees that make retail mortgage margins particularly attractive for lenders.

Returns are enhanced by particularly low funding costs, as retail loans are mostly funded by non-interest-bearing retail deposits. High margins are also made possible by the absence of caps on retail loan pricing.

m damsak

Mohamed Damak, S&P Global Ratings

According to property specialists JLL, the number of Saudi mortgage loans grew by 84% in the year to September 2020, compared with a year earlier, and by 90% in loan values.

Corporate lending was more muted in 2020. While overall credit grew by 14.5% during the year, mortgages and retail loans accounted for the major share of that. Of SR216bn ($33.6bn) in new lending, mortgages totalled SR120bn, retail lending SR31bn and corporate loans SR65bn.

“More banks are actively chasing the mortgage market,” says Amin Sakhri, the Dubai-based director of financial institutions at Fitch Ratings. “The landscape on pricing is changing and you are beginning to see more competition. The smaller banks will feel the pressure first.”

Retail banking potential

These developments are reflected in the rising share of retail lending in Saudi banks’ overall loan portfolios. Fitch reports that it accounted for 38% of total lending by the end of the third quarter of 2020, up from 31% at end-2016.

This, the rating agency says, largely benefits the banks’ financial and risk profiles, since retail has inherently lower impairment levels than the corporate segment. It is also characterised by lower risk-weight requirements, which enhance their risk-adjusted returns and regulatory capital ratios.

Some 75% of Saudis aged over 15 years hold a bank account, making this the largest retail market among Gulf Co-operation Council (GCC) states. However, as Fitch points out, it also has the lowest proportion of retail loans relative to gross domestic product, leaving it with considerable potential for growth.

That is even more the case given present Saudi demographics, with more than 65% of the population aged under 35 years. The population itself, currently around 35 million, is expected to grow to 39 million by 2030, and the appetite for home ownership is expanding. In a 2020 survey of Saudi housing, estate agency Knight Frank determined that 56% of tenants would like to buy a property in the next five years.

M&A drivers

The retail market leader is Al Rajhi Bank, with a 35% share, followed by what used to be National Commercial Bank (NCB) with 23% and Riyad Bank with 10%. NCB has just merged with Samba Financial Group (number three by Tier 1 capital, fourth by assets, and whose business is largely corporate), following a $14.8bn deal that completed in April. The bank has now rebranded as Saudi National Bank (SNB).

Ranked by Tier 1 capital and by assets, NCB and Al Rajhi have been the country’s number one and two banks respectively.

A merger of some kind was not unexpected. A year earlier, NCB had been in talks with Riyad Bank (number four in Tier 1 capital and third in assets), but they came to nothing.

“Bank mergers and acquisitions in the region have been driven by the desire of the shareholders to reorganise their assets,” says Mohamed Damak, senior director at S&P Global Ratings. In the case of both NCB and Samba, those shareholders are largely government entities.

NCB was Saudi Arabia’s first licensed bank, dating from 1953, while Samba had its roots in Citibank’s local operation. Citi sold its last shares in 2004.

SNB will not only be the largest Saudi bank, but also the third-largest bank in the Arab world. It will have assets of some $223bn and its largest shareholder will be the Saudi sovereign wealth fund, the Public Investment Fund (PIF), with 37%.

Bank mergers and acquisitions in the region have been driven by the desire of the shareholders to reorganise their assets

Mohamed Damak, S&P Global Ratings

S&P Global Ratings observes that the new entity has a 30% market share built on well-established franchises, enjoying a prime market position, strong capitalisation and a well-balanced risk profile. It has upgraded NCB’s BBB+/A-2 ratings to A-/A-2 with a stable outlook for SNB.

Moody’s, on the other hand, affirmed SNB’s long- and short-term local and foreign currency bank deposit ratings at A1/P-1, but with a negative outlook. This rested partly on the agency’s negative outlook for the sovereign’s A1 long-term issuer rating, and partly on operating environment pressures caused by moderate oil prices, reduced government spending and coronavirus-induced disruption.

Supporting role

SNB’s two businesses complement each other well and the potential cost savings, while not insignificant, probably do not add up to a reason to merge. The true rationale was almost certainly to create a national champion which is better able to support the country’s economic development in general, and Vision 2030 in particular.

That may give rise to the problems that national champion banks have suffered elsewhere, being obliged to lend to risky projects ‘in the national interest’. Vision 2030 includes some large projects where most banks would be happy to assume risk. But there are others which inspire less confidence, where SNB might find itself strong-armed into being the lender of last resort.

The crown prince has been aligning other Saudi institutions to bolster Vision 2030, including the central bank, SAMA. While SAMA continues to be charged with stabilising and defending the currency and regulating and supporting the financial sector, at least some of its investment responsibilities are being passed to PIF.

This year, Fahad al-Mubarak took over as central bank governor from Ahmed al-Kholifey, who becomes an adviser at the royal court. This is Mr Mubarak’s second stint as governor, after he ran SAMA from 2011 to 2016. Before that, he was chairman and managing director of Morgan Stanley Saudi Arabia, and he has also been chairman of the Saudi stock exchange.

SAMA is not quite the same institution Mr Mubarak left behind in 2016. Under a new law which came into force in February, the bank now reports directly to the king, and is explicitly mandated to support economic growth.

Some suspect there could be more pressure on SAMA to provide funding for PIF. The central bank transferred $40bn from its reserves to PIF in the spring of 2020 for investment in riskier assets than SAMA would normally approve.

Finance minister Mohammed al-Jadaan, who sits on the board of PIF, has said that the changes will not affect SAMA’s core responsibilities, which include maintaining sufficient reserves to protect the riyal–dollar peg.

A lot of banks are owned by the government or the royal family, so there is more political risk than in other regions

Jessica Leyland, AKE International

Mr Jadaan said it would not be the “norm” for PIF to receive transfers from SAMA’s reserves. He insisted PIF had sufficient funding, and would get additional financing from privatisations and any further listing of the state oil company, Saudi Aramco.

Covid-19 measures

In March last year, in response to the Covid-19 crisis, SAMA reduced its repo rate to a record low of 1%. It told banks to defer repayments from borrower groups, such as small businesses and health workers, providing liquidity support with two lines of zero-interest funds worth SR50bn each.

Roman Rybalkin, associate director at S&P Global Ratings, believes that between the payment deferrals and the interest-free funds, the banks will have broken even by the end of the year. “The deferrals and the gains from interest-free facilities will have balanced each other out,” he says.

Loan-loss provisions for 2020 are higher than would normally be expected, Mr Rybalkin says, at 105 basis points (bps). “You would expect 60–80 bps in a regular year,” he says. “But it’s not a disaster. There are still some losses to be booked once all the deferrals have been ironed out, and we expect the cost of risk to be more than 100bps in 2021.”


Roman Rybalkin, S&P Global Ratings

S&P expects credit growth generally to stay strong in 2021, with corporate loans picking up as PIF programmes generating business for contractors. Small and medium-sized enterprise (SME) credit growth will slow as deferral schemes wind down, though it should remain material thanks to subsidies.

One of Vision 2030’s goals was to increase banks’ share of SME financing from 2% to 5% by 2020. That seems to have been achieved — according to official figures, banks were already providing 6.8% of SME loans by the mid-2020.

In February, SMEs got their own bank, in the shape of the Bank of Small and Medium Enterprises, launched by the SME arm of the National Development Fund. The Ministry of Commerce said the new bank would bring together all appropriate financing solutions under one roof.

Saudi banks mostly follow Islamic practices, with the notable exception of the former NCB, which is still in transition. They are well-capitalised by international standards and S&P expects this to remain the case until at least 2022. It expects interest rates to stay low for some time, which would be negative for net interest margins. Higher retail margins would not fully compensate, resulting in lower returns than banks have been accustomed to.

Even so, S&P expects that Saudi banks, on average, will outperform their regional peers in the Gulf. This, it says, largely reflects the relatively modest impact of the pandemic on the quality of banks’ loan books and the stronger growth of mortgage lending.

New challenges

Saudi Arabia has traditionally been a cash economy and some believe that will not change any time soon. S&P argues, however, that payment in cash is gradually becoming less ubiquitous, noting that ATM cash withdrawals have been declining in favour of point-of-sale payments.

“Card payments are increasing at a rate of 35–40% a year,” Mr Rybalkin says. “In the first quarter of 2018, non-cash payments accounted for 22% of the total. By the fourth quarter of 2020, that had risen to 40%.” He adds that the use of ATMs for individual non-cash transactions, such as balance enquiries has also fallen, from around nine per quarter at the start of 2018 to under seven today.

The country is not exactly overbanked — it has the least number of banks in the GCC and the largest population. The industry’s barriers to entry have always been high, for foreign banks in particular, but as the banking system becomes more digitalised, it becomes more vulnerable to competition from challenger banks.

Fintech companies are emerging, offering a range of different digital payment and finance solutions, with pay-later cards and peer-to-peer lending beginning to catch on.

SAMA has been addressing the issue of digital services, establishing a regulatory fintech sandbox, laying down payment services provider regulations and issuing licences for non-bank financial institutions.

Earlier this year, the central bank said it would launch an open-banking initiative in the first half of 2022, allowing consenting customers to share their data securely with third parties. It sees this as a key part of Vision 2030 and an important step in the development of financial services in Saudi Arabia.

SAMA says it has studied open-banking practices around the world and collected feedback from local financial market participants. Now it is working to identify the most suitable way to implement the initiative.

Fitch’s Mr Sakhri notes that the authorities and the sector take the idea of open banking very seriously, but adds that the concept is still nascent. “It’s not a market disruptor yet,” he says. “It will take some time before it diverts activity away from the traditional system.”

However, the words ‘open’ and ‘banking’ may not sit together easily in a Saudi context. Jessica Leyland, senior intelligence analyst for the Middle East and north Africa at security and risk consultants AKE International, says there is still too much opacity in the Saudi banking sector.

“There’s no data,” Ms Leyland says. “A lot of banks are owned by the government or the royal family, so there is more political risk than in other regions, and not the same level of investor engagement.”

Much of the wealth within Saudi banks belongs to royal, government or establishment customers, who prefer traditional, unhurried ways of doing business, and rely on personal, rather than electronic connections.

Saudi banks are not blind to the digital revolution and are beginning to mount their own responses. Al Rajhi Bank has launched Emkam Finance, for example, which offers digital financial solutions such as online loan applications. But however rapid the change that the crown prince is able to bring, banks are unlikely to be leading the charge.


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