Despite low oil prices and flat economic growth, Saudi Arabia’s banks have remained active and stand in a strong position compared with their regional peers. James King reports.
Saudi banks did not have an easy time of it in 2016. Slower economic growth, which came in at 1.4%, coupled with a brief but severe liquidity crunch, weighed heavily on market sentiment.
In this environment, the banking sector registered a 5.3% drop in net profits for the period, contrasting sharply with the 5.2% gain posted in 2015, according to ratings agency Moody’s. Though much of this weaker profit performance is attributed to higher provisioning charges, most bankers in the country highlight a gradual shift in the landscape.
“Last year was a more challenging period for the economy as a whole,” says Soren Nikolajsen, managing director of Alawwal Bank, the oldest lender in the country. “Asset growth for the sector was about 2.5% in 2016 but it was really a tale of two halves. In the first half it was up by 5% but by the second half of the year it had dropped by about 2.3%. That was due to the liquidity crunch that hit towards the end of 2016.”
Saudi’s strengths
Other markets across the region face many of the same challenges. The difference for Saudi banks is that they are doing so from a position of strength. The average tangible common equity ratio for the sector was above 16% towards the end of 2016 and is expected to climb to about 17% by 2018 off the back of slower-than-usual loan growth, according to Moody’s. Meanwhile, loan-loss provisions stand at about 100% of non-performing loans.
“Banks in Saudi Arabia are in a stronger position compared with other banks regionally and globally. They are well capitalised and have strong financial positions,” says Steve Bertamini, chief executive of Al Rajhi Bank, Saudi Arabia’s second largest lender and the world’s largest fully sharia-compliant bank. “Some challenges [materialised] in the second half of 2016 related to market liquidity, but the government has taken steps in the right direction, and the liquidity position has materially improved as evidenced by the loan-to-deposit ratio for the industry ending the year at 80.7%.”
Indeed, the rapid improvement in liquidity has been a headline story in recent months. To counter nosediving revenues, the government had been tapping local debt markets to meet spending requirements and obviate the freefall of its foreign currency reserves. As a result, the local banks that were buying these instruments were being drained of liquidity. This led to a sharp increase in the three-month Saudi interbank offered rate (Saibor), which hit an eight-year high of 2.386 in October 2016.
In response, the government injected about $5.3bn of liquidity into the banking system, suspended its domestic debt issuance programme and instead executed the world’s largest emerging market sovereign bond at $17.5bn in October. Using the proceeds of this bond, the authorities paid long-overdue contractors’ bills and staved off a growing liquidity crisis.
“Liquidity conditions have eased considerably, helped by the highly successful sovereign international bond issue in the fourth quarter of 2016, government payments to contractors and a modest increase in oil prices,” says David Dew, managing director of the Saudi British Bank (SABB).
Inflection point
By February 2017, the Saibor had fallen to below 2%. Most bankers now expect a normalisation of the liquidity environment over the coming year. This in turn is expected to reduce pressure on customers’ borrowing costs and augment the lending appetite of Saudi banks, which, until recently, had adopted more cautious lending strategies. Indeed, the country’s improving liquidity outlook is seen as an inflection point for the economy, with many bankers predicting a more stable (if generally flat) outlook for the year.
“The improving liquidity situation was more than just the government paying off contractors. It was more about confidence returning to the market,” says Abdulmohsen Al-Fares, chief executive officer of Alinma Bank.
Saudi banks look set to benefit from an expansionary government budget in 2017 that outlines a spending increase of 7.9%, to SR890bn ($237.3bn), beyond the budgeted figure for the previous year. Most of this expenditure will benefit private non-oil activity, a sector likely to record growth of 1% in 2017, up from 0.1% in 2016. This will occur even as gross domestic product growth declines by a predicted 0.2% off the back of lower oil production, according to local firm Jadwa Investment.
But in this mix, Saudi banks still have plenty of growth opportunities to consider. For one, massive spending on infrastructure development and mega-projects continues, despite government efforts to consolidate some of this expenditure.
“Government spending and investments in infrastructure projects will be a key driver of credit growth. Mega-projects such as the Riyadh metro, which is costing about SR84bn, will be important moving forwards. In addition, there are big opportunities for growth in the kingdom’s housing sector. Saudi Arabia needs hundreds of thousands of new homes to meet the needs of its growing population,” says Mr Al-Fares.
Development spree
Alinma Bank has been a key player in a number of the largest development projects to date. This includes financing an SR8.4bn real estate investment fund to develop Jeddah Economic City, Jeddah Tower and other property projects. The fund will be managed by the bank’s subsidiary, Alinma Investment, while the Kingdom Holding Company, headed by Prince Al-Waleed bin Talal, will develop the projects.
“It took more than a year to get the right structure for the fund in place, but the project is in a prime location and our partners are strong,” says Mr Al-Fares.
Beyond mega-projects, massive investments are taking place in the Saudi housing sector. The ministry of housing estimates three million new homes will be needed by 2025 to meet expected population growth. Several agreements have recently been signed to develop housing capacity across the country, including a 2016 accord for the development of 56,000 new housing units in the Eastern Province, Riyadh and Mecca, among other locations. To facilitate increased home ownership, the Saudi Arabian Monetary Agency has recently increased the maximum loan-to-value cap from 70% to 85%.
This is big business for banks. “Home financing is a key growth area for Al Rajhi, which already holds a 20% share of the mortgage market. This number is expected to grow even further. We continue to work very closely with the ministry of housing to make sure that we have put the right programmes in place to help the government drive its agenda,” says Mr Bertamini.
Al Rajhi Bank has partnered with the state-owned housing Real Estate Development Fund to launch an accelerated finance programme. Under the programme, prospective homeowners can liaise directly with the bank, which will reduce the waiting period for a loan. Al Rajhi Bank, which is the first lender in the country to launch such an initiative, has now rolled out this programme out to all its branches.
“We expect to see increased competition in the housing sector moving forward. We believe that the goal to increase [the ratio of home ownership], from 47% to 55%, provides us with a great opportunity for growth and we are focused on helping Saudi Arabia go from current levels and reach its desired targets,” says Mr Bertamini.
A new kind of branch
Saudi banks are not resting on their laurels: huge investments in digital banking, including innovative products and services, is meeting the needs of a young, growing and tech-savvy population. In the heart of Al Nakheel Mall, Riyadh’s busiest shopping centre in terms of total footfall, Alawwal Bank has established its first digital branch, known as 'Ibda'.
Completely open-air, sheltered by palm trees and surrounded by a mini-moat, the location is a blend of coffee shop and bank, equipped with high-end digital interfaces for customers. It is a striking statement of the direction that banking is taking in the country. “The pace of change is so fast that if we look forward 10 years, it is difficult to imagine what a bank branch will look like. But it will definitely look a lot more like this [Ibda] branch than the traditional version,” says Alawwal’s Mr Nikolajsen.
He notes that Saudi Arabia’s population is growing quickly and that more than 65% of citizens are under the age of 30. Like other markets in Gulf Co-operation Council countries, smartphone penetration is extremely high. “We have to be at the forefront of these trends, be innovative and develop our products and services accordingly,” he says.
The development of the Ibda branch is a reflection of this changing and sophisticated market. Walking through the mall, it is difficult to differentiate the bank from the Costa coffee shop that shares the space: a deliberate decision by Alawwal Bank, which has partnered with Costa to develop the location. Baristas at the counter are trained to answer questions on banking products and services. The full-time branch employees all have commercial retail backgrounds and have been trained up by the bank to transition to work in finance.
“With our newly developed technology, in the digital branch customers can open a new account in less than 20 minutes,” says Mr Nikolajsen.
Seating areas, where customers and non-customers can drink coffee, are kitted out with fixed tablets permitting a wide array of bank products and services to be used. Nearby, integrated teller machines and ATMs allow for more complex transactions, with customers able to digitally connect via voice and camera with a service agent if required. “The branch had a one-year development time, from conception to rollout. This is all part of our retail expansion strategy that was enacted in 2014. Since then we have grown our branch network by 50% and the number of ATMs has also doubled,” says Mr Nikolajsen.
Boosting entrepreneurship
Developments in the banking sector, along the lines of Alawwal Bank’s Ibda branch, are likely to become more prevalent. Bankers in Riyadh have long been aware that engaging with the youth market and supporting efforts towards the promotion of hi-tech sectors will be paramount for the country’s development. The government’s reform plan, Vision 2030, specifically lists investments in the digital economy as a key component of economic reform.
To this end, SABB has partnered the King Abdullah University of Science and Technology to develop a mentorship-driven, multi-university start-up accelerator. The programme is designed to target student entrepreneurs and help to transform their ideas into prototypes before scaling up these concepts to a business level.
“We are excited about our Taqadam initiative, which is essentially a university entrepreneurship programme in collaboration with the university intended to help young entrepreneurs learn business skills and bring new ideas and start-ups to market. This is very much aligned to one of the components of Vision 2030 which we are delighted to support,” says SABB’s Mr Dew.
Questions around job creation for the millions of graduates that will, in the coming years, populate the employment market are front and centre of the conversations among bankers and policy-makers alike. Saudi lenders have a particular role to play here by supporting sectors of the economy that can help to plug the job creation gap.
Ambitious vision
“Vision 2030 is very ambitious and the implementation of this plan will be crucial. I believe the future of Saudi Arabia lies in the services, retail and industrial sector,” says Alinma Bank’s Mr Al-Fares. “The most critical issue facing Saudi Arabia is job creation. Millions of students will graduate from higher education in the coming years and they are all looking for jobs. So we have to invest in industry and to create jobs that will help us diversify our economy and move forward.”
In the longer term, a continuation of these challenges may yet undermine confidence in the Saudi economy. But for now, most bankers remain upbeat about its immediate prospects. Though most expect relatively flat growth for the coming year, in line with the wider performance of the economy, there are opportunities to be found in the wider reforms occurring nationally.
“The outlook of the [Saudi] economy is positive and the overall financial position of the government remains very strong, and we expect that Saudi debt will remain attractive in international markets as well as a stronger oil price outlook for 2017,” says Al Rajhi Bank’s Mr Bertamini. “Saudi Arabia is also continuing to build local, regional, and international investor confidence in its long-term strategy, especially with its focus on economic diversification.”
