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Middle EastMay 1 2018

Banks look to cash in on changing Saudi environment

Saudi Arabia’s economy is changing as taxes on expat workers fuel an exodus, while the relaxation of driving rules is giving women more employment opportunities. Together with developing sectors such as entertainment and home ownership, this is providing local banks with plenty of opportunities, as James King reports.
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SABB

Saudi banks have faced less than ideal operating conditions in recent years: the lower oil price environment squeezed liquidity across the system in 2016, while the economy contracted by about 1% in 2017, according to research from rating agency Moody’s.

These conditions reflect, in part, the challenges facing energy exporters across the region. But they also mirror the Saudi government’s push for fiscal and economic reform. Government spending, on which the economy relies, has been more conservative over the past couple of years while the introduction of new taxes, including value-added tax and the lifting of some subsidies has weighed on consumer sentiment.

As a result, growth opportunities have been less abundant than they once were with total bank lending decreasing by about 1% in 2017. “Private sector credit demand has been subdued over the past couple of years,” says David Dew, managing director of the Saudi British Bank (SABB).

Risk aversions

In this less supportive environment, many Saudi banks have also lowered their risk appetite – meaning both the supply and demand of credit have been operating at a diminished level. The corporate sector was hit particularly hard in 2017, with total credit contracting by about 2%. In some sectors it was worse, such as construction and building materials, where loans fell by about 15% over the period.

Nevertheless, most bankers in Riyadh expect the improved economic outlook for 2018, helped by a nearly SR1000bn ($267bn) government budget, to prompt increased private sector activity and loan demand. “Private sector sentiment is now a little more robust than it was for most of 2017. Businesses are looking more positively to the future than perhaps they were last year. We are cautiously optimistic that this year will be stronger,” says Mr Dew.

This optimism seems justified. Even as total credit has contracted and the economy has shrunk, Saudi banks have managed to post robust growth figures in recent times. The Saudi banking sector as a whole registered a 9% year-on-year increase in net profits in 2017 thanks in part to the improving cost profiles of most institutions. Moreover, it remains the Gulf Co-operation Council’s best performing banking system in terms of its profitability metrics; it is the only one with a net income to tangible assets ratio above 2%, according to research from Moody’s.

You have roughly 450,000 eligible [home] buyers who are facing obstacles in terms of affordability. There is a big backlog of demand

Steve Bertamini

Bucking the trend

A closer look at Saudi’s key banks reveals some impressive growth stories. Al Rajhi Bank, Saudi Arabia’s second largest lender, recorded its highest ever annual net profit of SR9.12bn in 2017, representing growth of 12%. “Our goal is to always to try to outperform the market. Last year ended up being quite a good year for us. At a macro level we grew our market share across the board. So while the wider economy might have been tough we, as a bank, performed very well,” says Steve Bertamini, chief executive of Al Rajhi Bank.

Another Islamic lender, Alinma Bank, saw its net income jump by 34% in 2017 to hit SR2.01bn. In addition, Alinma’s financing portfolio grew by 12% while customer deposits increased by 10%. “Our customer base is growing by double digits. We have enhanced our branch and ATM network, as well as our digital offerings. In addition, we have and will continue to introduce a range of new products and services in 2017 and 2018,” says Abdulmohsen Al Fares, chief executive of Alinma Bank.

As a result, most Saudi lenders are well positioned for an expected, if gradual, ramping up of economic activity in 2018. The domestic liquid assets of the country’s banks are now sizable as a result of low credit demand over the past 12 months and the government’s tapping of the debt markets to finance its expenditure, which has helped to grow public sector deposits. Liquid assets grew by about 11% over 2017 and now account for 20% of total assets, compared with 14% by year-end 2015.

“Saudi banks have ample liquidity and are well positioned to support the economy over the next few years,” say Soren Nikolajsen, managing director of Alawwal Bank.

Home comforts

Credit growth in Saudi Arabia should accelerate to 4% in 2018 before picking up again in 2019, according to Moody's. For most Saudi lenders, opportunities are to be found under the government’s Vision 2030 realisation programmes, with housing being an area of focus for many. The country’s housing ministry has set a target for the mortgage market to reach SR502bn by 2020, up from about SR290bn today. Over a longer time period the government hopes to push home ownership levels from about 47% up to 70% by 2030.

“One of the government’s key domestic objectives is to increase the percentage of Saudis who own their own homes. There are roughly 450,000 eligible buyers wanting affordable housing. This large backlog in demand will translate into strong growth in mortgage lending in the coming years,” says Mr Bertamini.

In February 2018, the Saudi government announced a SR120bn home finance programme to support its mortgage market objectives. About SR18bn will be allocated to a loan guarantee programme while further funds will be channelled towards downpayments for prospective homeowners. This package and other government-led initiatives are going a long way to addressing the affordability gap that besets the Saudi mortgage market. And for the banks, these efforts offer encouraging growth prospects.

Alinma Bank has, for instance, partnered with the country’s Real Estate Development Fund to provide subsidised and concessional home financing across the country. “The government targets are very ambitious but they are opening up good opportunities for financial institutions,” says Mr Al Fares.

Al Rajhi Bank has also made impressive strides into the home finance market. “As additional affordable housing comes online we expect more and more citizens will be able to afford their own home. Today, if a prospective homeowner comes to us with all the necessary documents, by day five they can have the keys to the house. From a customer experience, we have a superior product and experience, which is helping us to capture more of the market,” says Mr Bertamini.

Product innovation

The scale of the financing required for Saudi Arabia’s mortgage market is vast, meaning most lenders will be able to secure large positions in this quickly maturing segment of the economy. Looking ahead, product innovation, as well as better data on borrowing behaviour offered through the Saudi Credit Bureau, should help to propel the market to the next stage of its growth.

“The scale of the challenge in terms of affordable housing and the need to provide housing for a growing population is very significant. It’s beyond any one institution so there are opportunities there for the whole financial sector," says Mr Dew at SABB.

Female drivers will be positive for car dealers and there is an expectation that car sales will increase as women demand more vehicles 

Abdulmohsen Al Fares

“Our market share at the moment is about 8% of the home loan market, so that’s in excess of our overall retail market share, which is about 5%. We aim to continue to maintain that outperformance. But more important than simply providing home loans is to provide more flexible products to customers and in doing so offer genuine choice - from fixed rate, to floating rate, to longer tenor products.” 

Sweeping changes

Beyond home finance, Saudi lenders are adapting to and capitalising on a rapidly changing economic and social landscape. Under the guidance of crown prince Mohammed bin Salman, the country is opening up like never before. Entire industries are emerging for the first time.

In 2017 the authorities announced the development of a new entertainment city near Riyadh that will boast theme parks and safari enclosures. Meanwhile in April 2018, the Hollywood blockbuster Black Panther opened in the country’s first cinema, and regional and international chains are expected to open hundreds more in the coming years. The logic of this move to open up entertainment options is clear. Rather than taking weekend trips to Bahrain or Dubai, the government wants citizens to spend their money stimulating the domestic economy.

Furthermore, from June 2018, women will be legally allowed to drive in Saudi Arabia. Taken together with domestic entertainment, such developments are set to radically transform the country's economy. “Female drivers will be positive for car dealers and there is an expectation that car sales will increase as women demand more vehicles. It won’t start suddenly but will increase gradually,” says Mr Al Fares.

Al Rajhi Bank’s Mr Bertamini expects the increased mobility of female workers to boost household incomes. “Women entering the workforce will be another long-term growth driver in the economy. You will have another earner in the household who may want some financial products and services so obviously we have been gearing up over the past 18 months to prepare for this through the expansion of our dedicated Ladies Branches, among other measures.”

Increasing female participation in the labour market is going hand in hand with other structural changes. The imposition of an ‘expat levy’ on private sector companies for each foreign worker on their books, as well as a tax on the dependents of expat workers in Saudi Arabia, is already leading to a slow but steady exodus of lower wage earning expats from the country. “The expat sector right now remains under a level of pressure. I think it’s a function of ongoing Saudi-isation efforts to increase and of new fees on expatriate families. You are starting to see expats leave the country for these reasons,” says Mr Dew.

As a consequence of this trend, and of the government’s drive to ensure more Saudis are working in the private sector, a number of local banks are looking to remodel their retail sector customer base. “Over time we don’t expect further growth in government employment but the mix of Saudis will increase and non-governmental employment will grow. As that shift occurs, it will offer a good growth opportunity for us,” says Mr Bertamini.

Embracing fintech

Other forces that are shaping Saudi Arabia’s future, as well as its banking sector, include the impact of financial technology. Saudi banks – and the country's regulator – are shrugging off their conservative reputation to embrace pioneering technology in the pursuit of operational, regulatory and service excellence. In February 2018, the central bank, the Saudi Arabian Monetary Authority, signed an agreement with US fintech group Ripple to launch a pilot programme for cross-border payments using blockchain technology. The scheme will test the technology among a small pool of banks and transactions.

“We believe there will be a major change in the Saudi banking sector in a few years. At Alinma Bank we are focusing on digital innovation and if we get our approach right, it will be a big opportunity for us,” says Mr Al Fares.

Elsewhere in the sector, some lenders are also pushing ahead with partnerships with fintech groups. SABB signed an agreement with Bolero International to assist with the digitisation of its trade finance activities. In doing so it became the first bank in Saudi Arabia to initiate trade finance transactions electronically. Meanwhile, Al Rajhi Bank is investing heavily in artificial intelligence chatbots, while it has become one of the largest user of robotics technology in the Middle East.

“Over the next 18 months you are going to see the gap between what happens in Saudi Arabia from a digital customer perspective and what is happening in the advanced economies close quickly. We are going to be on par with the best in class. It’s a very dynamic market,” says Mr Bertamini.

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Read more about:  Middle East , Saudi Arabia