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Middle EastMarch 30 2010

Brave new world

Despite suffering a few shocks in 2009, Saudi Arabia's banking sector remains healthy and stable. As the sector faces up to the new realities and the need for change, an era of more modest, sustainable banking is emerging. Writer Stephen Timewell
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Saudi banks had a difficult year in 2009. In what could be described as a watershed period, the features of booming growth between 2003-08 were suddenly cut down to size. And it was not the global financial crisis that was the main culprit, although it clearly contributed, but the realisation that the boom and the banking models associated with it were no longer sustainable. The penny dropped when the massive defaults of the two Saudi conglomerates, the Saad and AHAB groups, awakened bankers to the new realities.

Bankers claim that name lending, which had been at the core of Saudi banking growth in the 1970s and 1980s, had been dead for years. But the Saad/AHAB feud, which has left a regional and international debt pile of $20bn unresolved, shocked the banking community and emphasised the problems of old models where proper risk management and transparency were not adequately addressed.

Saudi banks paid the price in 2009 as provisions reached SR10.9bn ($2.9bn) for the year, with 43% of that (or SR4.7bn) taken in the fourth quarter amid concerns over exposures to the Saad/AHAB groups. Clear lessons on corporate governance, risk management and transparency have been learnt the hard way, but unlike many banking sectors damaged by the global financial crisis, Saudi Arabia's remains both sound and profitable.

"The banking system is very solid, very liquid and very well capitalised," explains Muhammad Al-Jasser, governor of the Saudi Arabian Monetary Agency (SAMA). And the SAMA aggregates reinforce this view. Despite various issues, Saudi banks' aggregate net income in 2009 reached SR26bn, matching those of 2008 and not far down on 2007 net income of SR30.2bn.

Aggregate returns

Saudi banks have had to bite the bullet but still remain highly profitable overall with an aggregate return on assets of 1.9% in 2009. This compares with the aggregate return on assets figure of Top 100 banks in the world in The Banker's Top 1000 World Banks listing last July of 0.12%, down from 0.87% the previous year.

Although aggregate lending has gone into decline for the first time since 1990, dipping by 1.1% in 2009, with loans-to-deposit ratio falling to 73.2% from 78.6% in 2008, other key measures continue to grow. Aggregate total assets still rose by 4.6% in 2009 to SR1357bn and total deposits were up 6.4% to SR1001bn. Saudi banks have preferred to not lend and build up their deposits with SAMA, and banks' excess deposits (above statutory deposits) were reported in February to exceed SR98bn.

Despite their various troubles, banks have significantly boosted their share capital with total aggregate equity rising 18.8% to SR190bn, reinforcing their already strong capital base and producing a capital adequacy ratio of 16.6%, well in excess of global standards of less than half that level.

Another interesting aspect of the Saudi banking system is the emergence of Islamic banks and sharia-compliant banking data. In recent years, not only has the bulk of retail moved towards Islamic products but much of the commercial area is also moving towards sharia-compliant product. With well established banks such as Al Rajhi expanding at home as well as abroad and new Islamic outfits such as Alinma and AlBilad, this Islamic market is opening up.

And SAMA is also now willing to provide sharia-compliant data. In 2009 total (sharia-compliant) assets reached SR472bn, up 5.8% on the previous year. This figure represents 34.8% of the Saudi banking system's total assets. What is also interesting from this new data is how profitable such sharia-compliant institutions are. The data shows net income from sharia-compliant operations was SR16bn in 2009, the same as the previous year, but a significant 61.5% share of the banking system's total net income of SR26bn.

How much sharia-compliant banking products will take over the Saudi banking system and others remains to be seen but they are clearly growing and profitable. The performance of sukuk (Islamic bonds), however, is a key issue going forward. While Richard Groves, managing director of Saudi British Bank, is positive about the growth of the sukuk market and says that sukuk are very much the same in terms of complexity as conventional bonds, different views are emerging.

Sukuk under review

In examining the Saad/AHAB case and events in the Dubai debt standstill, bankers are beginning to question the core assumption that sukuk are safer than conventional bonds because they are backed by definition by underlying assets. Some suggest that if the underlying asset supporting the sukuk is less than robust then the assumption of sukuk superiority falls apart.

While many are optimistic that sukuk will become an important part of the Saudi market, developments this year are likely to prove critical in terms of establishing their credibility and the depth of the market. Just as 2009 brought forth a sea change in examining transparency, risk management and corporate governance, this year is likely to see a continued hard re-examination of core banking principles. A new era of more modest, sustainable banking is beginning.

Meanwhile, as an indicator of the gradual recovery and growing confidence in the economy at the end of February, the Tadawul All Share Index (TASI) closed at 6437.5, a 2.96% gain on the month and a 5.16% positive return on the year to date. The TASI closed 2009 at 6121.76, a 27.46% rise on the year after a disastrous 56.49% slump in 2008. In 2009, the banks and financial services sectoral index climbed 15.29% during the year and continues to grow into 2010. The recovery in Saudi Arabia in 2010 is modest and cautious but, with strong government support and a strong banking sector in place, it looks solid and sustainable.

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