Saudi Arabia’s banks are in excellent health, despite grappling with a complex mix of pressures linked to the country, reforming economy. Cooler economic growth and the departure of foreign workers continues to weigh on the domestic market, contributing to suboptimal demand for credit. In tandem, a relatively sluggish corporate sector and low rates of foreign direct investment have done little to ease the broader environment. These challenges, and others, offer difficult operating conditions for Saudi lenders.
Even so, the banking sector’s profitability is strong, capitalisation levels are high and liquidity buffers are healthy. Several factors account for this relative disconnect between the performance of the banks and their operating conditions. For one, rising interest rates have improved margins, as the Saudi Arabian Monetary Agency responded to US Federal Reserve rate hikes in 2018. On the other hand, Saudi banks are benefiting from a lower cost of risk as asset quality improves.
More significant, however, is the fact that Saudi banks are pushing forward with innovative new products, services and back-office processes, by adopting digital solutions and tapping into under-served market segments such as home finance, to drive their performance. Taken together, this is a story of impressive stewardship by the country’s leading financial institutions and one that is mirrored in their 2018 performance.
Samba leads growth charge
Samba Financial Group, currently Saudi Arabia’s third largest lender by assets, achieved a record net profit of $1.47bn for 2018. “Samba’s excellent financial performance during 2018, which resulted in the highest ever profit by the bank, is a testimony to its long-term strategy to build diverse sources of income, and optimise investment opportunities in the market in line with Samba’s potential, capabilities and balance sheet strength,” says Rania Nashar, chief executive of Samba Financial Group.
Indeed, Samba posted a gain of 7.3% to its net special commission income, 3.4% to its operating income and a 9.9% expansion to its net income just as operating expenses dropped by 8.4% over the year. Ms Nashar pins this success on the bank’s strategy, which prioritises innovation, income diversification and investments in state-of-the-art banking technology. “We are striving to consolidate our leadership position within the local and regional banking industry, which has been built over the past decades,” she says.
Al Rajhi's stellar year
But Samba is by no means an outlier. Al Rajhi Bank, which is Saudi Arabia’s second largest lender by total assets and the largest fully sharia-compliant bank in the world, also enjoyed a stellar year of growth. Net profits jumped by close to 13% with total operating income growing by 8.9%, driven by a rise in special commission and net investment income. This performance builds on Al Rajhi’s multi-year success story since the lender implemented a new strategy covering 2015 to 2020, emphasising growth in key market segments and a focus on the customer and digital leadership, among other key pillars.
“We have managed to outperform the market in recent years across a broad range of metrics. This is largely due to the successful implementation of [our strategy],” says Steve Bertamini, chief executive of Al Rajhi Bank.
In common with other Saudi lenders, Al Rajhi Bank has prospered from the country’s housing development drive. Under the government’s Vision 2030 ambitions, a massive push is under way to encourage private home ownership. This has seen regulatory changes introduced to stimulate bank lending in this domain, including higher maximum loan to values for first-time buyers (increased from 85% to 90%) and an easing of risk weights for residential mortgages (to 50% from 75%).
“The growth of the housing sector continues to be a bright spot for the wider economy. But home financing is still relatively under-represented in the Saudi banking system. There is a lot of growth potential in this segment and Al Rajhi Bank has been very active on this front,” says Mr Bertamini.
“As a bank, we started to focus on mortgages in late 2015 and in that time we have really enhanced our processes. We have the fastest turnaround time in the market, our service level is excellent and we are trying to become the mortgage adviser that people want to turn to,” he adds.
A consolidatory mood
As Saudi banks look ahead to the challenges and opportunities linked to the Vision 2030 reform programme, change is in the air. For the first time in decades, the country’s banking system is experiencing consolidation through the almost-complete tie up between the Saudi British Bank (SABB) and Alawwal Bank. The merger is expected to be finalised in the first half of 2019.
Once complete, the bank will be Saudi Arabia’s third largest lender with about $71bn in assets. All of Alawwal Bank’s assets and liabilities will be transferred to SABB and David Dew, SABB’s current managing director, will lead the combined group under the existing SABB brand. “The merger with Alawwal Bank will bring scale and efficiency. Scale in the sense that we will have a 50% larger balance sheet, which will give us a bigger underwriting capacity to support larger customers,” says Mr Dew.
Indeed, as Saudi Arabia’s Vision 2030 programme unfolds, banks with larger balance sheets will be required to support the scale of its various projects and initiatives. As the new SABB will boast a 12% market share in terms of assets, according to research from rating agency Moody’s, it will be in a much better position to leverage its strong corporate banking proposition with that of Alawwal Bank, to secure a greater magnitude of business in future.
“Large initiatives emerging as a result of the Vision 2030 reforms will benefit from banks that have greater underwriting capabilities,” says Mr Dew. “The merger will be transformative for the Saudi banking system.”
SABB and Alawwal Bank are not alone in this endeavour. In December 2018, National Commercial Bank (NCB), Saudi Arabia’s largest lender, and Riyad Bank announced that they had entered into preliminary and non-binding merger discussions. If this transaction is executed it would create a banking behemoth with total assets of $179bn. This would position the lender on a similar tier, in terms of its size, with some of the Gulf region’s mega-banks.
One financial executive in Riyadh, speaking on the condition of anonymity, indicated that at least part of the impetus for the deal lies in the Saudi government’s ambitions to develop the country’s regional and global brand through institutions of scale. NCB and Riyad Bank have a common shareholder – Saudi Arabia’s Public Investment Fund – making the prospect of a deal easier.
Chasing innovation
Beyond consolidation, other trends are also shaking up the Saudi banking system. This includes the deployment of digital technologies to support product and service offerings, as well as back-end processes. On this front, Saudi lenders are at the vanguard of regional, and in some cases global, innovation. These trends can be detected in Saudi banks’ cost-to-income ratios: the sector-wide average was 36% in September 2018, according to research from Moody’s.
“[This reflects] the banks’ low cost base [and] their extensive use of automation and alternative distribution channels, such as internet branches and their ability to cover the market with a limited number of branches,” says Ashraf Madani, vice-president and senior analyst at Moody’s.
For its part, Samba Financial Group is investing in key initiatives across the domains of payments, artificial intelligence, robotics and a new core banking system. These emerged as a result of the lender’s enterprise architecture review, which led to a roadmap designed to make the bank more agile and modern, with cloud-ready infrastructure and peerless customer services. One function of this roadmap is the development of a new payments hub. “The need for a payments hub is driven by having a flexible platform that enables us to build our own payment services that can integrate with multiple systems and channels, essentially breaking down the silos of the legacy structure,” says Ms Nashar.
“We are looking at options that will enable us to carry out cross-border payments by streamlining global payments, have effective liquidity management and cashflow forecasting, assist with preventing fraud and financial crime by monitoring user behaviour and tracking payments, and [ensuring that] reconciliation becomes easier,” she adds.
Meanwhile, Saudi Arabia is emerging as a leader in the field of artificial intelligence and robotics. Al Rajhi Bank, in particular, has assumed a pioneering position among the country’s banks in this area. “Al Rajhi Bank is the largest user of robotics in the Middle East. We have 253 operational bots and they are doing up to 21,000 transactions per day across 52 different processes in the bank. We keep expanding their use,” says Mr Bertamini.
He says the next step in the evolution of the bank’s bots is to optimise tasks between them. This means that, instead of dedicating a single task to each bot, they can work between multiple functions at the bank if they are free and have the capacity to take on other tasks. “In terms of productivity, efficiency and error reduction, employing bots is game changing. I think people underestimate their utility,” he says.
Blockchain potential
Blockchain is another domain in which Saudi lenders are making progress. In the case of Al Rajhi Bank, which was the country’s first financial institution to execute a blockchain transaction, the bank has moved from intra-business blockchain transactions with its Jordanian unit to exchanges with third-party lenders in Kuwait. Now, Al Rajhi’s ambition is to scale up the use of blockchain with its correspondent banks.
SABB too is eyeing blockchain’s significant potential in the arena of trade finance. “We are the leading trade bank in the country and we think global trade and global trade finance are going to undergo a technical revolution. A lot of what happens in trade finance hasn’t changed in 100 years,” says Mr Dew.
In late 2018, the bank became the first Saudi institution to join the global R3 blockchain ecosystem. R3 bills itself as an enterprise blockchain software firm that works with more than 200 members and partners around the world. The Saudi Arabian Monetary Agency has also embraced blockchain technology by signing an agreement with US-based fintech group Ripple in February 2018.
Ready for transition
As Saudi banks look to the future, they have every right to be optimistic. Though conditions are likely to remain relatively subdued in the short term, the government’s 2019 budget is expansionary and should provide a boost to credit demand nationally. Meanwhile, broader reforms – particularly those linked to privatisation – are expected to accelerate in 2019 and 2020, after a few years in which there has been little meaningful change. Among other things, this will deliver substantial business opportunities for Saudi banks.
“We are now beginning to see a number of structured financing opportunities for private sector investors resulting from government initiatives based on the public-private partnership and privatisation format within several key sectors, including water and power, infrastructure and commercial real estate. We anticipate such opportunities to set the tone for many more to come in the future,” says Samba’s Ms Nashar.
Well managed and tech savvy, Saudi banks are in an excellent position to deal with the challenges and opportunities of an oil-dependent economy in transition. As consolidation and technology begin to reshape the sector in new ways, Saudi banks have every opportunity to emerge from decades of localism to become genuine regional champions.
