Despite the threat of war in Iraq and the global economic slowdown Saudi Arabia's financial sector has bucked worldwide trends and produced another year of record growth and profitability. Not only did most banks produce impressive results in 2002, but also the recent privatisation of 30% of Saudi Telecom was a huge success and at $3.7bn was the second largest initial public offering (IPO) in the world last year.
This IPO, the imminent new capital markets law and the prospect of further large privatisations have boosted optimism in the already buoyant sector - and many bankers believe 2003 could be another excellent year. War in Iraq could change all that. But the atmosphere in Riyadh in early March was far from despondent. For bankers, many of whom had dealt with the ramifications of previous Gulf wars, it has been largely business as usual with consumer finance booming and the prospect of new capital markets business tantalisingly close. A long drawn-out war was clearly seen as potentially damaging but, that apart, the outlook was viewed with equanimity. A country with 23.4 million people, 65% of whom are under 21 years old, cannot stand still. And while bankers were naturally concerned by the implications of a US-led invasion of neighbouring Iraq, they were also focused on the new opportunities available in the kingdom.
Downplaying any significant negative impact from Iraq, Abdulhadi Shayif, general manager of the country's biggest bank, National Commercial Bank (NCB), says: "Everything being equal, we could have a better year in 2003."
Underlining the positive attitudes is the simple but true analysis that the Saudi economy tends to grow on the back of high oil prices and abundant liquidity. Saudi American Bank (Samba) chief economist Brad Bourland explains: "Saudi economic performance was strong in 2002. Oil revenues were the highest in 20 years, the private sector had robust growth, consumer borrowing and spending were high, the government's actual deficit was smaller than projected in the budget, trade balances were strong and the stock market rose.
"Driving the strong performance were high oil prices and low interest rates, which combined to create abundant liquidity – money supply grew by 13%, more than double the average growth rate, and inflation was nil. In addition, Saudis spent more money at home as they curtailed their usual summer and business travels to Europe and the US," he says.
The oil factor
Oil is critical to the health of the Saudi economy and 2000, 2001 and 2002 have been the three best years for oil revenues since the oil boom ended in 1981. In 2002, Saudi oil prices averaged $23.7 a barrel, according to Samba, well above the government's budgetary expectation of $17 a barrel. With high prices and production approaching eight million barrels a day (b/d) at year-end, oil revenues for 2002 were estimated at $65bn, $1.5bn more than 2001.
This year, prices have remained high on the back of fears over Iraq and Venezuela. Analysts believe prices will stay high initially, falling back as and when tensions ease later in the year. Apart from unforeseen dramatic circumstances, analysts forecast a price averaging $22 a barrel this year on average production of eight million b/d, producing revenues not radically different from 2002. The war's actual impact on prices and revenues, however, remains to be seen. Samba, nevertheless, forecasts 5% real growth in the oil sector this year, a strong 4% growth in the private sector and a 1% growth in government, combining together for an overall forecast for real GDP growth this year of 3.8%, well up on 2002 growth of less than 1%.
Showing confidence in the economy, the deputy governor of the Saudi Arabian Monetary Agency (Sama), Jammaz Al-Suhaimi, is optimistic that the banks will have a good year in 2003. Speaking to The Banker, he notes that consumer finance contributed significantly to the banks' performances last year, and those trends and improved liquidity are expected to continue. On the successful Saudi Telecom flotation, which attracted 920,000 Saudi subscribers, he notes: "The IPO represented a significant vote of confidence in the equity markets and in the economy."
Mr Al-Suhaimi is also bullish about the prospects for the long-awaited Capital Markets Law. Having passed the Shura Council, the legislation is now in its final stages before the Council of Ministers and he expects it to be passed in the next few weeks. "The new law will provide a boost for the financial sector, allowing more private sector companies to join in the capital markets, strengthening the IPO market within the right regulatory framework."
Bankers are enthusiastic about the potential. Mike de Graffenried, managing director of Samba, says: "Saudi Telecom was the ice-breaker, the new law will help to jump-start the economy through privatisations and open up the markets to a wider shareholder base. At present, far too much financing is done through the balance sheets of the banks; the capital markets law will redress this and the structure of bank earnings will change."
Alhassan Goussous, head of investment services at Saudi British Bank (SBB), agrees. "It is a virgin market with lots of opportunities, one of the few large markets in the world where investment banking has not been developed to the degree it deserves," he says. He and others believe that many companies are hitting their borrowing limits at the banks and for them and the economy to grow, bond markets and commercial paper markets need to be developed along with enabling companies to make IPOs.
Privatisation desires
The government has recently declared that there are 20 sectors it wants to privatise. Many areas, such as hotels, should be relatively easy to sell and attractive to investors. Bankers note that the Public Investment Fund (PIF) holds $30bn of investments on behalf of the government, including a 70% stake in the NCB, so there is a lot of business to be done.
The new law will also help in the securitisation of assets, such as the rapidly expanding area of mortgages. Some banks, such as Riyad Bank, SBB and Al Rajhi Banking & Investment Corp, have recently introduced mortgage products. Given the demographics of the country, there is huge demand for housing finance. Given the need to fund mortgage lending, Riyad's chief executive, Talal Al-Qudaibi, believes there are huge opportunities in setting up specialised funds (mortgage and real estate funds) through securitisation, thus creating space for more mortgage funding, and also valuable investment vehicles that work well for Islamic investors. In the same way, bankers believe the leasing mechanism, which is a critical tool of Islamic banking, has enormous potential in freeing up bank balance sheets and providing new investment products. One enthusiast notes: "Leasing could change the economy of Saudi Arabia."
Growth is strong
Unlike many countries, the Saudi banking sector continues to demonstrate strong growth in most areas, with net income for the 10 major banks growing by 6.4% in 2002 to SR10.7bn ($2.9bn), producing a healthy return on equity of 21% across the sector. The overall picture shows an 8% growth in total assets to SR499bn with the combined loan portfolio expanding by 13.6% as a result of the rapid development in consumer finance. Deposits showed steady growth of 8%.
The key to the consumer lending boom has been the ability to assign salaries to banks, thus mitigating risk for the banks and easing the process for customers. The regulator, however, has been careful not to give banks unlimited access and has imposed a limit on how much salary can be assigned. Fahd Al-Mufarrij, Sama's director of banking supervision, notes that banks' assignments cannot exceed 33% of salary and banks can be fined if they are in excess. With its characteristic conservatism and tight regulation, Sama is unlikely to let the retail finance boom get out of control.
The kingdom's largest bank, NCB, produced a record 26% increase in net profits in 2002 to reach SR2.4bn and has at last resolved some longstanding shareholder issues. Chairman Sheikh Abdullah Bahamdan announced that the PIF had recently purchased the remaining shareholding of the bin Mahfouz family (30%) bringing the total government ownership to 80% with the remaining 20% held by 24 private investors. The sale of the bin Mahfouz holding for a reported $1.8bn should end the embarrassing lack of full disclosure of the NCB accounts in recent years and should pave the way to the bank's eventual privatisation. Benefiting from rapid growth in consumer and Islamic banking, NCB's total assets also increased by 9% to SR107bn.
Despite the overall increase, two of the largest banks, Samba and Al Rajhi, suffered declines in net profits of 17.5% and 8.4% respectively. While both banks still retained acceptable return on equity ratios of 20.8% and 17.4% respectively, according to Mr de Graffenreid, Samba "took a lot of reserves", experienced a decline in net commission income and, unlike other banks, a fall in customer deposits. The US's Citibank also reduced its stake in Samba from 22.8% to 20% for what were described as "purely financial transaction" reasons.
Aggressive strategy
Al Rajhi, known as the "people's bank", again suffered from low interest rates and reduced operating income. Nevertheless, it boosted customer deposits by 20.4% and general manager Abdullah Sulaiman Al Rajhi believes the bank's better customer service and better product delivery are producing better results. The bank is working on a wide-ranging customer relationship management project with consultants Booz Allen and Mr Sulaiman hopes to offer a broader range of insurance products when details of the new insurance law are available.
Riyad Bank, which has a 14% market share, is embarking on an aggressive growth strategy focusing on selected market segments, says CEO Talal Al-Qudaibi. Riyad posted a 4.8% increase in net profits to SR1.4bn with steady 7.2% deposit growth but assets remained flat at SR67.2bn.
The best performances were largely among the medium-sized banks. Arab National Bank (ANB) led the way with a 20.2% increase in net profits, which reflects the turnaround at the bank in recent years and its strong and steady improvements in all indicators. CEO Nemeh Sabbagh is keen to point out that ANB's provisions to non-performing loan coverage ratio has now reached 100%, double what it was in 1999, and it has the best performing investment funds in the market.
Banks of a similar size, SBB and Banque Saudi Fransi, also had good years with 17.2% and 20.1% growth in net profits respectively. Both also showed strong growth in consumer lending and SBB had particular success in handling the complex IPO for Saudi Telecom, which is likely to be the trend-setter for further such deals.
Investment banking could be another growth area as Saudi banking takes on new dimensions. Four foreign banks, Bahrain's Gulf International Bank, Emirates Bank International, National Bank of Bahrain and National Bank of Kuwait, are now licensed to operate in the kingdom and more Gulf banks are expected to join them. The presence of these four is modest at best but the capital markets law could change that and help to facilitate a range of new players. For example, SBB's managing director, David Hodgkinson, says: "We are in discussions about a possible joint venture with HSBC on the areas that would be covered by the capital markets law." A joint venture with SBB's existing shareholder HSBC, which provided research assistance on the Saudi Telecom deal, could provide the necessary expertise to give the capital markets development real bite. Samba had considered a similar venture with its partner, Citibank but decided against it for the moment.
New dimensions
The new law raises the prospect that investment bankers wanting to do business in the kingdom may need to be registered or licensed. This could put an end to decades of 'briefcase bankers' visiting the kingdom and could change the game considerably for those wanting to operate out of Dubai, for example.
While the growth in consumer banking, the Saudi Telecom deal, the capital markets law and the current state of the Saudi economy give bankers reasonable cause for optimism, there are also a number of negative factors underpinning the way forward. Decision makers do not need to be reminded of the Iraq crisis, the high unemployment rate and the various political uncertainties facing the House of Saud. There are clear dangers ahead, both internally and externally. But the prospects for the financial sector in the short and medium term are remarkably good.
