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17 July 2024

Saudi banks to face radical laws

By Bhaskar Raj


The Saudi Arabian Monetary Agency (Sama) has designed new rules to foster competition in the financial sector in accordance with the government’s new policy.

Among them, a law has been issued mandating segregation between commercial and investment banking activities, compelling most of the main operators to launch separate units. In the short term, this will probably lead to a radical change in the market structure with banks competing to maintain their investment market share, said a sector study by UAE-based investment bank Shuaa Capital.

Increasing competition could threaten banks relying on this critical business line and tighten their non-interest revenues going forward. However, most subsidiaries will probably remain under full ownership and control of the banking parent, said the report Vision 2008.

Among GCC countries, the Saudi Arabian banking sector is the second-largest in terms of total assets at SAR 998 billion (Dh979bn) as of September 2007, right after the UAE with Dh1,064bn in assets. The industry comprises 12 local commercial banks, 10 of which are listed on the stock market – Tadawul.


In the first nine months of 2007, almost 50 per cent of the industry’s operating income was generated by non-interest revenues. These include income generated from commercial and investment banking as well as asset management and IPO-related revenues. The large contribution of this category emphasises the strong reliance of Saudi banks on non- interest-related activities. Despite the key role the banking sector plays in the domestic economy, loans and deposits stood at 40.3 per cent and 49.6 per cent respectively of the estimated GDP in September 2007, making them one of the lowest ratios in the region.

It also puts emphasis on the high GDP levels recorded by the kingdom, which has been recording large budget surpluses buoyed by high oil revenues. However, a favourable macro economic environment and strong performance of the local stock market, prior to the 2006 crash, has resulted in high consumer expenditure and, consequently, enhanced lending activity. “We expect deposits to grow by 19 per cent in 2007 following sustained high oil revenue surpluses,” said Shuaa’s report.


The banking sector liquidity, although capped by Sama’s 85 per cent legal maximum requirement, is likely to tighten due to conjunction of stock market recovery and surge in financing needs.

Banking concentration in Saudi Arabia is moderate as the Herfindhal-Hirschman Index (HHI) stands at 12 per cent. The higher the HHI percentage the more concentrated the sector. The four largest banks held 59 per cent of total assets of the sector in the first nine months of 2007, establishing their leading position in the Saudi Arabian market.

With total assets worth SAR 192bn, NCB was at the top of the list, followed by Samba Financial Group (SAR141bn) and Al Rajhi Bank (SAR125bn).

In addition to the 7,150 ATMs and 59,537 points of sale available in the country, access to banking products and services in the kingdom is provided through a network of 1,340 branches.

Seen against total population, this represents a relatively low penetration rate of one branch for more than 18,000 people. In this context, and given the growing population eligible for banking products and services, holding a large and modern distribution platform (including online banking) will represent one of the major competitive advantages for banks in securing market share in the future.

Total claims to the private sector reached SAR548.2bn as of September 2007, compared to SAR476bn as of December 2006, driven by a strong growth in consumer loans and sustained corporate lending activity.

Breakdown of loans by sector highlights the predominance of the miscellaneous category (which includes consumer loans and credit cards), accounting for more than a third of total private sector credit in the third quarter of 2007.

As for loan portfolio quality, the average non-performing loans/total loans ratio showed a slight decrease in 2006 which, considering the strong growth in lending activity, does not seem to be a sustainable trend. Most Saudi banks are adopting an over provisioning policy that can be considered excessive as it implies lower reported returns for the system.


Totalling SAR24bn in September 2007, Saudi banks’ aggregated net profit is expected to decrease in 2007, mainly due to the negative impact of lower stock market-related income.

In 2008, the growth in bank assets, the increase in lending driven by upcoming mega projects, and lower interest rate environment are likely to help improve core banking activities and net special commission income. Return on assets and return on equity amounted to more than four per cent and 38 per cent respectively in 2006, significantly outperforming regional peers.

Thanks to its ample capital base, the Saudi banking industry enjoys a high capital adequacy ratio (CAR) of almost 20 per cent compared to a minimum regulatory requirement of eight per cent. This relative overcapitalisation highlights the comfortable position that the sector is in to secure coverage of commitments and contingencies. Most banks have increased their paid-up capital during the first nine months of 2007, mostly by issuing bonus shares for an amount totalling SAR19bn.

As a consequence, statutory reserves will have to be strengthened by a minimum of 25 per cent of net income, in accordance with the Banking Control Law of the kingdom. The report has warned that distributed earnings will be falling.

Like other GCC countries, Saudi Arabia moves its interest rate in step with the US Federal Reserve rate.

The Saudi Interbank Offered Rate (Saibor) went down 91 basis points (bps) year-on-year to 4.03 per cent as of December 2007, after the Fed cut rates three times in 2007. Saibor currently stands below Libor by 25 bps. While declining repo and discount rates are likely to fuel up the domestic economy, Saibor looks set to fall by 25 bps in 2008.


Fees and commissions (including banking, asset management, brokerage and investment banking) are one of the main components of Saudi banks’ operating income, accounting for 29 per cent of total income in 2006. As the bulk of stock market related activity is operated by banks or their specialised subsidiaries, the steep plunge in value traded on Tadawul by 56 per cent year-on-year to Dh2,004bn in the first nine months of 2007 directly hit banks’ fee income level.

It decreased from SAR12.9bn in the third quarter of 2006 to SAR7.1bn in the corresponding period in 2007, lowering its share to 19.7 per cent of operating income against 33.2 per cent in the previous year.

The Shuaa report estimates brokerage fees in the first nine months of 2007 to have totalled SAR4bn, slightly more than half the fees recorded during the same period previous year (SAR9bn).

As for IPO-related revenues, the overall performance was sustained by increasing initiations – a total of 19 IPOs up to September 2007 (total value of SAR14bn) compared to seven IPOs up to September 2006 (total value of SAR 8bn).

IPO-related revenues for banks, which still dominate IPO management in Saudi Arabia, have increased from SAR118m to SAR208m.

“The volatility in fee revenue reflects high sensitivity of bank revenues to stock market-related business, hence, the need to strengthen core banking activities,” the report said.

As local banks establish their own units to comply with Sama’s requirement, their competitive advantage will mostly rest upon maintaining privileged business relationships with important clients (both private and public) enabling them to attract large cash flows.

Merger opportunities

Saudi Arabia currently hosts the lowest number of banks in the GCC, which has led to an involuntary oligopoly of financial services. As fewer banks on the market reduce competition and increase price pressures on customers, a consolidation move in the Saudi industry, will not be encouraged. However, given parameters indicate an alternative consolidation drive outside of Saudi Arabia could be a more likely scenario.