Key Features of Islamic Banking Business in the Kingdom of Saudi Arabia - Term Paper Example

Key features of Islamic banking business in the Kingdom of Saudi Arabia a) Describe the structural features of the banking market - number of banks, size of banking system, role of domestic + foreign banks, + number and size of Islamic banks The banking market in the Kingdom of Saudi Arabia is dominated by a few (less than ten) sizeable banks and several other smaller banks. Many of the larger banks have been providing a full complement of services to both businesses for their commercial needs, and individuals for their personal banking needs. The smaller banks concentrate on localized services and providing retail services for the individual sector. As of the mid-70s in line with the Saudification of the financial sector, all banks including the then Dutch (Saudi Hollandi Bank), then American (Samba Financials, formerly Saudi American, formerly Citibank), and then British (SABB). The new financial regulation required that all financial institutions be majority (60%) owned by Saudi nationals, therefore rendering all KSA banks Saudi. The following are the top Saudi banks that constitute the major players in the Saudi banking industry (BMI, 2009): National Commercial Bank, Riyad Also known as Al-Ahli Bank, the NCB was founded in 1953 with the distinction of being the first commercial bank in Saudi Arabia. In 1999 the government became its majority stock holder through the Public Investment Fund of the Ministry of Finance (NCB, 2010). Presently, NCB is the largest bank in the Arab world, with assets amounting to SAR 220 bn (about US$ 55.6 bn); a full employee complement of 5.400 people, 86% of whom are Saudi; 2 million clients served through 266 branches. NCB has expanded it branches to Beirut and Bahrain, with representative offices in Singapore, Seoul and London. The bank has fielded several alternative sharia-compliant banking services and has pioneered in the spread of Islamic banking in Arab territories as well as internationally (BMI, 2009). Riyad Bank, Riyad Riyad Bank is counted among the largest financial institutions in the Kingdom of Saudi Arabia. It boasts of a strong and expanding corporate as well as retail banking franchise, and by market value it is Saudi’s third largest lender (see Table 1 below). Its principal strengths lie in its excellence in providing the five principal banking services, which are retail banking, corporate banking, investment banking and brokerage, treasury and investment. Riyad has been aarded the highest ratings by the world’s most reputable credit rating agencies among which are Fitch, Standard & Poor’s and Capital Intelligence (BMI, 2009). Samba Financial Group, Riyad Samba Financial Group (formerly Saudi American Bank) was formed pursuant to Royal Decree dated 12 February 1980, to take over what were then the existing branches of Citibank, N.A. in Riyadh and Jeddah. These branches were opened in 1955 and 1966 respectively; in the mid 1970s, the Kingdom adopted a program wherein all foreign banks were mandated to sell majority equity interest to Saudi nationals, pursuant to which program Samba was formed. Under the program, 60% of equity interest in Samba was acquired by Saudi nationals, while Citibank retained 40%. Citibank also seconds staff to the bank and provides technical support, for no compensation other than as a shareholder and reimbursement of actual expenses, under a Technical Management Agreement. Through the years, however, and according to a transition plan earlier agreed with Citigroup, Citibank gradually divested its equity interests and management control to the Saudis. Today, Samba is fully Saudi-owned and managed. As of 2005, Samba’s capitalization was increased to SR 6 billion. Samba was the first Saudi bank to pioneer in Priority Banking (Gold & Diamond), Phone Banking, Credit Shield, Saving Linked Insurance, Cash Deposit through ATMs, Speed Cash Remittance Service and Automated Signature Verification. It is the first bank to establish a dedicated Investment Department, introduced the first local equity fund and the first fund (SAIF) open to overseas investors and listed on the London Security Exchange (Samba website, 2010). Samba has long been operating not only in Saudi Arabia but in London, maintaining a branch there for more than 20 years. In 2008, Samba has also opened up branches in the UAE and Pakistan. The company intends to strengthen its global presence by expanding to Europe, the Middle East and South Asia (Samba, 2010). Al Rajhi Banking and Investment Corp., Riyad Al Rajhi was founded in 1957, and is one of the world’s largest Islamic banks. It has paid up capital of US$ 4 billion and an employee workforce of over 8.000. Although it is home-based in Riyad, Al Rajhi has a network of more than 400 branches, plus upwards of 100 dedicated ladies’ branches, 15,000 point-of-sale (POS) terminals at merchant outlets, 1,000 ATM machines, and a reputedly large customer base that surpasses other banks in Saudi Arabia. The bank is noted for its deeply rooted Islamic philosophy and banking practices, and is credited with being instrumental in bridging the gap between traditional sharia values and customers’ contemporary needs. Al Rajhi is largely retail but plans to expand into investment and corporate banking. Its large retail base leads it to believe that it could count on government’s financial assistance if needed (BMI, 2009). Saudi Arabi British Bank (SABB), Riyad The SABB is a Saudi joint stock company established on 21 January 1978. It formally commenced operations on 1 July 1978 when it gook over the operations of the British Bank of the Middle East in Saudi Arabia. It is 40% held by HongKong Shanghai Banking Corporation (HSBC), a major multinational banking company. HSBC Saudi Arabia Limited is a joint venture between HSBC and Saudi Arabia British Bank. The joint venture company is the first full-service, independent investment bank in the Kingdom of Saudi Arabia that was licensed by the Saudi Arabian Capital Market Authority (CMA), the regulatory authority over the stocks exchanges and capital markets, under the new Capital Market Law. HSBC holds 60% of the new company and SABB holds the remaining 40%. Arab National Bank, Riyad (Arab Bank Subs.) This Saudi Joint Stock company was established in 1979 and is today one of the top 10 banks in the Middle East, with 143 local branches, 21 ladies’ sections, and one UK branch in London that was operational since 1991. ANB is proud that it is capable of delivering a full range of conventional and Islamic products and services, both in personal and commercial banking, for the domestic and international markets. It also offers it clients financial services such as consultancy and investment, mutual funds and assets management, local and international equity trading, foreign exchange, and treasury services. The bank employs 3,532 individuals, nine out of ten of whom are comprised by Saudi citizens (BMI, 2009 & ANB, 2010) Saudi Hollandi Bank, Riyad Saudi Hollandi Bank was founded in 1926 and is the first operating bank in the KSA. It was formerly known as “The Netherlands Trading Society” and located its operations in a single office in Jeddah. At the time its business was solely focused upon providing financial services to Haj pilgrims from Indonesia. Being then the only bank in the Kingdom, it also operated as a central bank, acting as repository for the gold reserves of the KSA and as recipient of oil revenues on behalf of the Saudi Arabian government. In 1928, the bank assisted the government of then King Abdulaziz in launching its first independent local currency, the Saudi Riyal. In 1969, the ABN also became the model for other foreign banks in the Kingdom during the implementation of the Saudisation initiatives set forth by the SAMA (Saudi Arabian Monetary Agency). Branch networks have now expanded to Riyadh, Jubail, Makkah, Hofuf, Madinah, Qatif and other regions (SHB, 2010) In 2007, a bank consortium including the Royal Bank of Scotland, Banco Santander, and Fortis had made an acquisition of ABN AMRO, and, consequently, 40% shareholding in Saudi Hollandi Bank. The following year, two consortium members, namely the Royal Bank of Scotland and Fortis, received a capital infusion from their respective governments. Ultimately, the Saudi Holland Bank is held indirectly by the British and Dutch governments as minority shareholders, while 60% continues to remain within the hands of Saudi Arabian investors. The SHB. It has a paid-up capital of SAR2.6 billion, employs 1,721 personnel out of whom 86% are Saudis, operates 43 branches, eight ladies’ sections, 22 preferred banking centres with 201 ATMs scattered throughout the KSA (BMI, 2009). There are a host of other, smaller, banks that concentrate on retail banking for the private sector. For the sake of enumeration and to get a view of the industry’s structure, they are enumerate here as follows: Al-Akami bank, Riyad Al Bank Al Saudi Al Tejari Al Muttahed, Dammam Faysal Islamic Bank of Bahrain, Jeddah International bank, Riyad Islamic Development Bank, Jeddah Saudi Arabian Agricultural Bank, Riyadh Saudi Cairo Bank, Riyadh Saudi Development and Industrial Corp., Riyadh Saudi French bank, Riyad Saudi Investment Bank, Riyad Saudi United commercial bank, Riyad United Saudi Bank, Riyadh Western union, Jeddah World Bank, Riyadh In the table following are the financial highlights of the banks. It is evident that asset-wise, lending, total deposits and total shareholder’s equity, the government-owned and supported National Commercial Bank leads the other major players. Saudi Hollandi is the smallest although it may by history be the most closely linked to the development of the KSA financial sector. Table 1: Financial highlights of the major banks in Saudi Arabia Sources: BMI, 2009; NCB, 2010; SABB, 2010; SHB, 2010, Samba 2010) b) Explain what type of business the Islamic banks performs, who they compete with, whether they have grown or lost market share + their performance Islamic banking used to concentrate, as a class in itself, on personal banking products directed at the retail market. However, due to increasing demand from corporate clients in the Arab world, more and more commercial services directed at the corporate financial needs have been gradually developed. With a strong slant towards real value, aversion to speculation, and ban on interest, all in the interest of remaining sharia-compliant, Islamic banks have been able to emerge from the US subprime-mortgage cum financial crisis relatively unscathed, if not for the reduced volumes of transactions due to the secondary economic effects of the financial debacle. Among the product commonly offered by the major banks (NCB, 2010) are the following enumeration of financial products and services: 1. Personal banking – Individuals’ banking needs for personal purposes a. Accounts (savings, checking, etc.) b. Credit/payment cards b. Home finance c. Savings and investment d. Banking services e. Money transfer f. SADAD service 2. Wealth and asset management – Tailor-made investment products for individuals and business firms, including both investment advisory and brokerage services a. Mutual funds b. Wealth management c. Brokerage services d. Investment services 3. Business banking – From corporate and small business banking that meets specific banking needs of different businesses. a. Treasury services b. Cash management c. Hedge funds 4. Private banking – Personalized wealth management, investment consultancy and brokerage services a. Asset allocation b. Financial planning c. Investment center According to the Islamic Banking Overview prepared by the Business Monitor International (BMI) Saudi Arabia Commercial Banking Report for the first quarter of 2010, it is expected that Islamic banks “will perform in line with, or slightly better than, their conventional counterparts” (p. 24). This observation reflects a growing sentiment, even among conventional bankers, that the relatively risk averse, speculation averse position of Islamic banks would present an appropriate alternative to the traditional banking system. Stated a different way, Islamic banking will prove a strong competitor to conventional banking, encroaching upon the latter more than the latter posing a competitive threat to the former. Islamic banks’ high capital adequacy ratios put them in a highly advantageous position in comparison with the established Western banks. As a group, there is every indication, though not yet evident now, that when economic recovery does take place, Islamic banks will be capturing rather than giving up their share of the market for financial products and services. In the Kingdom of Saudi Arabia, in particular, the Saudification of banks ensures that the local banking industry is protected from the entry of not only Western conventional banks but also Islamic banks based in other Arab countries, because of the need to comply with the 60% Saudi ownership requirement. Foreign banks were allowed access into the Saudi market in 2002 but account for a low proportion of the retail banking market. Their main activity has been in the area of project financing; this has gradually been reduced as foreign banks devoted more attention to the crisis in their markets (Al Jasser et al., 2009). It is therefore evident that any source of market competition will be generated from within the country, from other local banks. However, because of expressed interest to expand to other countries, the expanding market is not expected to create any incentive for consolidation any time soon. Following is the table of comparative performance among the major Islamic banks in the Gulf Cooperation Council (GCC) region. Despite the relative safety of Islamic banking, several banks have shown substantial losses, mainly due to exposure to the Madoff Ponzi scheme in the US and the bad debt issued by the Saad or Gosaibi groups in the second quarter of 2009, in combination with domestic non-performing loans (NPLs) (BMI, 2009b). From Table 2 below, however, the three major Saudi Arabian banks all emerged with modest gains, attesting to the relative stability of their portfolios despite other Islamic banks having succumbed to the risks. Table 2: GCC Banks’ Financial Results, 2nd Quarter 2009 (BMI, 2009b) c) Outline the future prospects for Islamic banking in the country and where possible identify any unique features of the system under study The future prospects for Islamic banking, though much subdued from the pre-crisis era, is nevertheless much more optimistic than the toxic-asset-riddled, massively bailed out financial institutions of the West. Theoretically, the high capital adequacy ratios on Islamic banks’ balance sheet puts them in an excellent competitive position to take advantage of lending opportunities in light of the global economic recovery. What is apparently holding it back is the limited financing options and an innate conservative banking philosophy which, while not averse to growth, necessarily limits the rate of growth (BMI, 2010). There are many developments which, according to the banks themselves, they perceive as threats to the banks’ growth in this challenging environment. These threats include slower economic growth due to the recession; the lower price of oil, upon which much of their business is built; and, for the likes of NCB, the need to privatise in an increasingly competitive industry. While more Islamic banks come on board, and as Western banks proceed to add Islamic banking windows in their operations, cost efficiency and product innovation to capture the non-Muslim market will increasingly become definitive of successful banking operations. Banking product innovation has been the concern of Saudi Arabian economic planners for several years. The viewpoint from Muhammad Al Jasser, Governor, Saudi Arabian Monetary Agency; and an interview with Eisa Al Eisa, Managing Director & CEO, Samba Financial Group, expresses optimism for the new mortgage law to be passed anytime soon as the major regulatory change expected in the near future. The law is much anticipated because it may potentially unlock pent-up demand (Al Jasser et al., 2009). Regulation is performed by the Saudi Arabian Monetary Agency (SAMA) which acts as Saudi’s central bank, and which is expected to modify regulatory standards and procedures to take into account the new mortgage law when it is promulgated and takes effect (Al Jasser et al., 2009). On the matter of the industry’s performance in the light of strict regulation, compared regionally and internationally, the Saudi banking sector appears relatively robust; total domestic assets reached $347 billion at the start of 2009, which indicates a 21% annual growth. However, there has been a contraction in lending since November 2008 due to higher risk sensitivity since the US financial crisis. The drop in loans is partly due to the delay in some local projects and financial plans pending the return of a more stable economic environment. As a sector, the loan-to-deposit ratio has declined from a high of 91% in 2009, and is now barely 85%, SAMA’s statutory minimum limit (Al Jasser et al., 2009). There are significant opportunities to be explored, particularly in massive government infrastructure projects and the consumer sector which remains “under-banked,” both prospects of which appear unaffected by the uncertainties of the financial crisis (Al Jasser et al., 2009). Alternatively, are other financial services other than the principal banking function that may be developed for the broader market. In a round table interview with Abdullah Sulaiman Al Rajhi, Managing Director and CEO, Al Rajhi Bank; Abdulmohsen Al Fares, CEO, Alinma Bank; and Khalid Al Jasser, CEO, Bank Albilad, it was commented that in Saudi Arabia and the GCC region in general, there has been a growing trend towards sharia-compliant financial products and services, even before the crisis called attention and interest to the relative risk averseness of these products. In Saudi Arabia, there is a dominance of Islamic products, such that local conventional banks and several foreign banks have opened Islamic windows (Al Rajhi et al., 2009). As it presently is, Islamic financial products and services are generally more expensive and more difficult to implement than the conventional financial services and products. This is because the latter are more efficient for having evolved for over two centuries, while the former have only been operational for the past five to seven years. More recently, Islamic financing options, derivatives and mortgage products are being developed in order to more closely bridge the gap between the benefits of one compared to the other. The new mortgage law in 2010 is expected to facilitate this development (Al Rajhi et al, 2009). Conclusion The field of Islamic banking despite having been affected by the economic recession, is nevertheless poised to take advantage of the weakness in the conventional banking industry. Saudi Arabia, in particular, appears particularly robust compared to Islamic banks in other Arab countries. The major Islamic banks in this country will do well to gear up towards greater cost efficiency and more innovative products, particularly in the commercial banking services area, in order to capture the broad Western corporate market for financing. The direction for these financial institutions will be towards expansion to other Muslim countries even to the Western non-Muslim countries, and may necessitate tie-ups and joint ventures with conventional banks that wish to set up an Islamic banking facility. References Al Jasser, M & Al Eisa, E interviewed by Oxford Business Group 2009. Accessed 28 February 2010 from http://www.oxfordbusinessgroup.com/publication.asp?country=44 Al Rajhi, A; Al Fares, A; & Al Jasser, K interviewed by Business Group 2009. Accessed 29 February 2010 from http://www.oxfordbusinessgroup.com/publication.asp?country=44 Al Rajhi Bank 2010 About Us. Accessed 3 March 2010 from http://www.alrajhibank.com.sa/pages/default.aspx Arab National Bank (ANB) 2010 Accessed 3 March 2010 from http://www.anb.com.sa/default.asp Business Monitor International (BMI) Ltd. 2009a Saudi Arabia Commercial Banking Report, 3rd Quarter 2009, pages 50-58. Accessed 28 February 2010 from http://www.the-saudi.net/directory/banks.htm Business Monitor International (BMI) Ltd. 2009b Middle East Banking Sector Outlook, Q2 2009. Accessed 28 February 2010 from EBSCO Journal Search Business Monitor International, Ltd. 2010 Saudi Arabia Commercial Banking Report Q1 2010. Accessed 5 March 2010 from EBSCO Journal Search. HSBC Saudi Arabia Limited 2010 About Us. Retrieved 2 March 2010 from http://www.hsbcsaudi.com/About_Us/about_us_en.shtml National Commercial Bank (NCB) 2010 Financial Reports for 2008. Accessed 2 March 2010 from http://www.alahli.com/en-US/About%20Us/News_Reports/FinancialReport/Pages/Financial%20Reports%20Archive.aspx Samba Financial Group 2010 About Samba. Accessed 2 March 2010 from http://www.samba.com/ENGLISH/Common/HTML/ABOUTSAMBA_01_05_EN.HTML Saudi Hollandi Bank (SHB) 2010 Accessed 3 March 2010 from www.shb.com.sa The Saudi British Bank (SABB) 2010 Accessed 5 March 2010 from http://www.sabb.com/home/home_en.shtml Read More