How Saudi Arabia’s banking system is building a solid future

Saudi Arabia was the world’s fastest-growing among the ‘Group of 20’ (G20) countries in 2022, as sweeping reform momentum, a sharp rise in oil prices and improving economic conditions boosted the kingdom’s fiscal and external position. Overall GDP crossed the $1tn mark for the first time in the country’s history last year – the highest among G20 economies.

Despite Saudi Arabia’s reliance on oil and gas – which accounts for 70 per cent of the country’s total goods exports and total revenues – the government is leaving no stone unturned in its economic diversification strategy.

“The authorities’ continued implementation of Vision 2030 policies will help diversify and liberalise the economy and thus pave the way to more stable growth,” the International Monetary Fund said in November last year.

Since the launch of the National Transformation Program in 2016, the Gulf state has undergone a speedy economic transformation with a strong focus on foreign direct investment, tourism, technology and the financial services sectors.

The financial services sector is the lynchpin of Vision 2030, Crown Prince Mohammed bin Salman Al Saud’s economic blueprint to drive growth across non-oil sectors.

Saudi Arabia is building mega projects in the middle of the desert from scratch and bank lending has been driven almost exclusively by mortgages as the authorities seek to expand home ownership in the country.

A robust banking sector able to finance new industries is seen as key to efforts to boost the dynamism of the private sector and accelerate growth.

Return to profitability

Banks in Saudi Arabia, like their GCC peers, recorded higher profits in 2022 on the back of improved operating conditions marked by economic recovery and the central bank’s move to tighten monetary policy.

Monetary policy in the kingdom is usually guided by the US Federal Reserve (Fed), which looks set to stay the course on interest rate hikes in a continuing response to elevated inflation.

The Saudi Central Bank (SAMA) increased its key interest rates by 25 basis points to 5.5 per cent in March in lockstep with the Fed.

“With the Fed expected to maintain the tight monetary policy in 2023 to combat inflation and SAMA likely to follow, interest rates are expected to remain high, portending favourably for the Saudi banking sector,” consultancy firm BCG Group said in March.

Federal Reserve rate-hiking cycles and their almost full replication by SAMA and other central banks in the Gulf region resulted in higher aggregate net interest margin (NIM) for the banking sector in 2022.

Fitch Ratings projected that profitability in the banking sector will remain underpinned by higher NIM, lower loan impairment charges and growth in non-interest revenues.

S&P Global echoed similar sentiments noting that net interest income – the difference between interest revenues earned from lending activities and interest paid to depositors – at banks in Saudi Arabia soared last year as financial institutions passed rate increases on to customers.

With strong supervision from SAMA, the financial sector remains resilient and the positive outlook on the kingdom’s rated banks mirrors that of the sovereign.

Banks in Saudi Arabia started 2023 on a solid footing as the combined annual net profit of the top five banks in the country – Saudi National Bank (SNB), Alrajhi Bank, Riyad Bank, Saudi Awwal Bank (SAB) and Alinma Bank – surged to $13.7bn (SAR51.2bn) in 2022.

SNB made a net profit of SAR18.6bn in 2022, up 46.7 per cent from the previous year, Alrajhi reported a 16 per cent rise in its annual net profit to SAR17.2bn, Riyad Bank’s full-year net profit surged by 16.5 per cent to SAR7.01bn while SAB posted net profits of SAR4.9bn, up 52.2 per cent from a year earlier and Alinma Bank’s annual net profit soared 33 per cent to SAR3.6bn.

“We consider the Saudi banks’ capital position to be strong. Profitability improved due to an increase in operating income which was further supported by lower impairments,” says Asad Ahmed, managing director and head of Middle East financial services at Alvarez & Marsal.

The Saudi riyal’s pegging to the US dollar all but eliminates foreign exchange risk, a most valuable trait in emerging markets (EM) at a time when faltering commodity prices present a risk to the EM FX asset class.

The case for consolidation

Mergers and acquisitions (M&A) among financial institutions in Saudi Arabia are expected to continue amid the push to create lenders with greater scale as banks look to boost revenue, achieve cost synergies and support economic diversification. The same is true for banks across the GCC region.

“Consolidation among GCC region banks brings scale to support the diversification of Gulf economies away from oil and benefits in revenue and cost synergies,” says Francesca Paolino, lead analyst at Moody’s Investors Service.

The merger between SABB and Alawwal Bank in 2021 into SAB, a bank with paid-up capital of SAR20.5bn, broke an almost 20-year drought for M&A in Saudi Arabia’s banking industry. It also led to more deals in the country.

Saudi Arabia completed the merger of National Commercial Bank and Samba Samba Financial Group into SNB in January 2022 – a banking behemoth with a market value of SAR224bn and SAR946bn in assets as of December 31, 2022.

These mergers follow a trend within the kingdom and elsewhere in the GCC, where assets and funds are being consolidated to boost performance and increase efficiency through synergies.

Saudi Arabia further combined its two state-run pension and unemployment insurance funds – the General Organization for Social Insurance and the Public Pension Agency – in 2021 to create a fund with assets that exceed SAR1tn managed by Hassana Investment Company.

Digital banking

SAMA has been a proponent of innovation and development in the financial sector since the launch of Saudi Arabia’s financial sector development programme, one of the pillars of Vision 2030, in 2017.

The apex lender has taken new players in the financial sector under its wings and embraced a positive attitude towards innovative technologies to usher banking into the new era.

The central bank’s forward-looking stance has led to a push for digitalisation through open banking, the support of the fintech sector and licencing digital banks. Saudi Arabia issued a roadmap for open banking in 2021 and published an open banking framework in November 2022.

SAMA also launched its ‘Open Banking Lab’ to speed up the development of open banking in the country last December. Open banking will result in greater efficiency and help banks bridge the gap with fintech firms.

Today, a cocktail of evolving customer demands and preferences, an ambitious fintech development programme and a growing fintech ecosystem all play an important part in the kingdom’s flourishing digital banking sector.

Saudi Arabia has licenced three entities since 2021. stc Bank, which boasts eight million retail customers and more than 120,000 merchants within its network, is currently converting all its activities and functions from an e-wallet to a digital bank.

Saudi Digital Bank, which will run on cloud-native infrastructure and will focus on providing hyper-personalised financial services and products, will target both retail and small and medium-sized enterprise customers.

D360 Bank, a Shariah-compliant neobank backed by the Derayah Financial Company and PIF, is targeting the underserved segments, focusing on addressing customer pain points and leveraging innovation and technology to make banking convenient, accessible and fair to all.

The digitalisation of the financial system is progressing at a fast pace, exceeding targets originally set under Vision 2030. Financial institutions that embrace a digital-first and customer-centred approach are positioned to lead the new era of banking in Saudi Arabia.

Vision turns into reality

The role of Saudi Arabia’s financial services sector has transformed over the years and banks continue to capture the benefits of economic expansion evidenced by an increase in lending to the state, large corporates and small business enterprises.

Alvarez & Marsal’s Ahmed projects that corporate lending would drive credit growth in the near term as Vision 2030 projects are currently being implemented.

The kingdom has made considerable progress in the implementation of its multi-pronged structural reforms to wean its economy from heavy reliance on oil and gas.

Under Vision 2030, the government in Riyadh is proceeding full steam ahead with the development of several giga-projects while opening up the country to the world in a way that it has never attempted before.

“These developments are being mirrored in the performance of the banking sector in Saudi Arabia, which is experiencing a period of much-welcomed profitability,” said the BCG Group.
Bank lending to the private sector rose by 14 per cent year-on-year (YoY) to SAR2.35tn at the end of 2022.

Breaking it down by sector – personal finance increased by 14 per cent (SAR142bn) and lending to corporates also jumped by 14 per cent (SAR147bn), according to SNB. Within the corporate segment, the highest annual rises were in real estate, up 32 per cent, mining rose by 22 per cent and finance increased by 22 per cent.

Similarly, cumulative gross mortgage originations, provided by banks and other financial institutions, rose 27 per cent YoY to SAR587bn.

Alrajhi raised more than SAR5bn from the sale of a real estate financing portfolio to the Saudi Real Estate Refinance Company (SRC) in March – the country’s biggest such mortgage refinancing for a bank to date.

SRC, which is wholly owned by PIF, bought a SAR1bn real estate financing portfolio from SNB in March 2022 and another SAR500m real estate financing portfolio from Riyad Bank in May of the same year, part of the real estate refinance firm’s broader strategy to boosting Saudi home ownership to 70 per cent by 2030.

The financial sector is the lifeblood of any economy in the world, Khalid Al-Falih, Saudi Arabia’s Minister of Investment said in speech at the Financial Sector Conference in Riyadh in March this year.

Saudi Arabia’s mortgage market has expanded over the past years, however, the rapid rise in home loans has stretched the capacity to keep lending. Mortgage approvals by banks have also slowed as banks struggled with tight liquidity and buyers faced soaring interest rates and rapidly rising home values.

“Continued improvements to the framework for financial sector regulation and sustained monitoring of rising mortgage lending are important to prevent risks from materialising,” according to the IMF.

Moving ahead, continued government support for lower-income groups including the provision of interest rate subsidies via the Real Estate Development Fund is expected to sustain momentum in mortgage lending in the medium term.

Saudi banks are likely to remain on a profitable path in 2023 with corporate lending continuing to drive credit growth in the sector. The banks witnessed a high credit growth compared with deposits in 2022 and going forward, credit growth is expected to grow further driven by strong economic momentum and investments.