Vision 2030 promises a transformation of Saudi Arabia’s economy, and the financial sector will be crucial to achieving this. The sector will facilitate private investment focusing on small and medium-sized enterprise (SME) financing, fund mega-projects, and be a driver for diversifying away from oil. As a result, banks’ role must go from being distributive and largely passive to developmental and active. This article1 will highlight how the role of the Saudi banking sector has been transformed in the last five years and how its composition is changing to cope. Commercial banks are becoming financial intermediaries between all facets of the Saudi economy, not only the state and large conglomerates. The new banking environment requires updated approaches and since Saudi companies — with a few notable exceptions — do not borrow abroad, the domestic banking system is a critical source of funding for Vision 2030.
This partially explains recent changes, such as the merger between Alawwal and Saudi British Bank (SABB) announced in 2018, the merger between National Commercial Bank (NCB) and Samba announced in 2020, and the granting of two digital licenses in 2021, which show a degree of dynamism that is highly uncharacteristic for the Saudi banking sector. The country’s commercial banks have diversified their portfolios from a near-exclusive focus on conglomerates and large-scale investments in industry and infrastructure to now also include mortgages and SME financing. To assist banks in these areas, government-financed funds have been overhauled and have become integral to bank profitability. However, it is important to not be mesmerized by slick brochures and eye-popping price tags, as several structural problems that have hindered banking sector development since the 1970s are still present.
Sector origins and trends
When the flow of oil wealth turned from a trickle to a flood after the sharp rise in prices in 1973, banks from all over the world poured into the country. While Saudi Arabia’s built environment was transformed, the structures underpinning its financial sector formed and then remained stubbornly similar for more than half a century. The state was the alpha and omega of investment, the legal system did not modernize concurrently with the economy, the commercial banking sector remained marginal, and the financial system was hostile to small actors, be they small banks, SMEs, or individual borrowers.
The 1973 oil boom led to a spending spree with few historical parallels, and the state’s extraordinary financial might made foreign direct investment (FDI) unnecessary and undermined the development of a competitive financial ecosystem. The glut of money meant little attention was given to modernizing the Saudi legal system, which was unfit to handle the needs of modern banking. In courts, the Islamically trained jurists would invariably rule against banks due to the Islamic prohibition on interest-taking economic activities, and borrowing against short-term assets, such as imported cars, was not legally enforceable. The government-induced preference for enormous industrial and infrastructure projects meant that banks preferred to lend to large conglomerates and government-related enterprises, because of the larger margins and more predictable contracts they brought. As a result of these two factors, banks made few inroads into retail lending, a problem that has only recently been given the attention it deserves.
When the oil price declined during the first half of the 1980s and then crashed in 1986, the high-spending government-centric investment strategy ground to a halt. The inadequate regulatory system, which could be sidestepped in the years leading up to the crash due to the monetary surplus, was now causing headaches. The government, suddenly low on funds, would delay or even cancel payments to contractors, creating a ripple effect of unpaid bills and loans across the economy. Suing the government was a non-starter and contractors would instead appeal to sharia courts, which would deduct paid interest from the principal of the loan. This put enormous pressure on bank balance sheets that were already buckling from the precipitous drop in government investment. The legal and financial troubles banks faced in the late 1980s gave rise to a decades-long trend of risk-averse lending, where the preferred borrowers would be conglomerates, well-connected royals, and the government itself.
The 1990s were the logical conclusion of the trends from the 1970s and 1980s. Low oil prices during the 1990s meant the government could not pay for the infrastructure projects that had become the bread and butter of commercial banks. The lack of trustworthy borrowers in the kingdom in this period caused banks to buy most of the $55 billion in treasury bills and bonds issued by the government because these had better returns and were more reliable than lending to the private sector. Retail financing was still off the table as the legal system was only modernized after the turn of the millennium. The structural advantages for large banks continued as they could buy more government debt, while the woeful economic conditions caused United Saudi Commercial Bank and Saudi Cairo Bank to merge and then become absorbed into Samba. In 1999, NCB came close to becoming insolvent due to the large number of bad loans in its portfolio. The Ministry of Finance — through the Public Investment Fund (PIF) and the General Organization for Social Insurance (GOSI), the kingdom’s private sector social insurance authority — bought a 50% stake in NCB.
In each of these periods, a defining feature of the Saudi banking sector was its lack of competition and dynamism. The centrality of the government as an investor stimulated big projects and, together with the opaque legal system, undermined lending to SMEs. A private sector independent of government investment did not emerge, perpetuating the need for continued government investment. Likewise, the absence of small, locally focused banks limited the growth of retail finance. These trends can be traced back to the spending patterns of the boom period and constitute the primary obstacles Vision 2030 will need to overcome.
Preparing banks for Vision 2030
The most eye-catching mega-projects under the Vision 2030 umbrella, including the Red Sea Project and the hypermodern city NEOM, have price tags in the tens and hundreds of billions of dollars. When the Crown Prince Mohammed bin Salman (MbS) came to power, no Saudi bank had the balance sheets nor the experience necessary to make these projects a reality, but following the merger of NCB and Samba, Saudi National Bank (SNB) is one of the 150 largest banks in the world. NCB predicted in 2019 that mega-projects would add to a “positive outlook for the Saudi banking sector” due to the vast amounts of funding involved in making them a reality, calling them “integral to the kingdom’s sustainable growth and prosperity.” Alawwal and SABB echoed this in their merger presentation, and mentioned that the enlarged balance sheet would create a “capacity to support transformational infrastructure and privatization projects.” The dominant credo is therefore “bigger is better.” A secondary goal is to ensure that local banks do not become sidelined by foreign banks that might want a significant piece of the action from Vision 2030, which may see profits from ancillary work alone reaching $100 million.
Along with funding mega-projects, mergers are also aimed at increasing synergy and saving on costs. Banks with an extensive retail network, such as NCB, or a very strong corporate bank, in this case Samba, are appealing targets for a merger. Another possible reason can be gleaned from the annual reports of Saudi Arabia’s central bank, the Saudi Arabian Monetary Authority (SAMA). The insurance market saw three mergers take place “as a result of SAMA’s efforts aiming at maintaining the stability and resilience of the financial system by encouraging insurance companies’ mergers.” Considering the unpredictability of oil markets, recent tensions between the UAE and Saudi Arabia, the growing impact of environmental policies, and the challenges the Saudi economy will face in the coming decades, a well-diversified and stable bank is a thoroughly appealing prospect. While it has been difficult to go bankrupt in Saudi Arabia — a bankruptcy law was only introduced in 2018 — there is no longer a bottomless pot of money that the government can use to invest in ailing banks, as it has done with NCB, Samba, and Riyadh Bank in the past.
Overhauling specialized credit institutions
To facilitate bank lending to SMEs and retail customers, several institutions in Saudi Arabia have been revamped. Historically, economic development in the kingdom has been catalyzed by the government and its specialized credit institutions (SCIs), such as the Real Estate Development Fund (REDF), the Saudi Industrial Development Fund (SIDF), and the Agricultural Development Fund. These would supply the capital required for the kingdom’s cement plants and petrochemicals industry and gave stipends for housing and agriculture. Commercial banks would focus on lending to big projects, while avoiding retail finance and SME lending. These SCIs filled the gap, with three significant results. First, they cemented the government’s central role in important economic sectors; second, and more problematically, they perpetuated commercial bank exclusion from these sectors as they removed any impetus for legal modernization; and third, because SCI terms were more generous than those of banks, there was very little demand for banks to enter these sectors. The government therefore crowded out commercial actors as both an investor and a lender, hindering the creation of a flexible and transparent banking ecosystem.
Vision 2030 has revolutionized the SCIs. Instead of funding projects or homes directly, they now provide guarantees for loans banks make to individuals. This enlarges the role of banks in financial intermediation and increases the number of people that have access to banking services. For example, the SIDF’s capital has almost doubled since 2017, with loan disbursements — serving as guarantees for loans made by banks to other businesses — growing by more than 25% between 2017 and 2019. Likewise, the REDF’s growth has been stratospheric, driven by a joint REDF-Ministry of Housing initiative to provide suitable and affordable housing to 63.5% of the population by 2020 and 70% by 2030, from a baseline of around 50% in 2016. Samba stated that REDF support ensures access to “top quality finance mechanisms for a very real and genuine need,” referring to housing, while NCB reported a 57% increase in residential financing in 2019 alone, “in close cooperation with government initiatives.” The results are clear: Housing has been the main driver for bank profitability since the program has taken off, and the policy to synergize SCIs and commercial banks is paying dividends, rather than producing the more exclusionary results of earlier policies. The IMF has, however, cautioned that letting these programs grow too large could raise “contingent fiscal risks for the government” if money is given to less-efficient SMEs or if prudential steps are not taken to protect banks from large price fluctuations in the housing market.