Saudi Arabian Monetary Agency

Speech delivered by Hamad Al-Sayari Governor Saudi Arabian Monetary Agency

“Saudi Arabian Banking System & Capital Markets”
At the Saudi British Forum, London
Tuesday, June 24, 2003.

Mr. Chairman & distinguished audience

It is a great pleasure to be here and to have this opportunity to speak to such an eminent audience. Let me begin with brief remarks about Saudi Arabia, which is the largest economy in the region in terms of its GDP, trade and financial system. Additionally, the Two Holy Cities give the country a unique position in the Islamic world. The country’s modern infrastructure and on-going structural reforms are paving the way for a greater private sector role in the economy and a better future for the country. The Government is keen to see timely implementation of a number of reform measures introduced over the last three years. The rationale behind creation of the Supreme Economic Council, followed by the Saudi Arabian General Investment Authority and many other initiatives highlighted by other speakers, the last of which was the issuance of the Capital Market Law, is to streamline policy decision making, improve the investment environment for local as well as foreign investors, and make use of the potentials and opportunities to achieve the country’s economic objectives and address its challenges.

Since a wide range of subjects is covered at this forum, I have chosen to focus on our banking system, monetary stability and capital markets. The maintenance of stability in the overall financial system is one of SAMA’s three core tasks – the other two being responsibility for monetary stability and Banker to the Government.

As you know, the global banking system is going through a period of unprecedented change, driven by shifts in the competitive environment and by regulatory changes. A combination of IT revolution, disintermediation pressures arising from market liberalization and emphasis on shareholder value has compelled banks to change the old ways of doing business. Our banks are no exception to these changes. Trends in our domestic banking include consolidation through mergers and acquisitions, diversification of asset composition, offering conventional and Islamic investment products to a diversified investor base and emphasizing shareholder value as opposed to growth in balance sheet.

Saudi Arabia’s banking system is well integrated with international banking, as seven out of eleven banks operating in the Kingdom have foreign shareholders, including branch or joint venture set-ups. This cross-fertilization has ensured a competitive and diversified banking environment which meets the best international banking practices. Our choice of branch banking across the country has been quite instrumental in extending financial services to small businesses and retailers.

Saudi Arabian banks are among the top-rated ones in the industry, based on capital adequacy, liquidity, provisioning norms and profitability. For the last decade, there has been an organic growth in domestic bank balance sheets (aggregate $ 138 bio) through internal capital generation. The domestic banks financial ratios speak for themselves, with capital adequacy at about 20%, all of it in core capital, liquidity ratio at 50%, NPLs at less than 5% of gross loans, loan loss provisions exceeding 100%, return on equity 20% and return on assets 2%.

Saudi Arabia’s regulatory system matches the international standards for banking supervision. Banks are meeting accounting and disclosure standards prescribed by SAMA, which are in line with International Accounting Standards. SAMA’s policy of maintaining solid prudential regulations and corporate governance has resulted in well-regulated and well-managed banks. Resilience has been the defining characteristic of our banks during the international crises, due to the strength of their balance sheets and strict supervision. The recently proposed Basel 2 Capital Accord under its three pillars suggests that sound banks depend on three disciplines: internal discipline of the bank itself, external discipline of the supervisor and external discipline of the market. In Saudi Arabia we have been practicing these principles for more than the past decade.

In recent decades, many countries have experienced systemic banking crises requiring major restructurings of their financial systems. These restructurings have often had high fiscal costs, with budget outlays sometimes reaching as high as 50% of GDP. In the early days of Saudi Arabia’s banking history, there were a few incidents of banks running into difficulties, triggering official intervention in the form of liquidity support and/or capital injection. These episodes were catalytic in strengthening bank supervision and corporate governance, which are particularly important for banks because of their leveraged nature of business and exposure to various risks. During the 1990s, communications between SAMA and banks have improved considerably beyond the formality of the regulator and the regulated entities. SAMA has developed a process for holding regular meetings with banks at different levels to discuss broader issues, such as trends in the industry, system liquidity, market practices & ethics, development of capital markets and regulatory matters. Such meetings have been helpful in creating a better understanding and working relationship between SAMA and banks as major participants in the financial system.

In the past decade Saudi banking system has invested heavily in new technologies. SAMA has guided banks towards a number of sophisticated payment and settlement systems. These include Automated Cheque Clearing Houses; Saudi Payments Network (SPAN) which supports ATM’s and Point of Sale Terminals and Tadawul the Electronic Share Trading System, with T+O settlement features. These state-of-the-art systems have been linked together with the Saudi Arabian Riyal Inter-bank System (SARIE), an electronic fund transfer system with Real Time Gross Settlement (RTGS) features. The payment systems not only meet but exceed BIS standards.

SAMA is vested with the conduct of monetary policy, which includes exchange rate policy within the broad framework set by the Government. The role of monetary policy is to provide a stable monetary environment for the economy. We do not have a precisely defined framework of action for the central bank as it exists in some other jurisdictions, which is sometimes regarded as a necessary formal safeguard to monetary stability. The distinction may be less important under our firmly pegged or rule-based exchange rate system than it might be in other circumstances.

Having cited these facts, I would like to add that there is no single exchange rate regime that is best for all countries in all circumstances. While increased capital mobility has been leading an increasing number of countries to either end of the spectrum between firmly fixed rates (or monetary unification) and free floating, intermediate regimes are likely to remain viable and appropriate in many cases.

Lessons from the recent crises in emerging markets are that the requirements for sustained pegged exchange rate regimes have become more demanding as a result of the increased linkages to global capital markets. Against this backdrop, the sustained stability of the Riyal against the anchor currency is attributable to sound macroeconomic fundamentals, including flexibility of prices of other factors, and Saudi Arabia’s net creditor position in international capital markets.

Monetary policy has an important bearing on capital markets. The exchange rate stability is vital for attracting capital flows and lowering the cost of debt. Riyal interest rates are influenced by global interest rates and domestic money market conditions. SAMA’s monetary policy stance has been accommodative over the last two years in response to global monetary easing and favourable domestic money market conditions. With the growing market sophistication, the shape of the yield curve is often analysed for expected growth, inflation and investment. SAMA does not seek to manipulate the yield curve for managing Government debt.

In Saudi Arabia, the capital market is undergoing changes. Greater role is envisaged for the private sector in the future investment growth. The recently enacted Capital Market Law and the formation of the Securities and Exchange Commission and a privately owned Stock Exchange should augur well for further developing the domestic capital market.

The stock market has come a long way from the unregulated broker trading of the 1980s to the present day screen based trading. The market, with a current P/E of 17x and dividend yield 2 ½%, is the largest in the Middle East in terms of market capitalization, which is over $ 127 bio. The market is supported by an electronic stock exchange system, known as Tadawul that I referred to earlier.

Saudi Arabia’s Government debt market has a short history. The Government has been issuing bonds since 1988 for deficit financing. SAMA is fiscal agent and debt manager. During the last 15 years, the fledgling Government debt market went through evolutionary changes in terms of issuance procedure, pricing, maturity spectrum, settlement and the use of repos. Investors in Government Development Bonds (GDBs) include domestic financial institutions, banks and foreign investors. GDBs are zakat deductible for domestic investors and exempt from withholding tax on coupon income for foreign investors.

In emerging economies, development of bond markets has been a daunting and time-consuming task. The market dynamics dictate periodic evaluation of the infrastructure. In this context, SAMA and banks are currently considering changes that would enhance marketability of GDBs. These include introduction of primary dealers, switching to auction system, encouraging investment banking culture and broadening the investor base through institutional reforms. SAMA’s ultimate goal is to apply market-oriented practices to the domestic debt market.

In conclusion, stability of the financial system is vital for monetary or broader economic stability. SAMA would continue to preserve monetary and financial stability by ensuring that our banks are prudently managed. Development of the domestic bond market is also high on our agenda, which is crucial for cost-effective debt management and broadening the spectrum of the market. The Securities and Exchange Commission, with its focused mandate, would seek to facilitate listings and improve transparency through disclosure requirements. The potential benefits of further mobilizing capital markets are huge, and so too are the challenges.