NATIONAL COMMERCIAL BANK (NCB) and Saudi American Bank (Samba) recently became involved in a minor spat over which of them had introduced the first Islamic credit card into Saudi Arabia. Their cards were issued on virtually the same day and each bank insists that it was ahead of the competition.
This illustrates how keenly the banks are looking to expand Shariah-compliant banking, the fastest-growing part of the kingdom's financial system, and suggests that there will be intense competition to win market share.
Al Rajhi Banking and Investment Corporation, which offers only Shariah-compliant products, until recently dominated the market. But it has now been joined by Bank Al-Jazira, which has converted from being a conventional bank. All the other banks are busy developing products, ranging from credit cards to Shariah-compliant alternatives to time deposits, which are being delivered through a mix of conventional outlets and specially designated Islamic branches.
Demand-led growth
"We have seen an increased demand for Islamic products and we have spent a significant amount of time trying to develop solutions for our clients who want to use Shariah-compliant products. In relative terms, sales of these products and service are growing faster than other parts of the business," says Mike de Graffenried, Samba's managing director.
According to Abdulkareem Abu Alnasr, NCB's deputy general manager: "Islamic finance is a cornerstone in our strategy. We started looking at this sector 13 years ago - today a lot of banks are trying to become players. This is good for the market because it creates more credibility and helps to accelerate the development of new Shariah-compliant products which meet customer demand."
At Saudi British Bank, managing director Geoff Calvert says that "growth of our Al Amanah Islamic services has been strong and new products have successfully been introduced to meet an increasingly sophisticated market for Shariah-compliant products".
This trend is already starting to show in the banking figures produced by the Saudi Arabian Monetary Agency, the central bank. "This sector has been growing rapidly and now 17% of the assets of the banking system are derived from Islamic banking," says Sama governor Hamad Al-Sayari.
It is difficult to quantify precisely the growth of the Islamic banking market in Saudi Arabia. This year the government and oil industry (Saudi Aramco) have enjoyed massive additional oil revenues that have been put on deposit. These are in conventional instruments. Anecdotally, bankers say that Islamic banking assets are growing at 15% a year.
However, Sama has no plans to follow the example of Bahrain, which has introduced a package of reporting and accounting standards specifically designed for Islamic banks - an approach it hopes will enable it to become the regional centre for Islamic banking.
Al-Sayari says that there is "no great demand for an Islamic banking law or a special supervisory regime in Saudi Arabia" and that Sama has "deliberately opted for a universal banking model, which allows banks to provide all types of financial services".
He says that "Sama has regulated and supervised Islamic banks under the existing supervisory laws" as these institutions "generally speaking, face similar challenges and constraints to all other banks". However, he adds that there are some areas such as bank liquidity and access to government securities where "Sama has worked closely with the industry to develop specific workable solutions to these issues".
A long-term shift
Sama's low-key approach is unlikely to deter the growth in this market. Bankers are convinced that there is a long-term shift in customer attitudes. At Riyad Bank, deputy chief executive Suliman Al-Gwaiz says: "Shariah-compliant banking is growing much faster than the conventional side. I am convinced that this is not just a short-term fashion. This market will be here in five years' time and we have to cater for it."
There is plenty of anecdotal evidence to support that view. At NCB, Al-Nasr says that "it is our experience that when you offer two options to a customer which provide the same utility and one is conventional and the other Shariah-compliant, an ever greater number are choosing the Shariah-compliant option. For example, almost 90% of our new consumer loans business is in this area."
But the days are long gone when customers would accept lower standards and higher costs just to ensure that their financial products complied with their religious beliefs.
"Customers will not accept a Shariah-compliant product if it is more expensive or a less efficient product or service. They will want a product that compares favourably with conventional ones. It will no longer be enough just to have a Shariah-compliant product," says Mishari al-Mishari, chief executive of Bank Al-Jazira.
Among the products growing most rapidly are Islamic-based consumer loans, time deposits, credit cards, share trading products and insurance. There is also talk of introducing sukuk products - short-term, liquid, asset-backed tradeable treasury instruments - whose introduction would help Islamic banks manage their short-term liquidity more effectively.
Quality wins out
"Customers now have much more choice. We are offering more products through all our outlets. Consumer finance is growing particularly rapidly and competition in that area is growing," says Abdullah Sulaiman Al-Rajhi, director and general manager at Al Rajhi Banking & Investment Corporation.
One of the trends being watched most closely by the banks is whether customers show any preference for using specially designated Islamic banking outlets or if they wish to use those banks that offer only Islamic services. Most bankers say that at present customers are more interested in the quality of products than the means of delivery.
This rapid growth in demand for Islamic products has helped boost the profits of Saudi Arabian banks in the first half of 2003 after a downbeat period in the previous year.
"In the first half of this year, total assets grew by 7.2% compared with the same period last year, customer deposits were up 9.6%, loans by 9.9% and net income by 14%. Return on equity was 22.74% and return on assets was 2.45%," says Al-Sayari.
These results included a 16.1% rise in profits by Saudi British Bank to SR565 million ($151 million) while Bank Saudi Fransi (BSF) announced a 16% increase in net income for this period. "These excellent results have been achieved through a sustained momentum across all business lines of the bank," says BSF chairman Sheikh Ibrahim Al-Touq.
Sama attributes these good results to the continued expansion of consumer loans and Islamic finance, the surplus liquidity in the domestic market resulting from higher than expected oil revenue and the ability of the banks to benefit from past investment in technology. Other factors include strict cost-cutting and the ability of the banks to avoid the worst effects of the international economic slowdown by focusing on the domestic market.
However, bankers are concerned whether this performance can be sustained if the period of low interest rates continues for more than a year. All Saudi banks, but particularly the Islamic institutions, have benefited from the fact that they have had a substantial source of non-interest bearing deposits.
The margins that can be earned from this source of free income is now under attack as interest rates continue at a low level - the cost of borrowing cannot continue to fall to maintain healthy net interest margins earned from lending at low rates. "Low interest rates always make life more challenging for the banks," say de Graffenried.
Saudi banks won't be hurt too much. Most loans are at fixed rates and bank borrowing is at a floating rate, which means that financial institutions are protected from the impact of lower rates. But the impact will be felt increasingly as customers take out new loans at lower rates. "If rates do not go up next year or the year after, banks will start to feel the pinch," says Al-Gwaiz.
Banks have responded to this challenge by diversifying their sources of income and focusing on fee-based services. Al-Gwaiz says that Riyad Bank "has concentrated on non-interest income, which was up by 45% in the first half of this year compared with the same period of 2002. We are a leading player in the local brokerage business and we have benefited as volumes have surged."
Bank Saudi Fransi is putting particular emphasis on developing its structured finance and syndicated loan business. Most recently the bank was mandated, along with Samba and Arab National Bank, by a consortium of International Power of the US and Saudi Oger as lead arranger for the financing of four power and steam plants.
"The bank has a strong record in the power and water sector as well as in greenfield sites. We also have excellent credentials in the petrochemical, oil and gas, shipping, industrial and trade sectors in the region," says Bertrand Viriot, the bank's managing director.
NCB, which is now finally back on course after the state took over ownership, has continued to dominate the fund business. With SR23 billion of assets under management, it has almost 50% of the market. "This is a core business for us and we want to build further on this," says Al-Nasr.
All the banks are looking closely at developing the mortgage market, which will be essential if housing is to be made affordable for young Saudi families - bankers also say there is at present a lot of disguised mortgage lending, with borrowers saying they are taking out loans for other purposes.
The mortgage market has stalled because the legal power of banks to repossess in the event of default is extremely limited and, even if there was a court judgement there are doubts about whether it could be enforced.
However, there are signs of a shift in official attitudes. "All banks are looking at ways of devising mortgage products which offer good security. A change in the legal structure is also on the agenda of many government agencies. This is essential if we are to grow this market," says Al-Nasr.
