THANKS to higher oil prices, 1996 looks like being a good year for Saudi Arabia's banks.

The unexpected strength of the oil market has earned the kingdom several billion dollars more in revenues than it budgeted for, and some of that money has worked its way through to the 12 domestic banks.

Customer deposits rose on the year at almost all of the banks to have reported nine-month results, and most institutions have reported higher net profits for the period. 'The operating environment for Saudi banks seems to have been improving in 1996, partly due to increased liquidity from higher oil revenues and partly through the special bond issues through which the government has settled overdue debts,' says Andrew Cunningham, analyst at Moody's Interbank Credit Service in Cyprus.

The special bonds were issued to cover government arrears to contractors and farmers. Tranches of bonds issued to the two groups of creditors were redeemed in August and September and bankers say as much as $2,000 million in debt arrears could be repaid this year, out of a total of about $5,000 million. A surge in turnover on the domestic stock market following the redemptions implies that some of the money is being reinvested in Saudi equities (see page 48).

Loans down The banks' nine-month figures show that the extra liquidity in the economy is temporarily reducing the demand for credit. Most loan portfolios have contracted, with a commensurate rise in securities investments and interbank lending. Bankers also say the goveminent has paid off some of its bank borrowings without taking out new loans.

Most of the banks have performed well in the first nine months of this year. Out of the 11 which have announced their unaudited results, seven have reported higher profits compared with the same period last year.

The most spectacular increase was at Saudi Investment Bank (Saib), which earned net profits of SR 87.5 million ($23.3 million) - more than it made in the whole of 1995.

The other four banks all reported ninemonth profits which were between 5 and 7 per cent lower than last year. In the case of Saudi American Bank (Samba), the fall appears to follow the bank's decision to raise provisions by a massive 154 per cent.

This may reflect losses in the credit card market, where the Citibank affiliate has been the most energetic of the banks. 'I think

they expected to lose some money [in building up market share in credit cards] but they may have lost more than they planned to,' suggests one observer of the industry.

The retail market, including credit cards, is seen by many as the most promising field of expansion for the banks in the next few years. 'The market is going in that direction [towards retail]. That's why you're seeing more credit cards,' says one Saudi banker. He notes that when Saudi banks talk about retail banking at the moment, what they usually mean is private banking for high-net-worth individuals. The potential lies in doing more business with less affluent clients.

Expansion into the retail market can be a risky business in a country where the credit culture is in its infancy and where the law is, by international standards, relatively unfriendly to the creditor. 'The legal environment remains a concern for us though there are some signs that it is improving at the margins, for example through increasing use of the Saudi Arabian Monetary Agency (SAMA) committee (to resolve banking disputes),' says Cunningham.

Like anywhere else in the world, the rewards of the retail market can be substantial. Saudi banks can charge big corporate borrowers a margin of around 80 basis points above the global benchmark, the London interbank offered rate (Libor), while spreads on retail lending can be six or eight times as high.

Resisting retail

But a bigger retail business also means large investments in staff training and new technology, and not all banks are persuaded that the market is the right one for them. 'We are not interested in retail lending or credit cards,' says a well-placed source at Arab National Bank (ANB), the fourth biggest Saudi bank in asset terms. ANB has spent the year weeding out bad debts from its corporate loan portfolio and building up provisions, and expects net profits to rise 10 per cent in 1996.

This year has seen management changes at the biggest Saudi bank, National Commercial Bank (NCB). Khalid Bin Mahfouz replaced his brother Mohammed as chairman and general manager of NCB in July, five years after he resigned from the post of chief operating officer. Khaled and his wife have owned NCB since 1994, when he took over the Bin Mahfouz family interest in the bank. Mohammed is widely credited with having turned the bank around after it experienced problems in the early 1990s. There have been some management changes since July, but it remains to be seen whether the new chairman plans other changes to the bank's personnel or strategy.

The number of Saudi banks may be about to be reduced by one. Bankers and analysts say that Prince Alwaleed Bin Talal Bin Abdul-Aziz Al-Saud, the controlling shareholder and chairman of United Saudi Commercial Bank (USCB), may be planning to merge it with Saudi Cairo Bank (SCB), an affiliate of Egypt's state-owned Banque du Caire. The prince and a group of other Saudi investors acquired a 33.4 percent stake in SCB in June.

There has been no public announcement to date on a possible merger between the two banks, which would create an institution seventh on the list of Saudi banks in asset terms. Some observers of the industry argue that SAMA will oppose any reduction in the numbers of domestic banks. There would, however, be a natural fit between USCB, which is primarily a corporate bank, and Saudi Cairo which has a stronger retail portfolio. 'Prince Alwaleed has grown USCB about as far as it can go organically,' says an observer. 'To grow, it's got to take something over.'

Unlike the other banks which have reported third-quarter results, USCB has increased its loan portfolio. 'We are building up our business for corporate customers. We have not looked at containing or constraining credit,' says general manager Karl Swoboda, who joined the bank in 1995. He expects full year profits for 1996 to be about 10 per cent higher than last year's SR 308 million ($82.1 million).

However, the Cyprus-based ratings agency Capital Intelligence downgraded USCB's long-term credit rating to A- from A in September, on the grounds that overdue loans rose steeply in 1995 without a corresponding rise in provisions. The agency also downgraded Saudi Cairo Bank for similar reasons, adding that a merger with USCB would be 'the most likely scenario over the medium term.' Saudi Cairo was one of the minority of banks to record lower profits for the first nine months of this year.

Things are looking up for Bank al-Jazira, the kingdom's smallest bank, which rejoins its profitable peers after a long struggle with bad debts. The bank, which broke even in 1995 after two years of losses, has reported net profits of SR 11 million ($2.9 million) for the first nine months of this year after making big gains on its securities investments. The legacy of its bad debt problems remains in the form of accumulated losses which stood at SR 81.6 million ($21.8 million) in September.

The improvement in the bank's fortunes followed two capital increases in 1992 and 1994, halving its staff to 245, cutting its branch network from 22 to 12, upgrading its technology and putting more money into staff training and customer service. There was also a shake-up in the management of the bank, which was run under contract by minority shareholder National Bank of Pakistan until the early 1990s.

The board is now mostly made up of Saudi nationals, with a broad background of banking experience. Bank al-Jazira's current strategy is to build up its customer base among large and medium-sized companies and wealthy individuals, rather than small firms and retail clients.