For Saudi Arabia's 10 banks, the rollercoaster seems now to be coasting rather than rolling. Potential liquidity problems last year never materialised and profitability continues to be strong. But as the competition remains tough, the banks are investing heavily in new products and systems. For the larger players, the move into new markets is coming ever closer. Tom Everett-Heath reports

The largest economy in the Arab world has, in terms of bank numbers, one of the smallest banking sectors. Such an apparently anomalous situation is compounded by the regular, if somewhat spurious, rumours that impending mergers will make the sector even smaller. With the integration of Saudi American Bank (Samba) and United Saudi Bank (USB) completed in December there are 10 banks in the country. Compared to the 40-odd institutions operating in the UAE, or the 70-plus of Lebanon, the figure seems small. But most local bankers will say the sector is fiercely competitive and, ifanything, over-banked. For the larger institutions, limited opportunities at home could force them to spread their wings and build regional operations. For the rest, the scramble for domestic market share will become increasingly frenetic.

At the moment, the country's bankers can look at the numbers and allow themselves a smile. At the start of last year, most of them had furrowed brows, but things turned out much better than expected. The recovery in oil prices, which began around April, may have taken some time to filter through to the banks, but the sharp downturn of the previous year had its hidden benefits. 'There were signs of a liquidity squeeze among the corporates in the first and second quarters last year, and if you'd asked me then I would have admitted to being worried,' says one senior banker in Riyadh. 'But the danger passed quickly enough, and, in fact, the difficult period opened up some good lending opportunities to strong corporate customers who were faced with cashflow problems.' The recovery in oil prices was delayed long enough for most banks to exploit the new opportunities but the downturn was short enough to prevent the levels of non-performing loans (NPLs) rising alarmingly.

Well-handled

It was not just the timing and duration of the oil price drop that was convenient. 'Both the government and many of the local companies have learned how to deal with these swings much better,' says another senior local banker. 'The Finance Ministry and SAMA [Saudi Arabian Monetary Agency - central bank] handled the situation very well.' The effectiveness of their measures was most evident in their handling of the currency. 'Some big international players launched an attack on the riyal when the oil prices were at rock bottom at the beginning of last year, but the authorities reacted very well and the speculators got their fingers burnt, some badly,' says the banker.

With National Commercial Bank (NCB), the largest bank in the country, yet to post its 1999 results (see box), a full picture of the sector's performance cannot be painted. But the results from the rest of the banks last year show total assets grew by almost 4 per cent. With the exception of Samba, which was burdened with the one-off costs of its merger, all the other banks reported profit growth (see table). First-quarter results published by nine of the 10 banks show these positive trends are continuing.

The figures may look good but, true to their calling, the bankers continue to worry. 'While the operating environment is far from bad, we have seen more of an improvement in confidence and psychology within the market than actual business activity,' says another banker. 'The biggest concern for most of us is a lack of lending opportunities.' He, and many others, report a healthy growth in deposit levels but the general demand for credit is not all that it might be. On the positive side, none of the listed banks is confronted with serious NPL problems, but some are a little uncomfortable over the shape of their balance sheets.

'Some of the banks have up to 50 per cent of their balance sheets exposed to government securities,' says one of the bankers. 'And they may not like being quite so conservative. We don't think this exposure should really exceed 25-30 per cent, but the economy has to grow faster and more evenly to generate more outlets for our deposit bases.' All the conventional banks to have issued interim results this year, with the exception of Arab National Bank (ANB), have reported declines in their lending ratios. While this is partly a reflection of the comparatively strong lending opportunities in the first quarter last year, the trend has reinforced the conviction with which some of the banks are pursuing new strategies.

Perhaps it is a case of great minds thinking alike, but most of the banks have the development of personal banking either at the top, or very near the top, of their agendas. 'We are putting our focus on retail banking,' says David Hodgkinson, managing director of The Saudi British Bank (SABB). 'It is the fastest growing area and the one with the most lending opportunities.' He says SABB is investing heavily in developing its telephone banking call centre and its card services. 'Although cash is still king in Saudi Arabia, the card market is large and growing,' says Hodgkinson. With the other banks also committed to building market share, the services offered and the systems used to manage them are becoming increasingly sophisticated. 'We've introduced a system for behavioural credit scoring, which allows credit limits to shift more quickly and be applied more accurately. Our database is developing and the scoring system is getting better and better,' he says. With expanding deposit bases requiring fresh outlets, the need to combine new consumer lending with strict credit controls is strong: delinquency problems are never far away, and they do direct damage to the bottom line.

The appetite for card business brought a new arrival in the market last August, with the establishment of a joint venture between Saudi Investment Bank (Saib) and American Express (Amex). The new entity will own and manage Amex's burgeoning card business in the country: it will act as a card issuer and will also manage transactions at the point of sale.

Just as card services are being expanded as each bank chases a bigger share of the retail banking market, new products are under preparation. 'There are certainly a lot of opportunities in developing bancassurance activities,' says Robert Eichfeld, Samba's managing director. Samba, along with ANB and Saudi French, are already marketing annuity-based products, and it is understood that SABB is to soon join them. 'The wave of new lending products will be added to rapidly. In particular, attempts will be made by a number of banks to develop a market for mortgage products,' says another banker.

The launch of these new products will coincide with the arrival of new delivery platforms. ANB is, as yet, the only bank to offer internet banking services, but this situation is unlikely to last long. Samba, SABB, Al- Bank Al-Saudi Al-Fransi and Saudi Hollandi Bank are all in the process of developing services, with most expected to be ready for launch either by the end of the year, or in early 2001. 'The development of internet banking could, in time, be the key to changing the structure of retail banking operations here,' says one senior banker. 'It probably provides the best technological opportunity to undermine the dominance of cash.' Previous attempts have been made, such as automated teller machines (ATMs) with utility bill payment facilities, but with little success. 'Use of the internet is still in its infancy in Saudi Arabia, but the potential is huge,' he says. 'Not only are the basics of retail banking given a lower cost platform, but new products, such as online brokerage services, can be developed.'

It is no surprise that retail banking is in vogue. Lending opportunities elsewhere are limited or nascent. There is a general consensus that the project finance market is offering less than it might. Saudi Basic Industries Corporation (Sabic) - through its affiliates the single largest borrower in the country by some margin - has come to the end of its current round of financing needs. Saudi Telecommunications Company, Saudi Electricity Company and Saudi Petrochemical Company (Sadaf) are all considering financing options, but beyond these the other pickings are thin on the ground. And even the most excitable banker has his pulse slowed by the prospective pricing of the forthcoming big ticket deals. 'With deposit bases growing, the cost of money is relatively low at present and the banks have to be in the market due to limited lending opportunities,' says one senior local banker. 'The competitive market tends to produce very tight spreads. It will pick up but there is no gravy train here.'

There are, however, some reasons for optimism on the investment banking side. 'There is a generational change taking place and we have found there is increasing interest from businessmen wanting to change the way in which they structure their businesses,' says Bertrand Viriot, managing director of Saudi French. 'The trend away from family partnerships towards limited liability structures is growing, and a number of companies are looking at ways of financing buyouts. Advisory work, built on good customer relations, is likely to pick up.' Saudi French has already picked up three mandates for major advisory work, of which one is for a private equity placement.

Coming with this generational shift in management and incorporation structures is a rethinking of the areas of businesses focused on. 'Local corporate behaviour is changing and a number of companies are looking to diversify their activities into more technology-related areas,' says one senior banker. 'The younger generation is more interested in this, and the change is generating opportunities for the banks. Financing is needed for diversification, from which the banks will benefit, and advisory work is picking up as the younger generation seems more willing to seek bank advice on how to structure and manage their businesses.'

However, the trend is still in its infancy, and last year the corporate and investment banking sector grew little. It is also becoming more competitive with the arrival of a new player. Following its merger with London-based Saudi International Bank, through which SAMA took a 22.2 per cent stake, Gulf International Bank (GIB) was awarded a licence to establish local branch operations, the first new licence issued by SAMA since the transformation of the Saleh Bin Abdul-Aziz al-Rajhi Company intoAl-Rajhi Banking & Investment Corporation in 1988.

For some, GIB's arrival is a harbinger of the future opening of the financial services sector to outside competition. GCC resolutions permitting cross- border banking are already in place, and Saudi Arabia's pursuit of World Trade Organisation (WTO) membership has serious implications. Certainly, a number of regional banks, among them National Bank of Bahrain, have applied, without joy, for licences. But the market is unlikely to be opened imminently. 'The liberalisation of the financial services sector to foreign competition is a crucial chip in the WTO negotiations,' says one of the bankers. 'You can be sure that the authorities will not give it away prematurely. And anyway, they are largely insulated against the charge of discriminatory practice. It's not as if SAMA is unfairly selective in who it issues licences to, it doesn't issue them to anyone.'

Beyond this, the full implications of liberalisation are far from clear. With the main globally-orientated banks such as HSBC, Citibank, ABN AMRO and Credit Agricole Indosuez already present, how many others would want to spend heavily on entering at the bottom an already competitive retail market? There might be alternative routes in, with Bank al-Jazira possibly proving an acquisition target. Equally, Saib could be a useful partner for an institution seeking a strong presence at the higher end of the corporate market. On the investment banking side, the other most active international banks, such as Barclays, Industrial Bank of Japan, ANZ and Chase Manhattan are already active players, regularly participating in the big ticket deals they are most interested in.

In fact, for many of the local institutions it is less a question of how best to erect the barricades in preparation for a foreign onslaught, and more an issue of how to develop a strategy by which they can expand into new regional markets. 'Over the next three to five years the big three -Samba, Riyad Bank and NCB - are going to have to extend their reach,' says one banker. 'They are already among the largest and most profitable banks in the region and, given the constraints of the local market, it is the only way for them to go.'

The process has already started. NCB has applied for a licence to open a full commercial branch in Bahrain, and Samba is in the process of establishing representative offices in Egypt and the UAE, having already put one in Lebanon. 'We like these markets for different reasons,' says Samba's Eichfeld. 'In Lebanon we like private and investment banking, in Egypt, corporate and trade finance, and in the UAE mainly trade finance. Our strategy for regional expansion is based on following the needs of our Saudi clients.' However, while the establishment of representative offices could be the first step in gaining an understanding of a new market, bolder strides could follow. 'For a bank of this size the process of consolidation within the region represents an opportunity,' says Eichfeld. 'There may be opportunities for acquisitions or joint ventures.'

If Samba is to pursue a programme of regional expansion, and if it is joined by local heavyweights Riyad Bank and NCB, there will be less debate over the impact of WTO membership on the Saudi banking sector, and more talk of how Saudi banks might become the dominant force in regional consolidation. Big might yet prove to be beautiful.