SecM2012-0027 May 2012

SAUDI ARABIA

FSA Financial Sector Assessment

This volume is a product of the staff of the International Bank for Reconstruction and Development / The World Bank. The World Bank does not guarantee the accuracy of the data included in this work. The findings, interpretations, and conclusions expressed in this paper do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent.

The material in this publication is copyrighted.

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CONTENTS

Glossary .............................................................................................................................. ii

Preface................................................................................................................................ iii

I. Overall Assessment ..........................................................................................................1

II. Financial System Overview ............................................................................................5

III. Banking Sector Performance and Stability ....................................................................6

IV. Institutional Investors and Capital Markets ...................................................................7 A. Insurance Sector ..................................................................................................7 B. Mutual Funds.......................................................................................................7 C. Pension Assets .....................................................................................................8 D. Capital Markets ...................................................................................................8

V. Regulatory Oversight ....................................................................................................10 A. Banking Regulation and Supervision ................................................................10 B. Capital Market Regulation and Supervision .....................................................11 C. Financial Safety Nets and Bank Resolution ......................................................12

VI. Financial Infrastructure ................................................................................................13 A. Payments and Securities Settlement Systems (SSS) .........................................13 B. Credit Reporting and the Collateral Regime .....................................................14

VII. Expanding Access to Housing and SME Finance ......................................................15 A. Housing Finance ...............................................................................................15 B. Finance to Small and Medium-Sized Enterprises .............................................16

Tables 1. Selected Economic Indicators, 2005–11 ........................................................................18 2. Financial System Structure, 2007–10 ............................................................................19 3. Indicators of Banking Soundness, 2007–10...................................................................19

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GLOSSARY

ATM Automated teller machine

BCL Banking Control Law

CAR Capital adequacy ratio

CCHI Council of Cooperative Insurance

CMA Capital Market Authority

CML Capital Market Law

DSR Debt service ratio

ETF Exchange traded fund

FSAP Financial Sector Assessment Program

GCC Gulf Cooperation Council

GOSI General Organization for Social Insurance

IFRS International Financial Reporting Standards

IPO Initial public offering

LTD Loan-to-deposit

LTV Loan-to-value

MENA Middle East and North Africa

MOCI Ministry of Commerce and Industry

MOF Ministry of Finance

MOU Memorandum of Understanding

MTPL Motor Third Party Liability

NBFI Nonbank financial institutions

NPL Nonperforming loan

NPS National Payments System

OECD Organization for Economic Cooperation and Development

PIF Public Investment Fund

PPA Public Pension Agency

RBA Risk-based approach

REDF Real Estate Development Fund

ROA Return on assets

RTGS Real Time Gross Settlement

SAMA Saudi Arabian Monetary Agency

SARIE Saudi Arabian Riyal Interbank Express

SCIs Specialized Credit Institutions

SCSB Saudi Credit & Saving Bank

SIDF Saudi Industrial Development Fund

SIMAH Saudi Credit Bureau

SME Small and medium enterprise

SOCPA Saudi Organization for Certified Public Accountants

SRl Saudi Arabian riyal

SSS Securities Settlement Systems

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PREFACE

This report summarizes the findings of the Financial Sector Assessment Program (FSAP) Update mission, which visited Saudi Arabia, April 16–30, 2011. The FSAP Update was jointly led by Roberto R. Rocha (World Bank) and Karl Habermeier (IMF). The team included Åke Lönnberg, Étienne Yèhoué, Tahsin Saadi Sedik, Niklas Westelius (all IMF); Cédric Mousset, Massimo Cirasino, Olivier Hassler, and Ms. Subika Farazi (all World Bank), and Peter Hayward, Martin Kinsky, Jonathan Katz, and Rodney Lester (all experts).

The assessment is based on the laws, regulations, and other supervisory requirements and practices in place at the time of assessment. The report seeks to identify conditions and challenges facing the Saudi financial system at that time. It also describes the steps that are being taken to further strengthen the financial system and to expand access to finance while preserving the stability of the financial sector.

The mission met with Minister of Finance H.E. Ibrahim Abdel Aziz Al Assaf, Governor of the Saudi Arabian Monetary Agency (SAMA) H.E. Muhammad Al-Jasser, Deputy Minister of Finance H.E. Sulaiman Al-Turki, Vice Minister of Finance H.E. Hamad bin Suleiman Al-Bazie, Vice Governor H.E. Abdulrahman Al Hamidy, Deputy Governor H.E. Abdulrahman A. Alkalaf, Chairman of the Capital Market Authority (CMA) Dr. Abdulrahman A. Al-Tuwaijri, senior officials and staff from the Ministry of Finance (MOF), SAMA, and the CMA, other government agencies, and private sector representatives.

The team would like to express its appreciation to the authorities and other counterparts for their hospitality and support. In particular, the team is grateful to SAMA for the excellent organization of the mission and support to the team.

FSAPs are designed to assess the stability of the financial system as a whole and not that of individual institutions. They have been developed to help countries identify and remedy weaknesses in their financial sector structure, thereby enhancing their resilience to macroeconomic shocks and cross-border contagion. FSAPs do not cover risks that are specific to individual institutions such as asset quality, operational or legal risks, or fraud.

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I. OVERALL ASSESSMENT

Main Findings 1. Saudi Arabia confronted the global financial crisis from a position of strength. In the years before the crisis, the authorities strengthened the balance sheet of the government and enhanced the financial sector’s resilience. Public debt declined from 104 percent of GDP in 1999 to about 13 percent of GDP in 2008. The net foreign asset position strengthened from 23 percent of GDP to 92 percent in the same period (Table 1). The increased fiscal space allowed the authorities to substantially reduce the impact of the global financial crisis. Also, during the oil boom provisions for loan losses averaged 165 percent of non-performing loans (NPLs) and Capital Adequacy Ratios (CARs) averaged 19 percent.

2. The effect of the recent regional political turmoil has also been contained. Two large fiscal packages amounting to 19 percent of GDP will be fully implemented in the next few years. The packages include public sector wage increases, expansion in public employment, unemployment benefits, and measures to improve access to housing. These packages were designed to consolidate the ongoing output recovery and address some key social needs. However, the packages have also generated short and long-run risks that need to be carefully managed. The key short-term challenge is to prevent inflationary pressures resulting from potential bottlenecks in certain sectors. The key longer-term challenge is to preserve fiscal sustainability and manage the greater vulnerability to oil price shocks.

3. The banking sector remains the core of the Saudi financial system. It is well capitalized and would withstand severe temporary shocks, but could be vulnerable to large and prolonged declines in oil prices and GDP. The average solvency ratio is above 17 percent and remains above the 8 percent minimum for almost all of the individual shocks considered. However, significant and protracted declines in oil prices combined with protracted declines in GDP could result in distress scenarios for the banking system.

4. The authorities have made good progress in implementing the 2004 FSAP recommendations. They have issued several circulars related to FSAP recommendations, including connected lending regulations and consolidated supervision. They have also implemented risk-based approaches (RBA) to supervision and improved risk management practices through bank stress tests as part of Basel II implementation. The Saudi Arabian Monetary Agency (SAMA) has also updated the anti-money laundering and combating the financing of terrorism manuals for banking and insurance.

5. The assessments of standards and codes show that compliance is generally high. SAMA has made an impressive effort to introduce Basel II and used Pillar 2 requirements to foster improvements in the banks’ risk management and capital planning. SAMA has also been active in introducing Basel III requirements. The Capital Markets Authority (CMA) has developed a strong regulatory program in a short period of time that fully implements most of the international standards. Many critical aspects related to the payment and securities

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settlement systems (SSS) are covered in the existing legal framework, although there still exists no comprehensive payment systems law.

6. Substantial reform programs are underway to promote mortgage and small and medium enterprise (SME) lending. While the banking system is well capitalized, access to finance remains restricted for housing and SMEs. The 2004 FSAP had already emphasized the need to strengthen credit information and creditor rights to expand access to finance. The quality of credit information has been substantially improved with the development of a modern private credit bureau (SIMAH), but progress in improving the collateral regime has been mixed. There is a new registry for real estate collateral, but a registry for movables has not been created yet. Enforcement of collateral remains difficult. However, an impressive package of five draft laws recently approved by the Shura Council will strengthen the legal basis for mortgage lending and should benefit SME lending as well, as it strengthens enforcement procedures for all types of collateral.

Main Recommendations

7. While supervision and regulation are effective, the legal framework could be aligned with the practice and cope with evolving risks. In particular, an update of the Banking Control Law (BCL) that would align the powers that SAMA exercises in practice would be a step forward. The possibility for SAMA to allow large exposures of as much as 50 percent of bank capital should be removed and the definition of related parties strengthened to ensure that close family relationships are taken into account. The CMA can enhance public confidence by providing greater transparency on its enforcement actions. A comprehensive payment systems law would improve the existing legal framework.

8. Stress testing of the financial system and macroprudential policies could be further strengthened. SAMA is already taking steps to increase staff with the technical background needed for stress testing. Stress tests should be conducted on a regular basis, with a mechanism to incorporate lessons into prudential rules and supervisory actions. Drawing on work in international fora, it would be desirable to develop a more formal macroprudential policy framework, notably with respect to the definition of objectives, the elaboration of analytical methods, and the policy toolkit.

9. Financial safety nets and resolution frameworks have worked promptly and effectively in the past, but could be formalized to enhance market discipline. SAMA has made effective use of its strong intervention powers, prevented any bank failures, and preserved the stability of the system and the confidence of depositors. However, the introduction of a formal legal framework for financial safety nets and bank resolution would enhance the role of Pillar 3 in the Basel II architecture and strengthen further market discipline.

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10. Strengthening the institutional investor base would contribute to the further development of capital markets. To ensure the sound development of the insurance sector, the seven functional regulations that have been drafted by SAMA should be enacted as soon as possible. The role of the two large pension funds in capital market development may be enhanced through further disclosure of their investment policies. Moreover, a case can be made for additional outsourcing of the management of domestic portfolios to efficient private investment managers operating with clear mandates. Provided that effective prudential regulations are in place, foreign institutional investors could make important contributions to price discovery and market development.

11. While the mortgage package approved by the Shura Council is a decisive reform step, complementary measures to ensure the sound development of mortgage lending might be needed after its implementation. These measures could comprise a set of prudent mortgage lending regulations, a housing market observatory that includes a housing price index, and consumer protection norms. The Real Estate Development Fund (REDF) could consider an arrangement with the banks through which the banks would manage its existing and new portfolio in order to improve loan recovery as well as loan origination. The government and SAMA could also start preparing long-term funding arrangements and instruments starting with a mortgage refinance facility.

12. The efforts to promote SME lending are commendable, but the authorities may also want to consider a number of complementary measures. The Saudi Credit & Saving Bank (SCSB) could focus on start-ups and small firms while strengthening its capacity to handle SME lending. The guarantee scheme could shift from an individual to a portfolio approach as SME lending increases and also align premiums with the quality of SME portfolios. SAMA should supervise the quality of the new SME units in the banks, the robustness of their SME rating models, and their automated loan procedures. A registry for movable collateral should be created and enforcement procedures strengthened.

13. Most of the recommendations in this report could be implemented over a horizon of a year or two. Some, notably those that require the amendment of a law may take longer. The development of a more formal macroprudential framework may also require more time, as the understanding of these issues is still evolving.

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KEY RECOMMENDATIONS

Regulatory oversight

• Broaden the definition of connected parties in bank lending.

• No longer allow large exposures up to 50 percent of banks’ own funds.

• Develop a more formal macroprudential policy framework.

• Update the Banking Control Law and remove need for ministerial approval of certain SAMA decisions.

• Conduct stress tests on a regular basis with a wider range of shocks.

• Formalize the legal framework for bank resolution.

• Increase disclosure by conglomerates and tighten accountability for auditors.

• Strengthen the CMA’s regulatory transparency by fully disclosing all enforcement actions, interpretations, and funding rules.

• Introduce a payment systems law.

Institutional investors and capital markets

• Finalize and issue the outstanding functional regulations for insurance.

• Improve enforcement of mandatory motor third party liability (MTPL) insurance.

• Disclose the investment policies, portfolios,and portfolio performance of the Public Pension Agency (PPA) and General Organization for Social Insurance (GOSI).

• Further outsource the management of the portfolios of the PPA and GOSI.

• Permit foreign institutional investors to invest directly in domestic equities.

• Maintain a stable stock of government securities and regular issues to help anchor a robust yield curve.

Expanding access to finance and preserving financial stability

• As housing finance expands in the future, ensure loan soundness through strong prudential measures, notably lowering permissible loan-to-value (LTV) and debt service ratios (DSRs).

• Contract banks to manage both the existing and the new REDF portfolios.

• Complement mortgage reform by establishing a housing market observatory, developing consumer guidance options, and strengthening the developer industry.

• Prepare long-term funding solutions for mortgage finance, starting with a refinance facility.

• Create a modern, electronic, and unified registry for movable collateral.

• Enact and implement the draft Enforcement Law that introduces specialized enforcement courts operating with strict time-bound procedures.

• Closely supervise the quality of SME units in the banks, including the robustness of their internal rating systems and automated procedures.

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II. FINANCIAL SYSTEM OVERVIEW

14. Commercial banks are the largest segment of the financial system. As of December 2010, there were 20 licensed active banks. Of these, 12 are Saudi incorporated banks whose assets account for 98 percent of the banking assets, or more than half of total financial system assets and 85 percent of GDP (Table 2). As percentage of GDP, bank assets and credit are comparable to those in other countries with similar characteristics. However, as in the case of other Gulf Cooperation Council (GCC) countries, loan portfolios are concentrated, reflecting limited lending to sectors such as SMEs and housing. Credit concentration risk has been mitigated by high capital requirements, but the small volumes of SME and housing finance may have adverse implications for growth and employment and the welfare of the population. Sharia-compliant products are offered by commercial banks based on a single banking license.

15. The banking sector is fairly concentrated around a few banks. The three largest banks together have a share of asssets and deposits of about 45 percent, and each of the next four has a share exceeding 5 percent. The dominant shareholders of the three largest banks are government entities, although all banks with government participations appear to be run on a commercial basis. SAMA licensed two domestic banks in the mid-2000s, as well as several branches of foreign banks, but these remain small and market shares have not been significantly affected.

16. The five public specialized credit institutions (SCIs) still play a significant role.1 The SCIs were designed to complement bank lending and provide medium- to long-term subsidized loans to industry, SMEs, housing, and agriculture. Assets of the five SCIs account for 14 percent of total financial system assets and their loan portfolios represent 24 percent of bank credit to the private sector. The share of SCI credits in total credits has decreased substantially over time, but this trend was reversed during the crisis, as banks became reluctant to lend and the SCIs stepped up their lending activity. Their share might increase further as part of the government’s effort to step up housing and SME lending, although this increase should be temporary.

17. Nonbank financial institutions (NBFI) remain very small with the exception of the two public pension funds. The two public pension funds have combined assets of 46 percent of GDP. The PPA, the larger of the two, manages the scheme for public workers, while the GOSI manages the scheme for private workers. The two schemes operate defined-benefit plans financed on a pay-as-you-go basis but partially pre-fund their future liabilities and have accumulated a large volume of assets due to their young demographic profiles. The insurance sector is growing rapidly but is still minor, as indicated by assets of 1.5 percent of GDP. Mutual funds have grown in number but their assets amount to only 6 percent of GDP, 60 percent of which are in money market funds. The leasing sector also remains very small. 1 The SCIs are: the Saudi Industrial Development Fund (SIDF), which finances industrial projects and SMEs; the Public Investment Fund (PIF), which finances large scale government and private projects; the REDF, which finances residential real estate; the SCSB, which finances individuals and small businesses and professions and; the Agricultural Development Fund (ADF), which finances agricultural projects.

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18. Progress in developing capital markets has been mixed. Equity market capitalization is reasonably high by international comparison (80 percent of GDP in 2010) but the market lacks a solid private domestic institutional investor base. The investor base consists primarily of individual retail investors and large state investors, and the presence of foreign investors remains very limited. Moreover, fixed income markets remain undeveloped. The government debt market has not developed reflecting the continuous decline in the stock of debt outstanding to a low level (10 percent of GDP in 2010). There have been some large, but sporadic issues of corporate bonds and sukuks by a few large companies. Other fixed income instruments such as covered bonds and mortgage backed securities have not been developed yet.

III. BANKING SECTOR PERFORMANCE AND STABILITY

19. The banking sector is well capitalized overall. As shown in Table 3, the solvency ratio for the sector as a whole was above 17 percent in December 2010, and all banks have CARs above the regulatory 8 percent minimum. The Tier 1 capital ratio is about 15 percent, well above the 4 percent required by Basel II and the 4.5 percent required by Basel III, and providing a comfortable cushion. The NPL ratio has remained broadly at 3 percent, with provisions covering about 116 percent of NPLs in December 2010. Profitability weakened during the crisis, but appears to be recovering in 2010, as indicated by the slight increase in the return on assets.

20. Banks appear to be sufficiently liquid. The average ratio of liquid assets to short term liabilities is comfortably at 52 percent as of December 2010. The authorities consider that banks will be able to comply with the Basel III liquidity metrics going forward. The aggregate loan-to-deposit ratio (LTD) was kept within prudent bounds and currently stands at about 71 percent in December 2010. SAMA requires banks to maintain their LTD below 85 percent.

21. The stress tests show that the banking sector as a whole could withstand severe shocks given its high capitalization. The aggregate solvency ratio remains above 8 percent for almost all of the individual shocks. In addition, all banks would remain above the 8 percent minimum CAR for standard shocks such as uniform NPL increases, default by their largest debtors, a decline in non-oil growth, and a short-term decline in oil prices. However, the banking sector could be vulnerable to severe and prolonged oil price declines.

22. The corporate sector seems to be in a healthy condition overall, with only a moderate vulnerability to shocks. The Saudi corporate sector generally compares well with those in other Middle East and North Africa (MENA) countries in terms of profits, leverage, liquidity, and its ability to repay debt. However, there are significant differences across sectors: a few seem more exposed to external shocks, including construction, petrochemicals and telecoms. Some firms in these sectors could experience financial difficulties in the more adverse scenarios. These results are broadly consistent with those of the banking stress tests.

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IV. INSTITUTIONAL INVESTORS AND CAPITAL MARKETS

A. Insurance Sector

23. The insurance sector is still underdeveloped, but has grown rapidly since a formal regulatory and supervisory regime was introduced in 2003. Premiums and assets remain low in terms of global benchmarks, but have increased rapidly to 1 percent and 1.5 percent of GDP, respectively. Weak compliance with mandatory insurance (in the case of MTPL only 40 percent of registered vehicles are insured) has constrained the growth of the nonlife sector. The insurance sector is profitable but a number of small insurers runs losses and are below viable size. The systemic risks posed by these small insurers are minimal due to their small share, but there is need for some consolidation of the industry.

24. The regulatory and supervisory framework has improved significantly and continues to evolve. The 2003 Law and 2004 Implementing Regulations provide broad powers and modern supervision was introduced by the Insurance Supervision Department in SAMA. This allowed SAMA to consolidate the sector over a relatively short period. The regulatory framework is being further strengthened. Five important functional regulations (including risk management, reinsurance, and market conduct) have been issued since 2008, four key regulations (including investments, intermediaries, and outsourcing) are in the consultation stage, and three (actuarial services, governance, and audit committee) are being drafted. An onsite limited scope inspection program is already in place and full scope inspections will begin in 2011. However, health insurance is subject to two supervisors (SAMA and the Council of Cooperative Health Insurance, CCHI) and their respective roles are not yet clear.

25. The authorities may consider some additional measures to support the ongoing development of the insurance sector. The draft regulations being prepared by SAMA represent a significant improvement and should be enacted as soon as possible. The consolidation of the industry would be facilitated by the introduction of a risk based capital regime and specific regulation on mergers, portfolio transfers and windups. A decision on how to deal with the MTPL noncompliance problem should be expedited—possibly through linking the sector’s policy database with the traffic department database. The roles of SAMA and CCHI should be revisited so that in future SAMA deals with insurers’ performance issues, and CCHI focuses more on the insurer/health service provider interface.

B. Mutual Funds

26. The mutual fund sector in Saudi Arabia is small, especially considering the size of market capitalization. There are 267 mutual funds with approximately 6 percent of GDP in assets under management. This is a low figure compared to other similar countries and to the size of the equity market. Approximately half of all assets are invested in money market funds and about 23 percent in domestic equity. Fund groups typically provide a wide range of mutual funds including money market, fixed-income and sukuk funds, domestic equity funds, and international funds. There are also six real estate funds with special valuation and pricing rules.

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27. The regulatory framework for mutual funds substantially complies with international standards. The CMA requires mutual funds to be owned and managed by persons authorized to conduct managing activities. All funds (except real estate funds) are required by the CMA to calculate net asset value at least twice a week. All purchases and redemptions must occur on those days. Funds typically collect an initial subscription fee (0–3 percent) and an annual management fee (for local equity funds 1–2 percent). All fund managers must provide investors with annual and semi-annual financial statements on request and without charge.

C. Pension Assets

28. The two large pension funds have implemented adequate governance structures, operating procedures, and investment policies. The two funds have investment committees that seem to operate independently, conduct actuarial reviews every three to five years and maintain reasonable investment policies. Their strategic asset allocation is generally consistent with their liability structure and entails diversified portfolios. The shares of domestic and foreign assets amount to about 60 percent and 40 percent, respectively in both funds. The share of equity amounts to about 40 percent in both funds with a higher domestic content in the case of GOSI. Foreign portfolios are managed by SAMA, but through outsourcing to several external asset managers. The PPA also outsources the management of its domestic equity portfolio. The two funds have participated in initial public offerings (IPOs) and domestic sukuk issues.

29. At the same time, there is still ample room for further improvements and a more effective contribution to capital market development. The two funds should disclose their investment policies, total assets, portfolio composition and returns to their members and the public at large. Investment committees would benefit from a larger number of independent and expert members, especiallyin the case of the PPA. Portfolios are reasonably diversified but the share of short-term domestic assets looks excessive (10 percent and 15 percent in PPA and GOSI, respectively). The management of domestic portfolios should be further outsourced, especially in the case of GOSI. The exercise of ownership rights in bank equity holdings should entail the appointment of independent experts in bank boards. Finally, the government should consider introducing private defined contribution pension funds for expatriates.

D. Capital Markets

30. Capital market development in Saudi Arabia has been mixed. There are 146 equity securities listed in the stock exchange (Tadawul), but only 7 sukuk (bonds), and 2 ETFs. Equity market capitalization amounted to 80 percent of GDP in 2010 but is rather concentrated, with the 10 largest companies accounting for 62 percent of market capitalization.

31. The IPO market has been strong, but the market has not developed additional instruments. During 2008–10, there were 11 IPOs issued per year with an average value of 1 percent of GDP each year. These values compare well internationally, although half of recent new listings have been insurance companies. The market has not developed other types of instruments such as convertible or preferred shares, commodity-based products or other

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derivatives. Development of the fixed-income market has also been slow. The government debt market has declined dramatically due to the large net redemptions of public debt. The stock of publicly traded corporate debt remains very small – at end-2010 there were only seven sukuk issued by three companies for a total value of SR 35.7 billion. Many factors have contributed to the limited number of sukuks, including the complex issuing procedures, the lack of a government yield curve benchmark, the lack of credit rating agencies, Company Act provisions restricting corporate indebtedness and uneven tax treatment of loans and bond issues.

32. The capital market lacks a solid private institutional investor base. Individual investors account for the bulk of the investor base and dominate market trading. State investors are the largest domestic investors with interests in 69 listed companies representing 37 percent of market capitalization. Private institutional investors are too small to play a meaningful role. Foreign investment is strictly regulated and remains limited. GCC citizens and Saudi resident foreigners may invest directly but are stoo small. All other foreigners may only invest in Saudi mutual funds, in the two listed ETFs or by purchasing an equity swap from a Saudi broker.

33. Turnover ratios compare well with those in other countries, but trading has exhibited a high degree of price synchronicity, suggesting deficiencies in price discovery. A recent World Bank study found a high degree of price synchronicity in markets throughout the MENA region, with the Saudi market having one of the highest.2 There is also some evidence that foreign investor presence in MENA markets tends to reduce price synchronicity in those markets, suggesting that these investors tend to trade more on fundamentals than rumor and sentiment, and contribute to price discovery.

34. The CMA should set market policy and allow the private sector to make market decisions. The Tadawul should be able to expand its products and services, within broad parameters set by the CMA. Derivatives are not inherently speculative and short-selling is an essential component of a well-developed equity market. The development of commodity-based financial products would enable producers to lock-in attractive selling prices and manage risk. Similarly, the CMA should allow companies to determine the timing of IPOs and the IPO price.

35. Tadawul would benefit from greater participation by sophisticated foreign investors. It may be several years before mutual funds, insurance companies, and private pension programs are large enough to contribute to market development. In the near term, large foreign institutional investors could perform this role, if the CMA adopts a regulation to permit direct foreign investment. Greater institutional participation could also be achieved if GOSI and PIF follow PPA and outsource a portion of their domestic portfolios to qualified managers.

2 Financial Access and Stability for the MENA region—A Roadmap (2011). The World Bank.

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36. Development of a corporate debt market will require many changes. A private sector agreement on Sharia-compliant transactions would greatly facilitate new issues. The government could consider maintaining the mimimum volume of securities required for developing a benchmark yield curve for corporate and mortgage bonds. In this regard, it would be useful to examine the experience of other jurisdictions such as Hong Kong SAR, China, New Zealand, Norway, and Singapore. The CMA should consider licensing local credit rating agencies to facilitate price determination and promote investor understanding of the terms and risks of corporate issues. The Company Act should be amended to eliminate the limitation on corporate debt burden.

V. REGULATORY OVERSIGHT

A. Banking Regulation and Supervision3

37. There have been marked improvements in banking regulation and supervision since the 2004 FSAP. SAMA had introduced Basel II and used the Pillar 2 requirements to foster improvements in banks’ risk management and capital planning. In supervision, RBAs have been introduced and large resources allocated to supervision with an overall staffing now hovering around 200 people (a doubling over the past five years). SAMA has also actively initiated the introduction of Basel III requirements.

38. The legal framework is old (1966 Bank Control Law) and should be updated as it contemplates less independence and powers for SAMA than is exercised in practice. SAMA considers that the BCL served it well and that there would be more risk than benefits in amending it. The framework has not been an impediment as SAMA has been able to take adequate actions without using formal legal powers (a situation explained by its credibility and the limited number of banks). However, the BCL could be revised to remove the requirements for government approval to license banks and take sanctions, issue regulations and conduct inspections. Provisions could also be added to provide legal protection to supervisors, require SAMA’s approval in case of transfer of significant ownership, create a bank resolution framework, provide a clear mandate to exercise consolidated supervision, and lift confidentiality requirements when necessary (for example, to share information for supervisory purposes).

39. SAMA’s prudent licensing approach could benefit from a legal definition of its objectives and improved disclosure of its expectations for new banks. Only two banks have been licensed in the last decade and new foreign bank single branches remain marginal players. To make clear that the market is contestable, SAMA should publish its detailed criteria for licensing new banks, fully align them with objectives focused on safety and soundness and withdraw the requirement that new licensees should “add value.”

3 This section draws on a detailed assessment of compliance with Basel Core Principles.

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40. SAMA could complement recent strides in banks’ risk management by an improved regime for large exposures and connected parties. A framework circular should be issued bringing all guidelines on risk management into one document and updating requirements on market risk and internal controls. In a system characterized by high single-name concentration, attention to individual large exposures should be intensified, in particular during on-site inspections. The possibility for SAMA to allow large exposures of as much as 50 percent of capital, which was recently used, should also be removed. The definition of related parties needs to be strengthened to ensure that close family relationships are taken into account.

41. SAMA has made good progress in implementing risk-based supervision and should complete this transition. The requirements for banks to obtain SAMA’s ex ante approval (for example, before opening branches, ATMs, and launching new products) should be reviewed. On-site examinations should focus more on actual risks and banks’ ability to manage them and increased attention should be paid to branches of foreign banks.

42. While SAMA has exercised effectively its consolidated supervision authority, some banks are beginning to expand across border and creating new challenges. The draft Memoradum of Understanding (MOU) with the CMA should be finalized and exchange of inspection reports and common on-site work initiated. SAMA has good contacts with foreign supervisors, but should consider the advantages of written agreements, in particular to facilitate the exchange of supervisory information and provide for on-site inspections across borders.

43. Macroprudential policies have a long history in Saudi Arabia, but could be further developed and formalized drawing on new practices. SAMA has already adopted a large set of macroprudential tools to ensure the stability of the financial system. These include debt service to income ratios and the LTD ratio. SAMA’s actions have helped to rein in credit booms and equity bubbles and mitigate their negative effects. SAMA could build on these achievements and establish more formal macroprudential framework covering the definition of objectives, the elaboration of analytical methods, and the policy toolkit. In line with the practice of many other central banks and drawing on their experience, SAMA should also consider establishing a financial stability department and regularly publishing financial stability reports.

B. Capital Market Regulation and Supervision4

44. The CMA has developed a strong regulatory program in a short period of time that fully or broadly implements most of the International Organization of Securities Commissions (IOSCO) Principles. While the progress achieved by policy-makers and the CMA is commendable, there is scope for further improvements in important areas. The Capital Markets Law (CML) could be ammended to specify that CMA board members can be removed only for good cause. Also, the CMA could improve its regulatory effectiveness by providing

4 This section draws on a detailed assessment of compliance with IOSCO core principles.

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greater transparency. The CMA should publish a more detailed annual report describing its activities, including how the agency funds its operations, the fees it sets, and the amount of revenue generated. All CMA regulatory actions, interpretive guidance, and advisory statements should be published on its website. Similarly, all disciplinary actions should be published, including the name of the entity, the violation and the sanction.

45. Under the CML, the CMA has a dual mandate to regulate and to develop the Saudi capital market. Because there are occasions when these mandates may conflict, the CMA should provide Tadawul with greater independence and the primary responsibility for capital market development, while it concentrates on effective regulation and oversight of Tadawul.

46. The CMA and the Ministry of Commerce and Industry (MOCI) both have responsibilities in corporate disclosure and corporate governance. The CMA is responsible for implementing and enforcing the CML, and the MOCI for enforcing the Companies Act. Listed companies must file disclosure reports with both agencies. The CMA has adopted standards for corporate governance and the duties of listed company directors. The Company Act and the CML should be amended to establish a single set of standards for listed companies under the authority of the CMA.

47. IFRS should be adopted as a single national accounting standard for listed companies. Although the Saudi Organization for Certified Public Accountants (SOCPA) is the national accounting standard, SAMA has mandated banks and insurers to adopt IFRS. The result is that financial companies use IFRS and nonfinancial companies use SOCPA (with some exceptions). SOCPA should be instructed to adopt IFRS as the national standard for listed companies. At the same time, care should be taken to ensure that SMEs are not burdened with financial reporting standards that are designed for larger, publicly-listed companies.

C. Financial Safety Nets and Bank Resolution

48. The approach to financial safety nets in Saudi Arabia has entailed an implicit but strong commitment to the safety of deposits combined with a rigorous prevention of bank failures. As in the case of some other GCC countries, Saudi Arabia does not have an explicit deposit insurance scheme nor formal bank resolution rules. The authorities have favored strong preventive measures to maintain the safety of deposits, backed by strong powers of intervention and the forceful prevention of bank failures. This framework has ensured that no bank has ever failed, and no bank depositors and creditors have suffered losses. The authorities underscored that the current approach rests on clear principles that are well understood by markets. Insolvent banks are speedily resolved (normally through acquisition by other banks), there are no bailouts for shareholders of failed banks, and depositors are protected.

49. During the global financial crisis this traditional approach to deposit insurance was made more explicit by the official announcement that deposits would be safe. At the outset of the financial crisis, the authorities issued a statement assuring the safety of deposits and the financial soundness of banks without specifying a time limit and introduced a strong financial

13

stabilization package to back the guarantees. The authorities maintain the view that this approach has contributed to the stability of the Saudi financial system.

50. While the current approach to safety nets has preserved financial stability, it has also reduced the incentives for private monitoring of banks and has increased the burden on supervision. Under the current approach, neither depositors nor bank creditors have much incentives to monitor the banks, which dilutes the role of Pillar 3 in the Basel II architecture of bank supervision. Market discipline remains an important component of the architecture that needs to be strengthened in Saudi Arabia and other countries. This would call for a review of the approach to safety nets and bank resolution in the medium-run. The lack of an imminent threat to financial stability provides a favorable environment to start introducing a formal resolution framework without risking misinterpretations by the public. In this regard, the Saudi authorities could initiate the preparation of a specific resolution framework for banks in line with international initiatives (including those currently in train at the Financial Stability Board). A complementary measure would be the introduction of an explicit deposit insurance scheme with partial coverage.

VI. FINANCIAL INFRASTRUCTURE

A. Payments and Securities Settlement Systems (SSS)5

51. The national payments system (NPS) in Saudi Arabia efficiently serves the needs of a broad set of users. In particular, SAMA has implemented a comprehensive and robust infrastructure to support the provision of payment services and products by commercial banks. The infrastructure is primarily concentrated on payments in riyals and comprises the following systems: (i) the Saudi Arabian Riyal Interbank Express (SARIE) real time gross settlement (RTGS) system, which processes a wide range of large-value and small-value payments and provides settlement facilities; (ii) the cheque clearing houses operated at SAMA branches; (iii) ATM and point-of-sale services provided through Saudi payments network; and (iv) Electronic Bill Presentment and Payment (EBPP) processed by the SADAD system.

52. Many critical elements of a payments and SSS are covered in the existing legal framework. The current framework covers inter alia the clarity of timing and finality of settlements; the recognition of electronic processing of transactions; protection from third party claims for the collateral pledged in a payment system; competitive practices in the provision of payment services; and consumer protection for retail payment services. However, there is no comprehensive payment system law, and the enactment of such a law is strongly recommended.

53. The SARIE system is the backbone of the NPS. It is a RTGS systems and the only systemically important payment system in the country. SARIE processes both large-value and

5 This section draws on a detailed assessment of observance with the core principles of payments and securities settlement systems.

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small-value payments, both gross settlement and net settlement, and supports both credit transfers and debit transfers. SAMA. All settlements in SARIE are deemed final and irrevocable. SARIE observes fully most of the Core Principles for Systemically Important Payment Systems and observes broadly two principles.

54. Securities settlement systems work safely and efficiently, although some improvements are underway. Corporate securities transactions, with the exception of sukuks, are settled on T+0 with the cash leg occurring at the end of the day and the transfer of securities being executed immediately after trade confirmation. Risks are mitigated by caps and other controls. However, the CMA, Tadawul, and SAMA should quickly bring to fruition their plans to move towards intra-day settlement based on delivery-versus-payment.

55. SAMA is working to establish its payment system oversight function from an operational perspective. The power of SAMA to oversee the payment system is stated in the central bank and banking laws. However, the powers of the central bank to operate, regulate, and oversee the payment systems are not detailed in the law and could be also covered by the proposed Payment System Law. SAMA should also clarify in more detail its policy stance in payment system oversight in a publicly available document. SAMA should accelerate the process of creating a full-fledged oversight unit and ensure the visibility of the oversight function both internally and externally.

B. Credit Reporting and the Collateral Regime

56. Saudi Arabia’s credit reporting system has improved significanty in recent years. SIMAH has expanded substantially the coverage and depth of credit information since it started operating as a consumer credit bureau in 2004. The number of entities providing credit information has increased substantially, now including all regulated and nonregulated financial institutions, utilities, and retailers. SIMAH has benefited from the existence of a national identification number system and has achieved practically universal coverage of the adult male population with 3.8 million records. It has also increased the number of women records to 400,000. The consumer database has facilitated the expansion of consumer lending in recent years and will contribute to the expansion of mortgage lending in the coming years.

57. More recently, SIMAH has also started operating a commercial credit bureau that is expected to promote much better risk management and facilitate SME lending. SIMAH started operating a commercial credit bureau in January 2010 and has been expanding and consolidating the commercial database since then. In coordination with SAMA and the commercial banks, it estimates probabilities of default at the sectoral level and shares the results, allowing the banks to benchmark themselves against the whole banking system. It is also expanding the coverage of smaller firms and has developed a risk rating model for SMEs. Out of the universe of 218,000 registered SMEs, roughly 23,000 SMEs are already rated.

58. The old and ineffective collateral regime is progressively being improved, especially for real estate. A modern and centralized registry for real estate is already in operation and its

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database is being consolidated. This effort has included improvements in the information provided by public notaries. These improvements will prove essential to promote future mortgage lending, although enforcement of real estate collateral remains difficult and remains to be addressed. The situation is worse in the case of movables. The Commercial Liens Law enacted in 2003 allows the creation of a registry for movable collateral and the MOCI enacted the implementing regulations in 2010, but a registry for movables has not been created yet. This is problematic for SMEs, which frequently can only offer movables as collateral. Finally, enforcement of movable collateral has also been difficult.

59. The package of five draft laws approved by the Shura Council and submitted to the Council of Ministers will promote mortgage lending and should also benefit SME lending. The package includes an Enforcement Law that is expected to improve substantially the effectiveness of enforcement procedures for all types of collateral. The law will allow the creation of special enforcement courts and will introduce time bound procedures for the foreclosure of collateral. The disposition of seized collateral will become more efficient due to the possibility of outsourcing sales to the private sector. When approved and implemented, these improvements will promote both mortgage and SME lending, although in the latter case, outcomes will also depend on progress in creating a registry for movables, as noted above.

VII. EXPANDING ACCESS TO HOUSING AND SME FINANCE

A. Housing Finance

60. Despite recent growth, housing finance portfolios remain small. The Real Estate development Fund (REDF) has historically been the main provider of housing finance, with a portfolio of SR 78 billion. It has facilitated access to housing, but is unable to meet a growing demand with waits up to 18 years. In recent years, banks and mortgage finance companies have increased their portfolios but housing demand is not satisfied (annual needs estimated at around 250,000 units over the medium term, compared to 80,000 permits delivered on a commercial basis). Moreover, demand will increase further, reflecting the young and growing population and declining household size. Key constraints include (i) insufficient land availability; (ii) rapidly increasing prices in the main cities; and (iii) developers unable to take on large projects. In response, the Housing Ministry is preparing a National Housing Strategy and a SR 250 billion program is expected to support the building of 500,000 new houses. 61. Despite the good performance of housing loans, some practices will need to be reviewed if banks expand lending. Besides retaining title or ownership, lenders require the assignment of salaries to accounts in their books. Delinquencies are therefore minimal (from 0 to 3 percent). However, loan-to-value (LTV) ratios can be high—up to 100 percent, and debt service ratios (DSR) can be high as well—up to 50 percent for upper end segments. 62. The five draft laws in the mortgage package that are expected to be approved in 2011 would improve the housing finance framework. Besides laying the ground for an

16

efficient mortgage system, the new laws will create a consumer protection framework, empower SAMA to regulate and supervise nondepository lenders (which will help create a level playing field), and establish a framework for the development of funding instruments (mortgage refinance facility, securitization, covered bonds). The new laws would obviate the need for lenders to physically keep title deeds until full repayment (a nontransparent security method that raises operational issues and hinders the pledging/selling of housing loans). 63. In view of the risks that are inherent to residential real estate lending, additional measures are needed to ensure the sound development of the market. These include: (i) new prudential norms on mortgage lending (capital, provisioning); (ii) development of a housing market observatory, including a price index; and (iii) consumer protection norms (for example, on responsible lending principles). 64. The REDF’s new business model could have a strong catalytic impact on housing finance. The REDF has been plagued by high delinquencies (half of the portfolio), scarcity of resources and rigid origination criteria (requirement for borrowers to own a piece of land, financing limited to self-construction). The new policy aims to broaden the range of eligible projects, better target the lower income population, and set prioritization criteria. This new policy is expected to increase the demand for the REDF loans and for complementary bank finance. In order to maximize the impact of budgetary resources and ensure sound lending the Ministry of Housing and the REDF could consider the following measures: (i) outsource the servicing of the REDF old and new loans to the banks to improve recovery rates and the quality of loan origination; (ii) combine the resources of the SR 250 billion program with new bank lending under suitable risk-sharing arrangements and; (iii) explore ways to provide banks with long term funding matching the maturity of the new housing loans. 65. Asset and liability mismatches should be closely monitored, and new funding instruments established to facilitate adequate risk management. New funding models will be needed going forward as banks cannot fund large portfolios with short-term deposits only and nondepository lenders cannot rely exclusively on bank funding. Interest rate risk will eventually be a concern, as nearly half of portfolios carry fixed rates or mark-ups. A second tier refinancing facility is the best option at the current stage of market development. Securitization and covered bonds will also be useful, but time is needed to develop these.

B. Finance to Small and Medium-Sized Enterprises

66. The average share of loans to SMEs in total bank loans is only 2 percent, revealing the slow progress in developing this key line of business. Banks regard the SME credit market as profitable and have stressed the low NPL ratios (about 1 percent) in this segment. Banks indicate their intention to increase the share of SME lending and have set up dedicated SME units to build lending and risk management capacity in this area. They are also taking advantage of the increasing availability of credit information from SIMAH and developing internal rating

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models. Some banks indicate their intention to adopt automated credit processing systems. However, the slow development of the SME business also reveals lingering gaps in financial infrastructure, especially in the collateral regime.

67. The government is introducing a strong package of measures to promote further SME lending. In 2010, the government increased the resources of the Saudi Industrial development Fund (SIDF) by SR 10 billion and a significant share of these resources should be channeled to manufacturing SMEs. The capital of the Saudi Credit and Savings bank (SCSB) has been increased by SR 20 billion, half of which should be channeled to small enterprises. The rules of the Kafala Credit Guarantee Scheme have been revised to make SME lending more attractive to banks. In particular, the turnover threshold defining eligible SMEs has been increased from SR 20 to SR 30 million.

68. The package is an important and warranted initiative. The SIDF is well equipped to manage more SME lending. The changes in the rules of the Kafala Credit Guarantee Scheme seem warranted. Only 777 guarantees were issued in the first years of the scheme (2006–10) and Kafala remains the smallest guarantee scheme in the MENA region, as measured by the low ratio of outstanding guarantee to GDP (only 0.03 percent). The new threshold of SR 30 million is justified and still low by international standards. The scheme operates with a low leverage of 2:1 and has experienced modest losses.

69. The government and SAMA may consider a number of measures to ensure the sound expansion of SME lending and the maximum outreach of credit constrained SMEs. The respective roles of the different institutions and schemes could be better defined, especially the role of the SCSB, which has experienced large losses in the past and still lacks the capacity to manage SME lending. This institution should arguably focus on start-ups and its capacity to handle SME lending should be substantially strengthened. The Kafala scheme should consider shifting from an individual to a portfolio approach as SME lending increases, and align contributions with the portfolio performance of participating banks. SAMA should supervise the quality of the new SME units and the robustness of the rating models adopted, especially in the institutions that plan to adopt automated loan processing. Last but not least, financial infrastructure should be further strengthened, especially by developing a registry for movable collateral and strengthening enforcement procedures, as noted above.

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Table 1. Saudi Arabia: Selected Economic Indicators, 2005–11

Prel. Proj.2005 2006 2007 2008 2009 2010 2011

National income and pricesCrude oil production (million of barrels per day) 1/ 9.4 9.2 8.8 9.2 8.4 8.4 9.3Average oil export price (in U.S. dollars per barrel) 2/ 50.9 61.4 68.0 93.0 59.2 75.8 101.9Nominal GDP (in billions of Saudi riyals) 1,182.5 1,335.6 1,442.6 1,786.1 1,412.6 1,679.1 2,137.9Nominal GDP (in billions of U.S. dollars) 315.8 356.6 385.2 476.9 377.2 448.4 570.9Nominal GDP per capita (in U.S. dollars) 13,658.0 14,784.4 15,444.4 18,495.4 14,148.3 16,266.7 20,266.0Real GDP 5.6 3.2 2.0 4.2 0.1 4.1 6.5

Oil 6.2 -0.8 -3.6 4.2 -7.8 2.2 9.4Non-oil 5.2 5.1 4.7 4.3 3.5 4.9 5.4

Real GDP—Public Sector 4.0 3.1 3.0 3.7 5.2 6.3 6.5Real GDP—Private Sector 5.8 6.1 5.5 4.6 2.7 4.2 4.8

Implicit GDP deflator 3/ 19.3 9.5 5.9 18.8 -21.0 14.1 19.6Oil 37.2 17.5 13.6 31.6 -33.6 24.5 30.2Non-oil 4.1 3.7 1.6 3.1 3.3 5.0 5.4

Consumer price index (all cities index) 0.6 2.3 4.1 9.9 5.1 5.4 6.0

External sectorExports f.o.b. 43.3 16.9 10.5 34.4 -38.7 30.6 34.9

Oil 45.9 16.5 9.1 36.9 -42.0 32.0 39.0Non-oil 24.6 20.0 22.1 16.5 -9.9 22.8 10.2

Imports f.o.b. 32.8 17.0 29.3 22.9 -14.2 11.9 24.7Current account balance (in percent of GDP) 28.5 27.8 24.3 27.8 5.6 14.9 20.1Export volume 11.3 2.4 1.3 10.4 -13.7 12.1 18.5Import volume 28.0 7.1 19.2 13.6 -6.0 4.4 13.7Terms of trade 31.7 8.6 1.6 22.8 -26.4 16.7 19.6FDI (in billions of U.S. dollars) 12.1 18.3 24.4 38.3 36.5 21.6 22.8

Money and creditNet foreign assets 59.0 52.5 30.1 43.8 -3.1 7.3 20.8Domestic assets (net) -8.4 -16.8 -16.0 -130.9 -77.0 4.3 634.8 Claims on government (net) -389.7 87.7 69.0 127.7 -7.4 6.0 26.8 Claims on private sector 38.9 9.2 21.4 27.1 0.0 5.7 12.7 Bank claims on state enterprises 8.7 10.4 7.1 -14.3 -12.3 14.7 21.9Money and quasi-money (M3) 11.6 19.3 19.6 17.6 10.7 5.0 11.6

Deposit interest rate (in percent) 4/ 3.8 5.0 4.9 3.3 0.9 0.7 0.9

Central government financesRevenue 48.0 50.8 44.6 61.6 36.1 44.2 47.3

Of which: oil 42.7 45.3 39.0 55.1 30.8 39.9 43.6Expenditure 29.6 29.8 32.3 29.1 42.2 38.9 38.0

Current expenditure 24.4 24.5 24.1 21.8 29.5 27.1 27.3Wage bill 5/ 12.4 12.1 12.8 10.6 14.8 14.8 12.1Interest payments 2.2 2.1 1.5 1.0 1.0 0.7 0.4

Capital expenditure 5.3 5.3 8.3 7.3 12.7 11.8 10.7Overall fiscal balance 18.4 21.0 12.2 32.5 -6.1 5.2 9.3

Excluding oil revenue -24.3 -24.3 -26.7 -22.5 -36.9 -34.7 -34.3Non-oil primary deficit/Non-oil GDP -46.2 -48.2 -55.8 -57.7 -67.6 -70.8 -80.7

Central government's gross domestic debt 38.9 27.3 18.5 13.2 15.9 9.9 7.0General government fiscal balance 21.9 24.6 15.8 33.5 -5.1 5.9 …

Resource balance Gross investment 6/ 18.2 18.7 20.5 22.8 25.2 22.9 20.0

Government 4.6 4.4 5.8 6.2 7.9 7.2 6.5Private 11.9 13.1 14.7 13.3 15.8 13.5 11.7

National saving 46.7 46.4 44.8 50.5 30.7 37.8 40.0Government 23.7 26.3 20.5 39.9 6.6 17.1 20.0Private 23.1 20.1 24.3 10.6 24.1 20.7 20.1

Memorandum items:SAMA's total net foreign assets 150.5 221.4 301.3 438.5 405.9 441.0 535.4

In months of imports of goods and services 7/ 15.7 18.1 20.1 31.9 27.5 25.1 27.3Total external debt 8/ 29.8 42.6 75.9 83.4 89.7 90.1 …

Of which: short-term debt 8/ 13.6 11.9 28.5 32.2 35.5 41.2 …Imports Goods & Services/GDP 27.8 31.8 37.7 37.1 42.6 38.9 36.9Imports G&S/Total domestic absorption 42.6 47.3 51.8 56.2 48.7 49.7 50.1Real effective exchange rate (2000=100) 100.0 98.7 94.9 95.9 103.5 104.9 …Average exchange rate Saudi riyal/U.S. dollar 3.7 3.7 3.7 3.7 3.7 3.7 …Population (millions) 23.1 24.1 24.9 25.8 26.7 27.6 28.2All-Shares Price Index (TASI) 167,126.4 7,933.3 11,176.0 4,803.0 6,121.8 6,620.8 …

Sources: Saudi Arabian authorities; and Fund staff estimates and projections.

1/ Includes production from the Neutral Zone and condensate.2/ Includes refined products.3/ Includes all mining, manufacturing, construction, and other activities of the oil sector.4/ Three-month Saudi Arabian riyal deposits.5/ Includes a 13-month salary in 2010, 2013, and 2016 linked to the lunar calendar.6/ Includes changes in inventories.7/ Next 12 months. 8/ BIS-IMF-OECD-World Bank external debt database. Starting in 2004, coverage of bilateral loans and trade credit is less comprehensive.

(Percent changes; unless otherwise indicated)

(In percent of GDP)

(In percent of GDP)

(In billions of U.S. dollars; unless otherwise indicated)

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Table 2. Saudi Arabia: Financial System Structure, 2007–10 (In percent)

Table 3. Saudi Arabia: Selected Indicators of Banking Soundness, 2007–10 (In percent; end of period)

2007 2008 2009 2010

Capital Adequacy

Regulatory capital to risk-weighted assets 20.6 16.0 16.5 17.7

Regulatory Tier 1 capital to risk-weighted assets 15.9 14.1 14.9 15.3

Capital to assets 12.6 13.3 14.0 14.5

Asset quality and composition

NPLs to gross loans 2.0 1.3 3.2 3.0

NPLs net of provisions to capital -3.7 -3.8 1.4 -2.7

Foreign exchange loans to total loans 11.4 13.5 14.0 13.3

Earnings and Profitability

Return on assets 2.8 2.7 1.9 2.0

Return on equity 22.3 20.5 13.7 13.6

Interest margin to gross income 36.1 57.0 73.0 70.3

Noninterest expenses to gross income 26.6 31.0 31.0 33.0

Trading and fee income to total income 22.7 22.7 20.1 20.5

Liquidity

Liquid assets to total assets 21.7 22.8 25.3 24.7

Liquid assets to short term liabilities 41.4 41.6 40.0 52.0

Customer deposits to total loans 124.4 121.0 128.6 136.0 Foreign exchange liabilities to total liabilities 22.8 22.0 24.3 21.7

Source: Saudi Arabian Monetary Agency, and staff calculations.

Number Number Number Number

Banks 17 48.2 74.4 20 54.8 72.6 20 53.8 96.3 20 52.4 84.9 Domestic 11 46.6 71.9 12 53.2 70.6 12 52.5 93.9 12 51.2 83.0 Foreign 6 1.6 2.5 8 1.6 2.1 8 1.4 2.4 8 1.2 1.9

Specialized Credit Institutions1/ 5 13.7 21.2 5 14.0 18.6 5 13.6 24.4 5 14.3 23.1 Saudi Real Estate Development Fund1/ 4.1 6.3 4.1 5.4 4.1 7.4 4.4 7.1 Saudi Industrial Development Fund 0.8 1.2 0.8 1.1 0.9 1.6 1.1 1.7 Public Investment Fund 7.5 11.6 7.5 10.0 7.1 12.7 7.3 11.8 Saudi Credit & Saving Bank 0.4 0.6 0.7 1.0 0.7 1.2 0.6 1.0 Agriculture Development Fund 0.9 1.4 0.9 1.1 0.8 1.4 0.7 1.2

Institutional Investors 37.6 58.0 30.6 40.6 31.9 57.0 32.7 53.1Insurance Companies … … … … 0.6 0.9 … 1.0 1.7 … 1.1 1.7 Life … … … … 0.1 0.1 … 0.2 0.4 … 0.3 0.5 Nonlife … … … … 0.5 0.7 … 0.7 1.2 … 0.7 1.1 Health … … … … 0.0 0.0 … 0.1 0.1 … 0.1 0.1Mutual Funds 233 4.7 7.3 262 3.2 4.2 266 3.6 6.4 267 3.5 5.7 Money Market Funds 49 1.5 2.3 57 1.8 2.4 61 2.2 3.9 56 2.2 3.5Public Pension Funds 2 32.9 50.7 2 26.8 35.5 2 27.4 49.0 2 28.2 45.7 GOSI1/ 14.2 21.9 11.9 15.8 12.0 21.5 12.4 20.1 RPA1/ 18.7 28.8 14.9 19.8 15.3 27.4 15.8 25.6

Other Nonbank Financial Institutions 0.4 0.7 0.6 0.8 0.6 1.1 0.6 1.0 Leasing Companies … …… … …… …… … …… …… … …… … … Securities Firms 80 0.4 0.7 110 0.6 0.8 110 0.6 1.1 97 0.6 1.0

Total Financial System 100.0 154.0 100.0 133.0 100.0 179.0 100.0 162.0

Memorandum Items Equity Market Capitalization 134.9 51.8 84.8 79.8 Outstanding Government Bonds 83 18.5 74 13.3 62 16.0 46 10.0 Outstanding Corporate Bonds 1.1 1.2 2.0 2.2

Assets (in millions of Saudi riyals) 2225772 2368365 2520066 2694371GDP (in millions of Saudi riyals) 1442572 1786143 1409124 1661624

1/ IMF staff estimates for end-2010.

Total Assets

Total Assets

Total Assets

GDPGDP

(In percent) (In percent) (In percent)

GDP Total Assets

GDP

(In percent)

2007 2008 2009 2010