Financial Service Industry In Saudi Arabia

(BIS Papers No 28, 2006), Foreign banks’ presence in Saudi Arabia can be traced back to 1926, when the Netherlands Trading Company, later to become Algemene Bank Nederland (ABN) began operations. It enjoyed a virtual monopoly until the late 1940s. In 1947, Banque Indo Chine opened a branch, followed by the Arab Bank Limited (1949), the British Bank of the Middle East (1950) and the National Bank of Pakistan (1950). In October 1952, SAMA was established by the Saudi government with primary responsibility for monetary stability. Following SAMA’s creation, the government followed an open and liberal policy and permitted the opening of new foreign bank branches, including Banque de Caire, Banque du Liban et d’Outremer and First National City Bank of New York. This first wave of foreign banks linked Saudi Arabia firmly with the global financial markets and encouraged a competitive domestic environment. During this period, three domestic banks were also licensed. The National Commercial Bank was licensed in 1953; Riyad Bank started operations in 1957 and Al-Watany Bank in January 1958.

By 1975, 10 international banks with 29 branches were present in the Kingdom. These institutions operated as branches of their parent companies but, in 1976, a decision was taken by the Saudi government that these should become incorporated as local banks with majority Saudi shareholdings. The major reason for this important policy decision was that with the boom in oil revenues in the mid-1970s, the Saudi economy expanded and grew very rapidly. This led to sharp rise in demand for banking products and services, which the existing banks found difficult to cope with. The government quickly recognized the need for larger and more sophisticated banks. It also observed that capital invested in the banking sector was insufficient and inhibited banks from investing in branch networks, implementing new technology and training human resources. While the government encouraged all foreign banks to invest more capital, it realized their constraints and also noted that many local investors were ready to make large capital investments for developing the banking system. Consequently, in 1976 the Council of Ministers (the final legislative authority) offered foreign banks operating in the Kingdom a chance to form joint venture banks with Saudi shareholders. This decision required foreign banks to convert their branch operations to Saudi joint stock companies in which they could retain up to a 40% shareholding. In subsequent years, all foreign banks accepted these proposals and formed joint ventures, as there were a number of incentives offered, including the following:

The new joint venture banks were accorded full national treatment at par with fully owned Saudi banks. They were permitted to rapidly expand their branch networks and to access all the benefits and privileges available to local banks.

The foreign partners were offered and encouraged to take on Technical Management Agreements for the operation of joint venture banks. Thus, they exercised considerable management influence over the banks’ affairs and continued to provide human, technical and other expertise and resources.

All joint venture banks were given a tax-free holiday period of five years from the dates of their conversion. These tax-free periods were subsequently extended for an additional five years.
The creation of joint stock Saudi banks whose shares were held by a large number of investors also contributed to the development of the Saudi shares market as bank shares quickly became popular among investors. This further contributed to the increase in value of investments owned by foreign shareholders.

The conversion of foreign bank branches into joint venture banks also had prudential implications as the move permitted all banks to substantially increase their capital base. This helped banks to stay liquid and creditworthy despite the subsequent domestic and international economic turbulences they faced in the 1980s and 1990s.

Following these changes, during the period from 1982 to 2000, no new foreign or domestic banks except one were granted a license, as the government believed that the country was adequately served by the existing branch network. During the 1990s, the banking system made large investments in the payment systems infrastructure and in technology-based customer products and services. These include automated teller machines, point of sales terminals, telephone and internet banking, electronic share trading, etc. Consequently, while the banking system expanded greatly in size and scope of its activities, there was only limited expansion in the banks’ branch network. Nevertheless, the Saudi banking system currently has a presence of more than a dozen foreign bank shareholders from many parts of the world. Their shareholdings range from less than 1% to 40% of a bank’s total capital. In addition, there are international banks with full branch operations.

The Saudi Arabian financial system has always been open to foreign presence. The government has encouraged this policy to promote trade, investment and economic relations, and to attract expertise and technology. It already has considerable foreign investor presence as eight of the eleven banks have substantial foreign ownership. Many of the foreign partners in Saudi joint venture banks have technical management agreements. In past five years, Saudi Arabia has licensed a number of GCC (Gulf Cooperation Council) banking institutions, as a result of a decision of the GCC Summit to permit reciprocal opening of their banking markets. In this connection, Gulf International Bank of Bahrain was granted a license in September 2000 to open a branch in Saudi Arabia. This was followed by the grant of branch licenses to the Emirates Bank International, the National Bank of Kuwait, the National Bank of Bahrain and Bank Muscat. Two of these banks are already operational, while the other three are planning to commence operations over the next 12 months. The government has also decided to allow major international banks from different parts of the world to obtain banking licenses. To this end, branch-banking licenses have been granted to three major international banks: BNP Paribas, Deutsche Bank and JPMorgan Chase. These banks are now in the process of opening their branches. More recently, in August 2005, Saudi Arabia granted branch licenses to two regional banks: National Bank of Pakistan and State Bank of India, which are expected to become operational in 2006. It should be noted that with the opening of the branches of these new foreign banks by end-2006, the number of licensed banks in the Kingdom would have doubled since 2000. The entrance of these institutions into the Saudi banking market should enhance competition, support the transfer of technology, improve financial services in all sectors and create employment opportunities. This is part of the Saudi government’s vision for a dynamic financial sector, which will also benefit from the participation of non-bank investment and brokerage companies under the recent Capital Market Law, and the participation of insurance companies under the new Cooperative Insurance Law.

Saudi Arabia is believed to first know insurance during the 1920s through foreign agencies operating in the eastern and western provinces. In 1931, the government devised a regulation governing insurance on imported goods. Gradually, insurance had increased in the Kingdom during the 1950s, which was mainly driven by the need to have optional insurance to cover risks related to governmental construction projects, however the economic prosperity during the 1970s owing to the soar of oil prices had given solid grounds for the insurance industry to develop. The massive infrastructure projects essentially attracted insurance agencies to the market and the number of insurance providers had multiplied. The insurance industry in the late 1980s and 1990s was affected by the steadiness of government projects, (NCCI, 2002).

(Swiss Re No.7/2006),The Saudi insurance market is emerging with USD 1.4 billion market in 2005 and it projected by many experts to grow to USD 4 billion by 2010. According to a survey conducted by the Institute of Banking on the Saudi insurance market in 2003, the largest share comes from motor insurance, which accounts to 32% in 2003 followed by medical insurance with a share of 22% and property insurance with a share of 17% (Institute of Banking, 2003).

The cooperative insurance is an accepted Islamic concept form of insurance. Essentially, it is founded on mutual-like approach where a group of societal (Maysami and Kwon, 1999). Insurance companies operating in Saudi Arabia is required under the new regulations of 2004 to adhere to this approach. Out of the 70 insurance companies working in the Saudi market, only 15 companies are officially to operate.

While it ranks second in amongst Arab insurance industries, the Saudi insurance market represents 0.5% of the GDP, which is low compared to some regional countries (Arig, 2003). The insurance industry directly employs more than 2,500 employees out of which Saudi nationals represent 36% (IOB, 2003). Generally, the market in KSA is considered underinsured, the fact that attracts many foreign insurers to this market.

Different distribution channels are existent in the Saudi insurance market, which are direct sales, independent brokers, agents, franchise and Bancassurance. Low awareness of insurance and religious beliefs undermines the insurance business in KSA. Consumers tend to buy insurance to comply with regulation necessity by in large.

The Saudi Arabian Monetary Agency introduced the long awaited insurance regulations in 2004. The Cooperative Insurance Companies Control Law establishes a new legal structure for regulation of the insurance industry in Saudi Arabia. Under the Insurance Law, insurance business must be undertaken through a registered insurance company operating in a cooperative manner. The regulation permits foreign insurance companies to enter the Saudi market with shareholder ownership limited to 49%. There was no official framework prior to the regulation that governed insurance operations, except general company law of the Ministry of Commerce and a committee for dispute resolution through arbitration.