For the past decade, Saudi Arabia has been at the forefront of the development of the Islamic financial services (IFS) sector. The Kingdom, which is home to more than a quarter of the GCC’s Islamic financial assets and a handful of the world’s largest sharia-compliant financial institutions, is currently among the top IFS markets in the world. In 2011-12 the sector continued to expand, buoyed by Saudi’s strong economic fundamentals and the Kingdom’s growing reputation as a centre for innovation in IFS. The industry’s strong performance during the 2008-09 international economic downturn, in particular, has stood it in good stead in terms of opportunities for ongoing future expansion.
The Kingdom’s reputation as a regional and, indeed, global centre for the IFS industry is expected to continue to grow for the foreseeable future. The sukuk (Islamic bonds) and sharia-compliant insurance segments in Saudi have become key economic contributors in recent years. In the first quarter of 2012 the Kingdom overtook the UAE to become the single largest sukuk issuer in the GCC and the second in the world, behind Malaysia. Additionally, the Saudi Arabian Monetary Agency (SAMA), the country’s central bank, is in the process of organising a central sharia authority, which, given the Kingdom’s status as the birthplace and home of Islam, has the potential to become a global IFS authority. With these developments in mind, most local IFS players are broadly optimistic about the future.
History & Definitions
Saudi Arabia has played a major role in the history of the modern IFS industry. In the early 1970s the Kingdom was a key participant in a series of conferences aimed at liberalising the regional financial sector and developing sharia-compliant products and services, which until that point had been largely non-existent in the Gulf. Indeed, the Jeddah-based Islamic Development Bank (IDB), currently one of the largest sharia-compliant entities in the world, was founded by a group of finance ministers at the first Organisation of the Islamic Conference (now known as the Organisation of Islamic Cooperation, OIC) in 1973.
These gatherings encouraged many countries across the region – including the Kingdom – to liberalise their financial services sectors, with a focus on the IFS segment. In 1977, for example, senior Saudi religious scholars legalised Islamic insurance in the country, which jumpstarted the local insurance industry.
SAMA operates a relatively more relaxed regulatory framework when it comes to sharia compliance compared to many of its neighbours. While most Islamic financial institutions in the country maintain a sharia supervisory board, in practice the boards are free to approve new products and services as they see fit. This system is much more flexible than most other major IFS markets around the world. In Malaysia, for example, all new IFS products and services must be approved directly by Bank Negara Malaysia, the central bank.
The Kingdom’s liberal framework in regard to sharia compliance has resulted in a diverse local financial market. Different institutions operate under a wide variety of identities vis-à-vis sharia compliance, with some banks marketing themselves as strictly Islamic and others taking a more conventional tack. Many institutions have adopted the standards outlined by a handful of IFS authorities, including Malaysia’s Islamic Financial Services Board and the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions.
Oversight & Regulation
SAMA, which was created in April 1952, supervises all aspects of the financial system. The central bank oversees the Kingdom’s monetary policy, licenses and regulates commercial banks, and manages the government’s foreign exchange reserves, among other functions. SAMA also oversees the insurance sector (see Insurance chapter). In recent years the central bank has begun to look into potentially formalising the regulation of the IFS sector – and specifically the rules surrounding sharia compliance – under an independent entity, either within the bank or on a standalone basis. Incidentally, SAMA has made it clear that it does not plan to adopt a dual system, whereby IFS institutions and conventional institutions operate under separate sets of regulations. Many leading local players agree that the market would benefit from a central sharia authority, which would potentially certify products and services as sharia-compliant. As the birthplace of Islam, the Kingdom is well situated to host such an institution, according to Abdullah Al Rajhi, the CEO of the Riyadh-based Al Rajhi Bank, the largest Islamic bank in the world.
By The Numbers
Due to a wide variety of reporting and regulatory standards, and classification systems, IFS statistics vary substantially depending on the source. According to a mid-June 2012 report published by Deloitte, a professional services firm, Saudi was home to an estimated $94bn in Islamic finance assets as of the end of 2011, which was equal to some 26% of total Islamic assets in GCC members states and around 8.2% of global sharia-compliant assets. Meanwhile, according to a March 2012 report released by the UK Islamic Finance Secretariat (UKIFS), which is part of TheCityUK, at the end of 2010 Saudi boasted $151bn in total Islamic finance assets, including banking, takaful (Islamic insurance) and funds. Based on the UKIFS data, in 2010 the Kingdom was home to the second-largest IFS industry in the world, behind Iran. Additionally, the secretariat reported that in 2010 sharia-compliant assets accounted for around 35% of total banking assets in Saudi, which is in line with estimates by local firms.
Finally, according to the “2011-12 World Islamic Banking Competitiveness Report”, published by Ernst & Young (E&Y), another global professional services firm, at the end of 2010 Saudi was home to $132bn in Islamic banking assets, which was equal to 35% of total banking assets. According to Metaib Al Rawqi, the CEO of Weqaya, a local takaful firm, most of Saudi’s non-Islamic banks and funds are in the process of converting to a sharia-compliant model, to the extent that the industry is expected to be almost completely Islamic by 2015.
As per the E&Y report, between 2008 and 2010 the Kingdom’s Islamic banking sector grew by 19%, compared to growth of 14% in the conventional segment. At current growth rates, Saudi is expected to hold $291bn in Islamic assets by 2015, according to E&Y, making it the largest IFS market in the Middle East. This is in line with global trends. Between 2006 and 2011 global Islamic finance assets grew from $509bn to $1.3trn, according to UKIFS data. Similarly, a May 2012 report published by the Statistical, Economic and Social Research and Training Centre for Islamic Countries, a subsidiary of the OIC, notes that global Islamic finance assets jumped from $80bn in 2000 to $1.1trn at the end of 2011. Most sharia-compliant assets are held in the banking industry, though takaful and funds have also grown substantially in recent years.
Saudi is home to a variety of Islamic banks, insurance companies and other entities. The banking sector is dominated by a handful of major institutions. In 2011 the top four sharia-compliant banks accounted for over 90% of total Islamic finance assets, according to Deloitte and individual bank reporting.
Al Rajhi Bank, the largest bank in the Kingdom by market capitalisation, boasted total assets of $58.8bn in 2011, up substantially from $49.2bn at the end of 2010. The 2011 figure was equal to 62.6% of the Kingdom’s total Islamic assets at the time. The bank, which was launched in 1957, is a subsidiary of the family-owned Al Rajhi Trading and Exchange Corporation. With more than 500 branches and some 3100 ATMs in the Kingdom, at the time of writing, the bank dominates the domestic retail market, and it also has operations in Malaysia, Kuwait and Jordan.
With assets of $10.3bn in 2011, Bank Al Jazira is the second-largest Islamic bank in the Kingdom. In March 2011 the bank, which was founded in 1975 and became fully sharia-compliant in 2007, successfully sold a $267m sukuk, one of the largest in recent years. The third- and fourth-largest Islamic banks as of the end of 2011 were Alinma Bank, with $9.8bn in total assets, and Bank Albilad, with assets of $7.4bn. Other prominent Saudi banks that are either fully sharia-compliant or hold a substantial amount of sharia-compliant assets include National Commercial Bank (also known as Al Ahli Bank); SABB (formerly Saudi British Bank), which is affiliated with HSBC; Riyad Bank; Arab National Bank; and Banque Saudi Fransi, which is affiliated with the French Crédit Agricole Group (see Banking chapter).
The IDB, which is based in Jeddah, is one of the largest Islamic financial entities in the world. At the time of writing, the institution had a total membership of 56 countries. Saudi Arabia was the largest contributing member in terms of paid-up capital by a substantial degree, holding around 26.5% of the bank. The IDB aims to “foster economic development and social progress in its member countries and Muslim communities in nonmember countries individually as well as jointly in accordance with the principles of sharia”. From the bank’s founding in the mid-1970s through 2008 it has funded more than 6100 projects in OIC member countries, with total financing of $56.9bn (see analysis).
One of the most popular and widespread Islamic finance products in the Kingdom is murabaha, a financing arrangement wherein a bank purchases an asset on behalf of a client and then sells it on to the same client at a prearranged price. The sharia-compliant consumer financing market in Saudi relies heavily on murabaha deals, which are suited to asset acquisition. Indeed, many local retail banks extend murabaha financing to clients who are interested in purchasing a car or, in some cases, a house. The structure has also been used to finance larger corporate deals. In 2009, for example, Zain, a Kuwaiti telecommunications company, funded a major regional expansion effort with a $2.5bn murabaha from a handful of Saudi banks. More recently, in 2012 Mobily, a Saudi-based telecoms operator, benefitted from a SR10bn ($2.67bn) murabaha deal that involved the operator selling large blocks of prepaid mobile minutes to a number of local financial institutions, with the condition that Mobily would then distribute the minutes on the banks’ behalf.
Another popular form of Islamic financing in the Kingdom is musharaka (partnership), which involves a bank providing funding for a client to purchase an asset, with the two parties agreeing to share profits and losses for the asset. In general musharaka deals entail less risk for lenders than murabaha deals. In early July 2012 the government approved a new mortgage framework, which is expected to jumpstart activity in the construction and financial services sector and boost homeownership throughout the Kingdom.
The Sukuk Market
In recent years Saudi has become one of the largest sukuk issuers in the world. In the first four months of 2012 alone the Kingdom saw five new issues worth a total of $6.55bn, including an SR15bn ($4bn) sukuk from the General Authority for Civil Aviation (GACA) in January, which was both the Kingdom’s first government-backed sharia-compliant bond issue and the largest Saudi sukuk to date. As of mid-October 2012 Saudi government agencies and local companies had raised around $8bn from Islamic bonds since the beginning of the year, according to local media reports. By way of comparison, in 2011 local companies put forward a total of five Islamic bonds worth $2.76bn, down slightly from $3bn raised from four sukuk issues in 2010, $3.1bn in total in 2009 and $1.7bn in 2008. With these figures in mind, 2012 is expected to be the Kingdom’s biggest year to date in terms of Islamic bonds. In the first quarter of 2012 Saudi overtook the UAE to become the single largest sukuk issuer in the GCC and second in the world, behind Malaysia.
Unlike conventional bonds, sukuks pay returns based on asset values. In order to avoid riba (interest), which is forbidden under sharia law, sukuk deals involve separate sales and purchase agreements. Most Saudi sukuks are long-term issues, with a 10-year maturity, though in April 2011 the Saudi Binladin Group, a major local contractor, finished repaying a $186.7m short-term sukuk, which had been launched just a year earlier.
The GACA sukuk, which was sold on the domestic market and 3.5 times oversubscribed, was widely considered to be a milestone in the Kingdom. “What we saw in this issuance was extremely good prices, extremely liquid markets and extreme confidence among investors,” Fahad Al Saif, the head of debt capital markets at HSBC in Saudi Arabia, told the Financial Times. “Debt capital markets are now definitely an option for Saudi entities looking to diversify their funding.”
Indeed, while the primary purpose of the GACA sukuk was to fund the construction of Jeddah’s King Abdulaziz International Airport, the listing also served to highlight the government’s commitment to the Kingdom’s secondary debt market. Indeed, the government is currently working to expand investment options in all areas, in an effort to suck up excess liquidity in the banking sector and build Saudi’s capital markets.
As of late 2012 this effort appears to have yielded positive results. In early March 2012 Almarai, the largest dairy firm in the Gulf by market value, issued a $267m sukuk that was five times oversubscribed. In early April 2012 the Kingdom’s electricity utility, Saudi Electricity, issued a $1.75bn sukuk that was 10 times oversubscribed. Later in April SABB issued a $400m sukuk, which was privately placed and fully subscribed; and AJIL Financial services, a local leasing and asset management firm, issued an SR500m ($133.3m) sukuk, which was oversubscribed by 50%. Since April 2012 a substantial number of additional sukuks have been issued in the Kingdom. Saudi Fransi successfully sold a $750m listing in May, for example, and in mid-November 2012 the bank announced plans to issue up to another SR2.5bn ($666.5m) in a second sukuk. The National Industrialisation Company, a manufacturing firm, issued a privately placed SR2bn ($533.2m) sukuk later in May, which was over 1.5 times oversubscribed. IDB, meanwhile, issued a SR2.5bn ($666.5m) sukuk in Saudi in June, which was the bank’s sixth such issuance since 2003. Saudi Hollandi Bank completed an SR1.4bn ($373.2m) issue in late November 2012. With these deals in mind, 2012 is on track to be the largest year on record in terms of sukuk issues in the Kingdom.
The recent spate of Islamic debt issues in Saudi is in line with expansion in the sukuk market globally. According to a recent report from Standard & Poor’s (S&P), issues from GCC countries reached $19.9bn in the first three quarters of 2012, compared to 2011 issues of $19.4bn. Similarly, S&P forecasts global sukuk issuance to grow by 25% over the next three years, bringing the total value of the market to around $200bn on an annual basis by 2015. The GCC currently accounts for around 50% of total global Islamic bond issuance by value.
Islamic insurance has become a major contributor to the Kingdom’s economy in recent years. The Law on the Supervision of Cooperative Insurance, which was introduced in 2003, served to liberalise and modernise the industry. While the takaful model has become the predominant form of Islamic coverage in much of the world, in Saudi most companies operate under the Kingdom’s “cooperative” insurance model, which is defined by a handful of basic rules. SAMA, which regulates the insurance industry, requires that cooperative firms distribute part of their revenues among their policyholders and maintain separate profit and loss accounts for policyholders and shareholder. So long as firms adhere to these rules, they are considered to be sharia-compliant in the Kingdom.
As of 2011 Saudi was home to 30 insurance firms that brought in SR18.5bn ($4.93bn) in gross written premiums (GWPs) over the course of the year, up almost 13% from SR16.4bn ($4.37bn) in 2010, according to data from SAMA. The sector is dominated by the compulsory health and motor segments, which accounted for 52.5% and 21.2% of total GWPs in 2011. Life coverage, which is known as protection and savings (P&S) under the cooperative model, accounted for around 5% of GWPs in 2011, but it is expected to grow substantially in the coming years. In general, compulsory health and motor policies are low-margin lines for most insurers, while P&S coverage is more profitable. According to a recent S&P report, in 2011 over half of GWPs and almost 80% of revenues were concentrated in just three firms, namely Tawuniya (the state legacy operator, which was known as the National Company for Cooperative Insurance until 2004), the Mediterranean and Gulf Insurance and Reinsurance Company, and Bupa Arabia (see Insurance chapter).
While the Kingdom’s IFS sector has performed well in recent years, it faces several challenges. The lack of a large, well-trained national financial workforce means that many companies have been forced to hire expatriates to fill management positions, in particular. This is a major issue considering the government’s “Saudiisation” initiative, which requires that nationals make up a certain percentage of all employees. The standardisation of IFS products and services is also key, with the Kingdom’s sharia standards differing significantly from other IFS markets around the world, thus limiting global integration. Additionally, operating costs at IFS firms tend to be higher than at most conventional firms. While so far this has not been a major issue, given the higher rates of return, many companies are still looking to lower their operating costs.
Despite these challenges, the IFS industry as a whole is poised for substantial expansion for years to come. With GDP growth expected to top 6% in 2013, according to IMF forecasts, the government and private sector alike are bullish on growth for the foreseeable future. This bodes well for the IFS industry, which is seen as a reliable source of alternative financing regionally and around the world. At the same time, sharia-compliant banks and insurance companies will likely continue to benefit from growing demand for Islamic products and services among the domestic population, which, at around 28m in 2011, is the largest in the Gulf.
If the government goes ahead with plans to establish a formal, centralised sharia authority in years to come, within a decade the Kingdom could well become a key centre for IFS development and innovation.
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