Saudi banks face tests as fintech and foreign competition enter kingdom

Since the price of oil began declining in 2014, slowing economic growth and the demand for credit, banks based in the Gulf Cooperation Council (GCC) have been consolidating in an effort to compete in a saturated market.

Saudi Arabia's largest lender, National Commercial Bank, has been in discussions about joining forces with smaller competitor, Riyad Bank. One Riyadh-based banker confirmed to GlobalCapital that negotiations between NCB and Riyad Bank were well underway.

In June, Alawwal Bank and Saudi British Bank (SABB) merged under the latter's name. That merger created the country's third largest bank by assets, with $68.5bn on its book. 

But consolidation will not eliminate all challenges facing the sector. The growing burden of adapting to technological innovation and the opening up of the country to foreign banks both pose tests to what many have seen historically as one of the Middle East's most stable countries for the industry.

Many Saudi retail banks have deployed financial technology into their client services, in the form of, for example, e-payment functions. But they remain at risk of lagging behind banks in neighbouring countries. Earlier this year, Bahrain's central bank mandated all national lenders to implement open banking — where a bank lets third-party developers build applications and services around it — a move that was intended to cement the country's status as the leading fintech hub in the region. 

Ashraf Madani, vice-president, senior analyst at Moody's told GlobalCapital: "Saudi Arabia is a bit late compared to the other countries in the GCC in terms of fintech and digitisation, though the effect on banking profitability has been so far limited... Saudi is investing in digitisation and SAMA [the Saudi Arabia Monetary Authority, the central bank] is looking at the fintech threat, but ultimately they are playing a catch-up role compared to other systems in the GCC."

Saudi banks are taking the tech threat seriously. Speaking to GlobalCapital at the Euromoney Saudi Arabia Conference in Riyadh on Wednesday, chairman of Samba Financial Group, Ammar Alkhudairy, said: “We are not challenged by [artificial intelligence] and fintech, we are threatened. How many of our current services will eventually be provided by new parties that are not yet founded?"

The sheer cost of increasing digitisation is one of the drivers behind the M&A consolidation boom in the region, according to some market spectators.

Nitish Bhojnagarwala, vice-president, senior credit officer at Moody's: “There are also costs that are associated with growing regulatory compliance and technology adoption. The banks are investing in new technology to improve customer experience, streamline processes and also adapt to regulatory changes... Mergers would reduce the cost base by removing duplication in certain operating functions and in real estate investment [such as] branches and head offices.”

In recent years, SAMA has implemented reforms in a bid to inject international confidence into the sector. Earlier this year, it published guidelines for banks looking to apply for licences in the country, with foreign lenders not longer required to maintain capital in the country.

At least 13 foreign banks are licensed to operate in Saudi Arabia with another three, including Credit Suisse and Standard Chartered, approved for licences though they have not yet started operating, according to SAMA.

Earlier this year, SMBC opened a branch, becoming the latest international lender to open up in the country. After the SABB-Alawwal Bank merger earlier this year and the proposed NCB-Riyad Bank merger, there will be 11 domestic banks, according to SAMA. Lenders are mindful of the challenge from overseas competition.

“Another potential threat is the opening up of the Saudi banking sector," Alkhudairy said. "We all realise it is eventually for the benefit of the country and the Kingdom needs to do it… But looking at it purely from an individualistic point of view of a bank, it’s a threat. We see regulators, rightfully so in my opinion, allow the number of regional and international banks to gain licences. That makes the competitive landscape even more challenging.”

Consolidation among Saudi's domestic banks will have repercussions for smaller firms. Some in the market are concerned about what the growing dominance of the top tier banks means for the rest of the sector.

Alkhudairy said: “[Consolidation] is a challenge for small banks, because when there is a huge disparity of size then the amount the bigger banks can deploy for technology or marketing for their branch network is far higher. Therefore when you have a big gap between the size of the small banks and the leading one or two banks, then that is in and of itself a threat.

"Small banks need to reinvent themselves, to sit down and recontemplate what their business model should be. Should they become a boutique bank that specialises in services? To compete at the current level with banks six or seven times their size is not sustainable in the long-term."

That is what some banks in the Gulf have already been doing. Gulf International Bank, which is incorporated in Bahrain, operates across the GCC and is 97.226% owned by Saudi Arabia's sovereign wealth fund, the Public Investment Fund, launched "Meem" in 2015, the first Sharia-compliant digital banking service in the region. The launch was an attempt to capitalise on what was then the peripheral threat of fintech to traditional banking.

It is becoming ever more costly for smaller banks to invest in compliance, staff and the latest systems, which some say is the long-term threat to those not caught up in the merger mania. 

According to one Dubai-based banker, smaller banks, the shareholder structures of which have differed vastly from that of the top-tier banks, have showed an "unwillingness to compromise" on valuations when talks of mergers have arisen. "Smaller banks still have time to live on a standalone basis for now," he said. "If you look at reporting numbers, they are still showing strong figures despite having smaller profitability. But as time goes by and as bigger banks acquire more and occupy an increased market share, it will become increasingly difficult for them to survive."

Not all share that pessimistic view. Moody's Bhojnagarwala added that although mergers "potentially create an uneven playing field", the larger lending capabilities of the bigger banks will remain beneficial not just to the economy, but also to the smaller banks. 

The same transformations have been underway beyond Saudi's borders. In May, United Arab Emirates-based banks: Abu Dhabi Commercial Bank, Union National Bank and Al Hilal Bank merged to create the country's third largest lender, just two years after First Gulf Bank and National Bank of Abu Dhabi merged to create the country's leading bank.

Leading Emirati Islamic bank, Dubai Islamic Bank also announced in June that it had received board approval to acquire smaller rival Noor Bank, though one Dubai-based market participant said that merger was primarily driven by the poor balance sheet performance of both banks.