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Feb 25 2011

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Saudi Arabia: Financial Services Report

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Financial services report: Overview

The Saudi financial sector was relatively well insulated from the impact of the global financial crisis, as banks have high levels of capitalisation and a traditionally cautious approach to lending, and as government support has helped to provide additional liquidity since late 2008. Banks remained profitable in 2010. The local credit risk assessment system remains underdeveloped, and there are concerns about the ability of the courts to enforce defaults. Meanwhile, a long-mooted mortgage law remains on the backburner, and moves to allow foreigners to invest directly in the stockmarket are being contemplated.

As the economy recovers, alongside consumer and corporate confidence, banks will have ample opportunities to lend. Yet the growth and diversification of the financial sector is constrained by the limited number of tradeable stocks on the local stockmarket, the underdevelopment of the corporate bond market, the scarcity of government bonds, and generally low levels of transparency and corporate governance. The traditionally cautious approach of the banks limits the contribution that they make to growth of the wider economy. There is little in the way of venture capital and small and medium-sized enterprises find it difficult to obtain finance. A few microfinance initiatives are under way despite the fact that Saudi Arabia is a relatively affluent country.

Nonetheless, the financial services industry in Saudi Arabia has been growing rapidly since 2003, owing to a combination of strong economic growth and dramatic regulatory liberalisation. Since Saudi Arabia joined the World Trade Organisation (WTO) in 2005, the cap on foreign ownership of banks has been raised to 60%, the number of banking licences has been doubled to 22, and there are now more than 100 non-bank financial institutions. The insurance sector has also been liberalised and has grown rapidly. Islamic banking and insurance are also important subsectors, although they are underdeveloped compared with other Gulf Co-operation Council (GCC) states.

Together with business services, the financial sector accounts for just under 5% of GDP. It accounts for an even smaller proportion of employment. However, it offers more desirable and highly-paid jobs for Saudi nationals than other areas of the private sector, making it particularly valuable to the government.

The stockmarket, which is overwhelmingly dominated by retail investors, has proven volatile and vulnerable to rumour and herd instincts. Partly for this reason, regulators generally take a conservative approach and banks have traditionally been well capitalised.

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Financial services report: Banks

There are 12 majority-Saudi-owned banks operating in the country. Several are partly owned by the state or by public-sector institutions such as the pension funds. Majority foreign ownership of banks—albeit capped at 60%—has been permitted since 2005. Since then, ten foreign banks have received operating licences. Citigroup (US) is also said to be planning a return to the kingdom, having sold a 20% stake in a local bank in 2004.

Having stagnated in 2009, credit to the private sector is recovering slowly. Saudi banks have traditionally taken a cautious approach to lending, but before 2009 abundant liquidity, government debt repayments and low interest rates contributed to a boom in cheap credit, with lending to the private sector expanding by an average of 27% a year in 2003-08. Inevitably, this level of lending growth raised concerns about worsening quality of loan portfolios—a concern that was further heightened following the default in 2009 of two Saudi conglomerates, the Saad Group and Ahmad Hamad Algosaibi & Bros. On the back of the global liquidity crunch that began in late 2008, private-sector lending stagnated in 2009, but, buttressed by recovering oil prices and state-directed support, it increased by a modest 5.7% in 2010.

More than other Gulf banks, Saudi banks tend to focus their lending within Saudi Arabia itself. While they appeared to remain protected from falling global and regional property markets, Saudi banks have been reported to have some exposure to the debt of Dubai World, the UAE conglomerate that requested a standstill on its debt, and to other troubled companies within the UAE. The government is unlikely to allow any of the Saudi-owned banks to fail, and has in the past intervened to save banks. The banks maintain a relatively strong level of provisioning for bad debts. According to results in 2010, most Saudi banks have remained profitable.

The Saudi Arabian Monetary Agency ( SAMA the central bank) regulates the banking sector and takes a generally conservative approach. Nonetheless, a lack of transparency in the wider corporate sector is a concern. There is a shortage of information on borrowers' credit histories, with a consumer credit bureau only in its infancy. These factors, together with a lack of confidence in the ability of the judicial system to enforce default penalties, lead to a generally cautious approach to lending by banks and help to explain the conservative attitude of the regulator.

In addition, the government operates five specialised credit institutions that provide medium- and long-term concessional financing to the private sector and some public-sector enterprises. These are the Real Estate Development Fund ; the Saudi Industrial Development Fund ; the Saudi Agricultural Bank; the Saudi Credit Bank; and the Public Investment Fund . The role of these institutions will increase in order to supplement government spending and shore up economic growth in the early part of the forecast period. For example, in February, the Saudi king, Abdullah bin Abdel-Aziz al-Saud, announced a significant capital injection into the Real Estate Development Fund to allow it to accelerate lending growth.

Retail banking demand. Demand for retail banking has been increasing steadily in recent years as consumers have changed their habits from dealing predominantly in cash to depositing savings in banks. This trend has been underpinned by rising liquidity associated with strong oil export earnings (which are injected into the domestic economy through hefty annual increases in government spending) and the development of electronic banking services and payment systems. Salaries are increasingly being paid directly into bank accounts. Demand for Islamic retail banking services has been growing particularly strongly.

Demand deposits rose relatively strongly during 2009, despite the sharp economic slowdown, probably reflecting a general preference to hold cash amid the prevailing economic uncertainty. Longer-term deposits fell, however, as interest rates declined markedly. This trend persisted into 2010, with low interest rates continuing to encourage Saudis to seek better returns elsewhere. We expect the general aversion to time savings accounts to persist until the second half of the forecast period, when interest rates are likely to begin to rise once more.

Consumer lending remains poorly developed in Saudi Arabia. It has largely stagnated since 2005, primarily owing to a cap that was introduced by the central bank in 2006, aimed at lowering the amount of consumer debt that was devoted to investing in the stockmarket. However, consumer lending picked up somewhat in 2010, as consumer and business confidence began to return amid the economic recovery. Consumer loans are limited to tenors of five years and total monthly loan repayments (including credit-card repayments) must not exceed 30% of the borrower's monthly salary—although this does not currently include mortgage repayments.

At SR197.7bn (US$52bn) in September 2010, consumer lending accounted for 26% of all credit to the private sector and grew by almost 10% over the first three quarters of last year, according to central bank data. Growth in consumer lending is expected to continue to expand strongly in the coming years as economic growth recovers. A growing population and a high rate of household formation are also likely to drive demand for debt.

The risk of default on consumer loans is limited by the widespread practice of salary assignment whereby the bank makes its loan conditional on the borrower's salary being paid into a current account at that bank, from which it can deduct its repayment immediately.

Credit-card borrowing has increased strongly in recent years, although it barely grew over the first three quarters of 2010. It currently accounts for 4.8% of total consumer borrowing. As with broader consumer lending, credit-card lending growth will depend on salary growth because of the lending cap. The further development of the credit-card industry will also depend on addressing the currently widespread fears about fraud, and ensuring that the national electronic payments system is more reliable. Transactions are sometimes declined because of technical failures, which can be embarrassing for users. The central bank is working to improve the electronic payments system. Credit-card interest rates tend to be high.

A mortgage law has been approved by the Majlis al-Shura (an appointed council that advises the government) but is now awaiting review. The law has been repeatedly delayed, most recently in December 2010, out of fear that it could lead to a US- or Dubai-style housing bubble. However, even when the new law is enacted it will take considerable time to develop a viable and active mortgage market owing to caution on the part of banks and regulators and the difficulties of ensuring that the market remains compliant with Islamic laws, particularly relating to repossession. Banks will be particularly concerned about their ability to enforce penalties against defaulters, given the slow and unpredictable nature of the judicial system—judgements are based on interpretation of sharia (Islamic law) rather than a system of precedent. Land rights and laws may also need considerable development before they can provide a firm basis for the mortgage market. As the mortgage industry develops, it will encourage the growth of asset-backed debt markets, which are currently underdeveloped in Saudi Arabia.

National Commercial Bank ( NCB ), the country's largest bank by total assets, said in a report issued last year that the new law might double the size of the property market by 2015 and that it expected residential prices to rise by 20% annually over the next three years. Although some home lending does already exist in Saudi Arabia, financial institutions have hitherto been reluctant to enter the market because of the lack of a central regulator and any clearly defined mortgage legislation. The new law, once in place, is widely expected to attract strong interest from public- and private-sector lenders. Several mortgage finance providers have already been established in the kingdom in anticipation of the new law, with the Public Investment Fund ( PIF ), a state investment agency, set to take 40% stakes in new lenders to provide oversight and support.

The "Islamic finance" share of the retail banking market has risen strongly in recent years. (Islamic financial products are designed to comply with sharia law and are therefore forbidden to invest in activities deemed to be haram, such as gambling or alcohol businesses, or to charge interest, although some other forms of returns are permitted.) A number of existing banks have phased out conventional retail banking services in favour of sharia-compliant versions. The maturity of this market is hard to assess as the central bank does not recognise Islamic banks as a separate category and data on the size of the sharia-compliant subsector is lacking. Sharia-compliant mortgages may dominate the home-lending market.

All Saudi banks provide women-only branches, with female staff. The female customer base has expanded as banks have launched marketing campaigns to promote their "ladies' banking" services. There is also increasing interest on the part of Western financial institutions in catering for wealthy Saudi women. Women own an estimated 30% of the money in the Saudi banking system, in part as a result of inheritance under sharia, although only a small proportion of Saudi women work.

Commercial banking demand. Lending to private businesses has risen strongly in recent years. Although it stagnated in late 2008 and 2009, it rose by 5.7% in 2010. The single largest sector for corporate lending is "commerce", including retailers, which accounted for 24% of private credit in September 2010. This was followed by the manufacturing sector (10%) and building and construction (6.7%). Large increases in lending were recorded in commerce and building construction during 2010, but lending to the services sector fell dramatically. The figures suggest that banks have reverted to increasing lending levels, having retrenched in late 2009 after allegations of fraud between two of the largest Saudi conglomerates caused concern.

The investment banking sector has also begun to develop. A number of foreign investment banks have obtained licences to operate in the country. Investment banks do not require a local partner, but in practice banks with a local partner tend to have advantages in terms of local knowledge, information on potential employment candidates, personal connections and so on.

A rising number of government-backed infrastructure and industrial projects have required extensive project finance, which reached only US$1.9bn in 2009, but surged once more in 2010. The state-owned mining company, Maaden, launched a US$7.5bn project-financing package in April last year for a US$10.8bn aluminium smelter and rolling mill that it is building with a joint-venture partner, Alcoa (US). Saudi Aramco, the state-owned oil firm, has received commitments from banks for a 400,000-barrels/day (b/d) refinery it is developing with Total of France at Jubail—the total debt will be US$8bn, including a US$1bn sukuk (Islamic security) that was issued in late 2010—and will be looking for a further US$7.7bn of financing for another refinery at Yanbu.

The Saudi Electricity Company (SEC) issued a sukuk worth SR7bn (US$1.8bn) in May 2010. The firm is in the process of raising finance for two power stations with total costs in the region of US$5bn (although a large proportion of this may be met from a SR15bn loan it received from the government in April 2010). It is likely that financial markets are capable of meeting the increasing number of financing requests. Local banks are highly liquid and will be assisted by well-funded Saudi development funds and a number of export credit agencies.

The rising levels of activity in commercial lending, including substantial interest from international lenders and investors, show that the sector has largely recovered from the financial crisis and local and regional debt problems (although it is worth noting that the bulk of the recent large debt issuances have had the implicit backing of the state). Corporate credit demand will continue to be driven by the large number of upcoming industrial and infrastructural projects. Many of these are well supported by the government owing to their strategic importance, such as railways and roads, mining and petrochemicals projects, and power and water projects. Private partners or contractors will still need to raise some of the capital.

Small and medium-sized enterprises (SMEs) find it relatively difficult to access bank finance, given banks' traditional preference for large, well-known corporates. Access to credit is particularly difficult for businesswomen, a situation that is likely to change only slowly. SMEs and enterprises headed by women tend to lack collateral and credit histories. This situation is unlikely to change markedly over the forecast period, during which banks will probably increasingly want direct access to collateral as a requirement for borrowing. As result, SMEs may turn to state agencies for subsidised borrowing, including the Saudi Credit Bank (which in February was promised some SR20bn in new capital by the king). Another increasingly important source of funding is the government investment funds, such as the state-owned Saudi Industrial Development Fund .

The practice of "name lending"—lending to well-known family businesses on the strength of their name and reputation—is likely to be wound down following the defaults of the Saad Group and Ahmad Hamad Algosaibi & Bros in 2009. It is estimated that around 80 banks, including BNP Paribas (France) and Citigroup, are owed around US$16bn. Various legal actions have been launched around the world, although many of them have determined that the case should be tried in Saudi Arabia, which will be a critical test for the legal system.

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Supply. A total of 23 banks have licences to operate in Saudi Arabia, although in practice the sector is dominated by 11 Saudi banks, which account for most of the branch network. The sector has been liberalised since 2005, when the country joined the WTO. Since then, banks from any country have been allowed to open local branches, subject to obtaining a licence. Foreign firms have been allowed to increase their equity share in existing joint ventures to 60%, from 40% previously. Banks from other GCC states have been allowed to operate in the kingdom since 1999.

In October 2005 BNP Paribas became the first European lender to open an office in Saudi Arabia as a wholly foreign-owned bank. In the same year, the Capital Market Authority (CMA), the regulator, extended licences to another nine foreign banks including JPMorgan Chase (US), Bank Muscat (Oman), the National Bank of Kuwait, the National Bank of Bahrain, Emirates Bank and National Bank of Pakistan.

In 2004, just before this wave of liberalisation, there were only 11 banks, including the country's second sharia-compliant financial institution, Bank al-Bilad, which was established that year. Previously, there had been only ten banks for the best part of two decades. Another sharia-compliant bank, Al Inmaa, was licensed in 2006 and began operations in late 2008. Overall, the number of bank branches in the country rose from 1,216 in 2003 to 1,569 in December 2010. The number of ATMs more than doubled, from 3,676 in 2003 to 10,885 over the same period.

In recent history, high liquidity from strong oil revenue has contributed to a rise in deposits, prompting very strong growth in lending to the private sector. Meanwhile, the government has used portions of the fiscal surpluses recorded between 2003 and 2008 to repay its domestic debt, further boosting bank liquidity. Banking profits have been boosted by high margin spreads and by the amount of money deposited in non-interest-bearing accounts at Saudi banks. Over the same period, banks' main complaint has been rising costs, particularly for staff. Liquidity conditions began to tighten in 2008, but a series of interest rate cuts by the central bank, coupled with reductions in reserve requirements, helped to bring interbank rates down in 2009. The central bank also injected some US$3bn of deposits into the banking system, and the government has reiterated the fact that it guarantees bank deposits.

Bank results in the third-quarter of 2010 were mixed as provisions for bad loans continued to weigh heavily on balance sheets. The rise in provisions reflected the advice of the governor of the Saudi Arabian Monetary Agency , Mohammed al-Jasser, who in October called on the country's banks to act more conservatively and ensure that provisions cover all of their non-performing loans. Nevertheless, most Saudi banks are now profitable again (although provisional results from Saudi Hollandi indicate that it made a loss in the fourth quarter) after some banks made losses during 2008-09. Although there is a risk that some further provisions for bad loans may need to be taken in 2011, the outlook for bank performance is healthy. An expansionary government budget and high average oil prices in 2011 are likely to help boost business activity and bank lending.

The NCB is the country's largest bank by assets, and has been majority owned by the government (through the PIF ) since 1999. It was the country's first bank. The possibility of floating 50% of the NCB 's shares through an initial public offering has been discussed since 2004. NCB has an investment banking offshoot, NCB Capital, although this is based in Bahrain (where it tends to be easier to obtain visas for expatriate staff or business visitors). Between 1991 and 2006 the NCB converted all of its retail branches into sharia-compliant banks.

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Samba, another leading player in the banking sector, was formed in 1980 to take over the branches then operated by the US-based Citibank, following a government ruling that all foreign banks had to sell a majority share to Saudi nationals. Citibank maintained a share in Samba until 2004, but since then the company has been wholly Saudi-owned and managed.

Other key players with an established presence in the kingdom include the wholly Saudi-owned Riyad Bank, Banque Saudi Fransi (affiliated with Calyon of France), Saudi Hollandi Bank (in which the UK-based RBS has a 40% stake) and SABB (an affiliate of HSBC, another UK-based bank).

Only a minority of the Saudi banks are fully fledged Islamic institutions. However, most offer a mix of Islamic and conventional services, and most are increasingly focusing on sharia-compliant services, as demand grows rapidly. The first 100% sharia-compliant bank was Al Rajhi Bank, established in 1957. Bank al-Bilad followed in 2004. A third, Al Inma Bank, began operations in 2009. There are also two Islamic finance houses operating in Saudi Arabia: one, Dallah al-Baraka, is wholly based in the kingdom and operates out of Jeddah; the other, Dar al-Maal al-Islami, is based in Geneva, Switzerland, but has branches in Saudi Arabia and Bahrain.

The regulatory authorities are unlikely to award more new licences to retail banks until the impact of the recent liberalisation becomes clearer. Some of the smaller and less-efficient banks will probably see revenue decline as a result of the increased competition, potentially leading to some consolidation of the market through mergers. However, the government will seek to attract more commercial banks and non-bank lenders to Saudi Arabia, as part of its efforts to develop the capital, Riyadh, as a financial centre.

Construction of a new financial district in Riyadh, the King Abdullah Financial District (KAFD), began in 2007. It will face some competition from existing financial centres in the region. However, banks need a local presence in order to do significant business in the kingdom—which is by far the largest GCC market—and, with Bahrain suffering considerable domestic turmoil and Dubai a reputational hit after the emirate's debt problems, KAFD will be well-placed to benefit.

Traditionally, the banks have provided asset management and brokerage services as well as commercial and retail services. Since 2006, they have been required to spin off asset management and brokerage operations into separately licensed institutions. The CMA has also licensed a wider range of specialised financial institutions not connected with established banks.

The banking sector is well-capitalised, reflecting the strong growth of liquidity in recent years and a generally cautious attitude to lending that helps to insulate it from risk. All Saudi banks were required to implement Basel II's standardised approach for credit risk and the standardised or basic indicator approach for operational risk from January 2008. The ratio of capital and reserves to total assets was 13.2% in June 2010, up from a low of 11.8% in November 2009 and 8.8% in 2005, reflecting greater risk aversion by banks.

The aggregate loan/deposit ratio was 102% in June 2010. However, when lending to the government is stripped out, the private-sector loan/deposit ratio was 81%—the risk of sovereign default is perceived to be very low. The vast majority of Saudi bank lending is to the local market, with foreign assets held by the commercial banks accounting for just 13.6% of their total assets at end-2010.

Lending to the central government has declined in recent years as the government recorded large fiscal surpluses and paid down its debt. The government has accumulated substantial savings (roughly equivalent to one year's nominal GDP), which it can draw on to finance future deficits. The future public-sector borrowing requirement is likely to be volatile, and is subject to risks from the international oil market as the public finances are heavily dependent on oil earnings. Nevertheless, even though bank claims on the public sector (including public-sector enterprises) rose to SR214bn in 2010, at 13% of GDP the government's domestic debt stock remains unthreatening. The growth of the insurance and mortgage markets may require the government to issue more debt in order to provide the banks and insurance firms with long-term liquidity management tools.

Banks' returns on assets will continue to benefit from the maintenance of high spreads between deposit and lending rates, reflecting a lack of price competition in the sector. Moreover, the Islamic banks, and some of the conventional banks, do not pay interest on their current accounts (in line with the prohibition under sharia against riba, which is variously interpreted as interest or usury). Although the popularity of time and savings accounts has declined recently (owing to low interest rates), banks' margins may be eroded once rates begin to rise from around 2012 and consumers start to seek greater returns on their savings.

Several international investment banks have launched joint ventures in the kingdom in recent years, attracted by the booming market for project finance as well as the easing of official restrictions on foreign investment. HSBC (UK) was the first of these, having set up a local investment banking firm, HSBC Saudi Arabia, in 2006. This is a joint venture with SABB, which was already an HSBC affiliate. Morgan Stanley (US) also signed an agreement in 2007 to set up a local investment bank, Morgan Stanley Saudi Arabia, as a joint venture with The Capital Group, a boutique investment house based in Riyadh. Merrill Lynch (US)—now part of Bank of America—launched its own fully owned office in Saudi Arabia after gaining a licence in 2007.

Bank regulators. SAMA , which is based in Riyadh, is under the supervision of the Ministry of Finance. SAMA issues currency and regulates commercial banks and other financial institutions under its control. It manages the government bond programme, oversees the foreign-exchange market and stockmarket, and manages the nation's electronic debit payment system. SAMA also closely monitors international loan syndications and has a say in any government or private-sector moves to develop financial institutions, systems and instruments. The CMA is responsible for licensing and regulating investment banking activities.

SAMA takes a highly conservative approach both to domestic bank regulation and to the investment of the kingdom's surplus oil earnings. It manages a large part of the country's foreign assets and has adopted a low-risk strategy, maintaining the bulk of its external balances in US dollar-denominated fixed-income securities. As a result, unlike those of sovereign wealth funds elsewhere in the region, SAMA 's stock of foreign assets was not hit hard by the sharp fall in global equity prices that accompanied the global financial crisis of 2008 and its aftermath.

Staffed largely by Western-educated technocrats, SAMA is well regarded as an efficient and effective regulator, and has been the driving force behind most efforts in recent years to strengthen and reform the banking and financial services sector. SAMA has intervened to support banks in difficulty, and it is widely believed that no bank failures will be allowed. SAMA has also set caps on consumer lending. It also uses reserve requirements as a monetary policy tool, particularly as it has limited flexibility to vary interest rates; the Saudi riyal's peg to the US dollar, combined with an open capital account, means that local policy rates have roughly to follow trends in US interest rates.

Saudi Arabian Monetary Agency : www.sama.gov.sa

Financial services report: Insurers

Demand. The Saudi insurance sector is expanding strongly from a very low base. The low level of coverage at present is variously attributed to a general preference for tangible assets, and to religious and cultural concerns. There is still some need to improve consumer perceptions of the value of insurance. Changes in the law have made car insurance mandatory for all Saudi nationals and health insurance compulsory for foreigners, generating rapid growth in these sectors. Demand for other forms of insurance remains limited.

Insurance premiums rose to SR14.6bn (US$3.9bn) in 2009, according to figures from Swiss Re, a global reinsurer. This represented a 33.8% nominal (27.3% real) increase over the 2008 total. Life insurance premiums accounted for only SR1bn of the total, although this segment saw 68.9% nominal growth (60.7% real) on the previous year. Non-life premiums rose to SR13.6bn, up by 31.8% in nominal terms (25.4% in real terms).

Health insurance accounted for one-third of the total and was the primary driver of growth in the sector. Saudi nationals are less likely to purchase health insurance since they can access government healthcare for free, although private healthcare is often perceived as being of higher quality. That said, Saudi nationals are increasingly being encouraged to take up health insurance, too, to lessen the burden of health provision on the public finances. In 2009, for example, it was announced that a health insurance scheme would be gradually rolled out for 1.5m Saudi nationals (and their families) employed by small and medium-sized private-sector companies (larger companies were already obligated to provide insurance cover). The law became mandatory in 2011. A gradual rise in private-sector employment levels should therefore also add to the demand for health insurance.

Supply. The insurance sector has been liberalised even more rapidly than the banking sector, with 13 new insurance firms licensed in 2006, ending the monopoly of the state-run National Company for Co-operative Insurance. More firms have since been licensed: a total of 34 had been approved for establishment by the Council of Ministers by August 2010. These moves followed the insurance law passed in 2003 and further liberalisation agreed in 2005 in preparation for accession to the WTO.

Most of the new firms are joint ventures with foreign companies. Foreign firms can own up to 60% of locally based insurance companies. After obtaining a licence, insurance firms are required to hold an initial public offering on the local stockmarket and 31 insurance companies are now listed.

There are religious concerns that conventional insurance could be seen as akin to gambling on future risks. To address these concerns, all insurance companies in Saudi Arabia must operate on the basis of takaful (Islamic insurance, which has parallels with Western-style mutual insurance). Insurance companies are not able to invest in companies that conduct business activities that are deemed not to be sharia-compliant, such as gambling, selling or producing alcohol or pork, or providing interest-bearing financial services.

Financial services report: Asset managers

Demand. Saudi Arabia is a relatively affluent country with a significant number of high net worth individuals, implying that there is a potentially large market for asset management services. That said, the local stock exchange is still dominated by retail investors rather than institutional investors, suggesting that many Saudis still prefer to manage their own asset portfolios. This preference may change, however, since many Saudis lost money in the stockmarket downturns of 2006 and 2008.

Saudi investors have tended to invest heavily in US and European assets, but there has been a trend towards greater geographical diversification in recent years, with Asia and Middle Eastern markets being a key focus. It is likely that Asian assets will make up an increasing proportion of Saudi nationals' asset portfolios, given the robust outlook for growth in key Asian economies (although admittedly equity markets in the region over the past year have generally performed poorly) and the development of trade links between the Gulf and Asia.

Supply. The pensions market consists of two public pension funds: the Social Insurance Fund and the General Office for Social Insurance, which provide pension and welfare insurance for nationals. The two pension funds currently handle vast investments and hold most of the government's debt.

All the major banks offer asset management services outside their investment funds. The National Commercial Bank has emerged as one of the most important players. The emergence of foreign investment banks and brokerages since 2005 should also provide greater competition and services in the asset management sector.

The number of institutions licensed to carry out securities business, according to the list of authorised persons at the Capital Market Authority, the stockmarket regulator, has fallen from 116 in August 2009 to 98 currently, as low trading volumes and difficult market conditions have led to some consolidation. Licensed activities include dealing (including brokerage), management (including asset and portfolio management), arranging (including initial public offerings, and mergers and acquisitions) and advisory.

Major foreign and regional players on the list include Morgan Stanley (US; associated with The Capital Group, headed by Fahad al-Mubarak), Merrill Lynch-Bank of America (US), EFG-Hermes (Egypt), the Bank Audi group (Lebanon) and HSBC (UK). Local licensees include established firms such as Bakheet Investment Group, Rana Investment and BMG Financial Group, and new ventures such as Jadwa Investment.

Financial services report: Exchanges

Demand. Trends in the Tadawul (the Saudi stockmarket) have traditionally been strongly correlated with international oil prices, but this relationship broke down in 2006, when an unsustainably rapid boom that began in 2005 gave way to a pronounced downturn. Since then, trading values have steadily slipped, as retail investors have become increasingly risk averse and local institutional investors have failed to fill the gap. The stockmarket has also been affected by the unrest that has swept the Middle East since January 2011. The accompanying uncertainty, for example, drove a 6.4% decline in the index on January 29th alone. By end-January the Tadawul All Share Index (TASI) was at 6,358, compared with a high of over 19,500 in February 2006.

Despite the poor performance of the equity market in recent years, the number of investors has risen, with many first-time investors drawn to the market by a series of well-publicised, popular and profitable initial public offerings (IPOs). Retail investors dominate the market. There are few institutional investors and equity research is limited—although the newly emerging asset management companies and brokerages will begin to change this over the forecast period.

These characteristics mean that the market is highly vulnerable to herd instincts and rumours. There are 145 listed firms, but a relatively small number of shares are traded, reflecting the presence of large state-owned firms as well as large strategic holdings by the state pension funds. IPOs are often massively oversubscribed, indicating strong pent-up demand for shares.

Restrictions on foreign portfolio investment have eased in recent years. GCC nationals can trade in Saudi equities, and since 2006 expatriate residents have also been allowed to invest directly, although only Saudis can participate in IPOs. However, demand from other GCC nationals has been limited to date. This may be because they have preferred to diversify their holdings into other regions. It could also reflect concerns about the relative lack of research or other information about Saudi equities as well as the market's poor performance in recent years.

Foreigners are able to invest indirectly through mutual funds and swap agreements with licensed local intermediaries such as brokerages and investment banks. Reports proliferated in early 2010 that the authorities were considering allowing foreigners to invest directly on the bourse. According to the Reuters news agency, the management of 29 representatives of banks and brokerages operating in the kingdom's capital market were invited to a meeting at the Capital Market Authority (CMA), the stockmarket regulator, at which the question of handling foreign investor accounts was discussed. The agency quoted bankers as saying that they were confident that the market would be opened up to direct investment from abroad in the first half of 2011. Abdelrahman al-Tuwaijri, the head of the CMA, dismissed the Reuters report as speculation, and said that there were no plans to change the current regulations. However, it is clear that Saudi policymakers are at least considering the issue. However, IPOs are likely to remain limited to Saudi nationals, since the government sees them as an important means of distributing wealth.

The corporate bond market is in its infancy, but has begun to develop, with a few high-profile international issuances by leading companies, many of which are largely state-owned. An estimated US$4bn of sukuk (Islamic securities) were issued in 2009. In February 2010 Dar al-Arkan, a Saudi real estate developer, issued a US$450m sukuk with a five-year maturity, albeit at an extremely high yield of 11%. The sukuk was the first major one to be issued in the Gulf region since the Dubai debt crisis in late 2009. The Saudi-based Islamic Development Bank (IDB) raised around US$850m in a sukuk in late 2010, and plans to raise a further US$1bn a year between 2011 and 2015. The Saudi Electricity Company also issued a larger, SR7bn (US$1.9bn) sukuk in 2010. Although last year was relatively quiet for new sukuk issuance, it is expected that 2011 will see an increased number of offerings, with Saudi Hollandi Bank estimating that some ten Islamic bonds are planned.

In June 2009 the CMA set up a platform for secondary trading in debt securities and in sukuk. However, there are few such instruments available to trade at present and activity is therefore likely to be minimal in the short term.

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Supply. Equity trading is conducted through an interbank electronic trading system, the Tadawul, which was incorporated as a joint-stock company in 2007 owned entirely by the Public Investment Fund , a sovereign wealth fund. Since the passing of the capital markets law in 2003, the electronic exchange has been restructured as a more regulated body of licensed share traders under the aegis of the CMA. It has the highest market capitalisation of all the Arab exchanges. The market has historically been relatively limited because of the small number of companies traded.

The Saudi stockmarket has traditionally been dominated by state-owned companies that have been partially floated on the exchange. However, the pace of private-sector offerings has picked up since the CMA was established in 2003. The government aims to part-privatise additional state-owned enterprises through IPOs. It also requires new private-sector entrants to some market sectors—including telecommunications and insurance—to commit to floating at least a partial stake on the local stock exchange as a condition for gaining a licence. Saudi nationals can subscribe to an IPO very easily from an ATM. Between 30% and 40% of the population are approved to subscribe to IPOs. A number of IPOs took place in 2010, including listings from several Saudi insurance companies, an air-conditioning company and a property developer, Knowledge Economic City. A number of family businesses in Saudi Arabia and the wider Gulf, as well as state-owned enterprises, are in theory interested in issuing IPOs, but would need to improve their levels of transparency. Corporate governance and transparency are generally fairly poor.

Regulating the financial markets and educating participants remains a work in progress. The CMA has been highly active since its inception in 2003. It is seeking to improve business standards, having issued a new corporate governance code in 2007. In 2008 the CMA required the Tadawul to begin naming investors with stakes of 5% or more in listed companies in order to boost transparency and corporate governance standards. The disclosure rule was aimed at cracking down on abuse and market manipulation. The CMA is seeking to crack down on insider trading, and is currently investigating possible cases. It fined a major local investor for insider trading in June 2009, which may set an example for others.

Capital Market Authority: www.cma.org.sa

Tadawul: www.tadawul.com.sa