Interview: Patrice Couvegnes
In what way will Basel III affect the ability of banks to offer new products and services?
PATRICE COUVEGNES: Basel III will introduce new and stricter capital and liquidity rules to reinforce the solidity of the banking sector and avert financial crisis. This is a lesson drawn from the situation that developed from 2008 mostly in the US and Europe. Actually, Saudi banks have been benefitting from high liquidity and strong capital ratio required by its regulator. These requirements have proven efficient as the Saudi banking sector went through the financial crisis smoothly.
Saudi banks are already in line with the spirit of the Basel III regulation, so it will not drastically change operations. Though there will be some adjustments necessary in terms of business mix as some activities considered as risky would now require more capital. Banks will have to pay close attention to the return on assets, especially in the current low-interest environment. It will push banks to continue development of cross selling and balance sheet optimisation. Ultimately, it requires a balanced judgment: banks can only lend up to a certain multiple of their capital. Capital requirements must be determined to create a safe and resilient system, while also leaving leeway for the sector to support economic development through lending.
VAN LINDER: Owing to years of prudent regulation and management, Saudi banks are among the strongest worldwide regarding capital and liquidity. I expect most of them to comply easily with new regulations, including Basel III. Regulatory developments with regard to derivative transactions (such as the credit value adjustment capital charge, initial margining and push toward central clearing) may lead to changes in the local market, including potential for a local clearing exchange for derivatives. The additional cost of these regulatory changes will have some bearing on the pricing at which banks are able to offer derivatives (and products with embedded derivatives such as fixed-rate mortgages). However, in the short term and in context of the scope of products and services required in the Kingdom, we do not believe this will have a material impact. Similarly, and depending on their final drafting, liquidity regulations may have an impact on the pricing of term lending and create demand among banks for high-quality liquid assets, stimulating corporate and quasi-government entities to raise debt through rated issuance, thereby acting as a catalyst to the development of the local debt capital markets.
How do you assess the role of Saudi banks within the international Islamic finance sector, and how do they compare to their Asian counterparts?
VAN LINDER: Some of the largest Islamic financial institutions in the world are headquartered in Saudi Arabia, and the banks here are at the forefront of developments in sharia-compliant financing. In general, the Kingdom’s banks have progressed much faster than their Asian counterparts, the main reason being that Islamic financial services in the Kingdom have been driven by customer demand.
COUVEGNES: On a micro level, the GCC financial industry has witnessed a major shift in the last 10 years, from conventional to Islamic banking on both the equity and debt sides of financing. This is clearly evident in the uptake in the number of sukuk (Islamic bond) being floated in the GCC markets, as well as the exponential growth of tawarroq/murabaha and ijara (Islamic mortgage) financing. As the largest GCC economy, Saudi Arabia has been contributing to this change.
The drivers of change in GCC banking behaviour, both on the corporate and retail sides, can be attributed to the perception that Islamic banking is the next growth catalyst for banks, fuelled on the consumer banking side by the increasing appetites for socially and religiously responsible banking and on the corporate side by the ambitions of organisations for successful initial public offerings and positive momentum on trading volumes on the stock exchange.
On macro level, although the Asian countries (i.e. Malaysia, Indonesia and Pakistan) made an earlier entrance into this domain and continue to command a sizeable portion of the Islamic banking industry, future growth is likely come from the Middle East region, mostly due to sustainable market demand forces, market availability, and faster economic expansion fuelled by higher oil prices and increasing population growth.
To what extent do Saudi corporates understand the benefits of issuing debt versus equity, and how can the uptake of debt instruments be developed?
COUVEGNES: As reflected in the balance sheet of most listed companies, corporate debts have been increasing. However, most of these debts are borrowed from the banks mainly due to convenience and availability of cheaper funds, given higher liquidity and banks being able to lend due to their favourable debt to equity ratio.
During the last decade, Saudi Arabia has seen rapid growth, mainly stimulated by strong government spending. This has led to huge financing requirements for both the semi-government and private sectors. The increasing requirements of long-term financing and sizeable investor appetite provided an excellent opportunity to develop the Islamic debt capital market. Some semigovernment entities, such as Saudi Electric Company and Sabic, along with a few large corporations have also resorted to the debt capital market by issuing sukuk. These debt issues have been largely oversubscribed, creating more interest, which may result in growth in sukuk in the next few years. However, the number of local currency issues listed on the Saudi stock exchange remains limited. Moreover, the trading volumes are negligible, as most of the investors have kept their investment until maturity. Considering the Kingdom’s financing needs and the tighter regulations on lending, sukuk and debt capital markets have a key role to play. The latter, which is today de facto limited to large financial investors, will have to be developed toward individuals, thus widening the scope and capacity of the market.
VAN LINDER: A vibrant capital market requires interested issuers and investors, and good laws. Recently, we have seen several new issuers coming to market, including some leading corporate names in the Kingdom. With the supportive regulation, and a growing number of investors (such as specialised funds and the insurance companies), most of the elements are in place for further growth of the capital markets. Recent legislation may also facilitate development as it includes provisions regarding the establishment of special purpose vehicles for debt issuance, as well as other measures supportive of the creation of securitised products in the mortgage and wider asset-backed space.
With per capita income on the rise, will the retail sector dominate competition between banks?
VAN LINDER: Competition in the retail banking market will remain fierce. This market has always been an attractive one, and many new developments will make it even more so. These include the mortgage law and related legislation, and the significant increase in population of “bankable” age with the resulting increase in demand for financing of residential real estate and other assets. Similarly, with time, the current cashbased economy is likely to move toward greater use of cards and e-finance products for retail transactions, with obvious opportunities for banks. Banks that provide the best customer service across all distribution channels will be able to monetise these opportunities”.
COUVEGNES: Saudi Arabia has the fastest-growing population in the Middle East and North Africa region, with most of the country below the age of 25. This provides a tremendous opportunity for banks to expand the number of branches, accounts and deposits. At the same time, the competition between the banks for deposit and consumer finance has been growing. The days of free deposit will soon be over, and banks providing better and innovative services and higher returns will attract larger deposits. Expanding branch and ATM networks, developing technology and introducing attractive financing products to encourage young customers should help to maintain growth levels in retail banking.
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