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<p>This story appears in the Special Custom G20 Edition of Forbes Middle East.</p><p>In recent years Saudi Arabia has encouraged consolidation in its banking sector to create stronger entities that are able to support the role of the private sector and help the kingdom diversify its oil-dependent economy. Today, Saudi has 30 local and international lenders serving a population of more than 30 million people.</p><p>On October 8, 2020, the National Commercial Bank (NCB), Saudi Arabia’s biggest lender, agreed to merge with Samba Financial Group—this will be the biggest banking merger in Saudi’s history. Earmarked to be completed in the first half of next year, it will create the Arab world’s third-biggest banking entity, with assets worth $223 billion. The NCB-Samba merger comes a little over a year after the merger of the Saudi British Bank, an affiliate of HSBC, and Alawwal Bank, an affiliate of the Royal bank of Scotland, which was completed June 2019.‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬‬</p><p>Last year, Saudi’s Riyad Bank and NCB were also in talks for a merger, but in December the negotiations ended. While neither gave a reason for ending the deal, the two said in separate stock exchange filings that “the boards of both banks have decided to end preliminary merger talks and not to continue with the merger study.”</p><p>Despite this, in 2019 the kingdom’s financial services industry was thriving, with the value of the total assets of the kingdom’s five largest banks increasing by 16% to reach $453.2 billion. The value of the banks’ combined loans and advances expanded by 15% to hit $270.6 billion, with a 53% growth in profits to $9.2 billion up from $6 billion in 2018. This growth came amid general positivity in the market, with both economic and cultural reforms initiated by the government.</p><p>But with 2020 came the COVID-19 coronavirus pandemic, and like the rest of the world Saudi Arabia was adversely affected. As lockdowns came into effect and oil prices crashed, the kingdom’s biggest source of revenue suffered.</p><p>“We must acknowledge that the coronavirus pandemic that swept the world had a great impact on global markets and countries’ economies, which was reflected in banks performance indicators, especially during the second quarter, where the lockdowns were at their peak,” says Tareq A. Al-Sadhan, CEO of Riyad Bank. However, Saudi’s third largest lender appears to have already bounced back from the uncertainty of the pandemic. Its assets have grown 4.5% this year—the biggest growth in total assets among all commercial banks in the kingdom in the third quarter of 2020 (as compared to Q2).</p><p>While their profits have dropped, the pandemic has not had a devastating effect on Saudi banks. All but one of Saudi’s banks still managed to turn a profit in the second quarter of 2020, even as the effects of the lockdown were at their peak and the kingdom’s economy contracted by 7%. Al-Sadhan says banks in the kingdom struck the right balance between health and safety and business continuity. “[They did this] by continuing to provide banking services without stopping and balancing between meeting customer needs on the one hand and adhering to preventive procedures and requirements on the other hand,” he adds.</p><p>In fact, Saudi’s banking sector has played a crucial role in keeping the economy afloat, with support from the central bank, SAMA, providing vital assistance. By July 2020, Saudi banks had allocated over $13.6 billion into private sector financing programs, helping the kingdom’s private businesses keep going during tough times. Approximately 26,000 micro enterprises, 18,000 small enterprises, and 27,000 medium enterprises have benefited from programs initiated by SAMA. “The Saudi banking system was the lever that preserved the sustainability of the business of a wide range of companies and small and medium enterprises affected by the pandemic, and supported their ability to continue, recover and maintain their balance,” says Al-Sadhan.</p><p>Future growth for banks will depend on the recovery in Saudi’s economy, and vice versa. According to the International Monetary Fund, Saudi’s economy is expected to contract by 5.4%, followed by a 3.1% recovery in 2021. Given the current operating environment, analysts expect the profitability outlook for Saudi banks to remain subdued despite some of them boasting of sound funding profiles and strong capitalization, which should support their creditworthiness for the next year.</p><p>Al-Sadhan, a certified public accountant with over 23 years of experience in the financial sector, feels Saudi banks are well poised for the future. The Saudi banking system has showed its resilience, based on the strength of its capital base, the strength of liquidity, and the ability to adapt,” he explains. He has a right to be optimistic. Riyad Bank’s net income increased by 21.9% in Q3 2020 compared to the previous quarter, mainly due to a drop in total operating expenses and an increase in total operating income. Share prices have also recovered since the lows of March and are currently trading at $4.85—5.2% higher than a year ago ($4.61).</p><p>Most analysts agree that Saudi’s banking sector is in a comfortable position in terms of capital adequacy and liquidity, but the future outlook for banks is up for debate. In its ratings and assessments in May, Moody’s Investors Service set rates in Saudi’s 11 banks at A1-negative. At the same time, it changed its outlook on long-term deposit ratings to negative from stable for 10 of the banks and maintained the negative outlook on the long-term deposits of one. Fitch Ratings has placed all Saudi Arabian banks’ viability ratings on “Rating Watch Negative” due to “heightened risks of unexpected severe and prolonged deterioration in the domestic operating environment for Saudi banks following the sharp fall in oil prices.” On April 20, the price of a barrel of crude (West Texas Intermediate), fell as low as minus $37.63 a barrel.</p><p>Al-Sadhan disagrees. “During this year, and despite the circumstances, Saudi banks managed to grow the size of their assets to reach by the end of the first half to about $760 billion, registering a record level of 15% on an annual basis,” he claims. And KPMG agrees with him, stating that “Saudi banking outlook remains positive this year with expected profit growth driven by proactive policies by the government and a wide range of initiatives by the regulator.”</p><p>A slew of reforms in the kingdom—which include opening up entertainment and tourism destinations, creating public private partnerships, privatizing industries, and attracting foreign direct investment— will bring huge opportunities for banks and drive credit growth in the future. In his “Kingdom of Saudi Arabia Budget Report,” Dr. Abdullah Al Fozan, Chairman and Senior Partner at KPMG in Saudi Arabia states that “To support and develop the private sector, the government designed important initiatives such as the Private Sector Stimulus Package (PSSP) and the Privatization Program.”</p><p>According to Al-Sadhan, while the public sector has traditionally played a bigger role in the kingdom, future success and growth for Saudi banks and the economy will depend on the private sector. This sentiment is echoed in Vision 2030’s Financial Sector Development Program (FSDP), which says “The FSDP will achieve this ambition by enabling financial institutions to support private sector growth, ensuring the formation of an advanced capital market.”</p><p>The private sector and banks are dependent on each other. Banks are betting that future demand for credit will come from the private sector, as the Saudi government looks to unlock state-owned assets for the private sector by divesting several government-owned companies. Banks will have to help private entrepreneurs to finance these acquisitions.</p><p>For small and medium enterprises to thrive they need capital—this is where banks step in. To encourage private enterprise, Riyad Bank has implemented schemes like low-cost financing for SMEs at just 4%, without any charges for up to six months from the date of receiving the amount.</p><p>“The contribution of Saudi banks into the local economy is not new, rather it is inherent in the activity of Saudi banks since its inception and continues without interruption,” says Al-Sadhan. But achieving growth will be challenging. In its report “The $2 Trillion Question: What’s On the Horizon for Bank Credit Losses?” SP Global Ratings stated that “in Saudi Arabia, we also think that asset quality indicators will deteriorate, especially given that current conditions come at a time when the private sector was already under significant pressure. However, we note that most bank growth in recent years was spurred by mortgages to Saudi nationals, who are predominantly working for the government.”</p><p>One major impact that the pandemic has had on banks is in moving the sector online. Thanks to the lockdowns, most bank customers were forced to use digital solutions, and many of them will never go back to traditional banking. According to data from Mastercard, in February and March contactless transactions in Saudi Arabia grew three times as fast as non-contactless transactions in the grocery and pharmacy categories, where many day-to-day essentials were being purchased. Approximately 78% of Saudi customers now consider contactless to be their preferred method of payment.</p><p>In order to thrive banks will have to embrace technology and digitize. “[The] banking sector, which is gradually recovering from the consequences of the pandemic, must accelerate digital transformation, a step that we adopted at Riyad Bank early, and its results showed significantly during the lockdowns caused by the pandemic,” says Al Al-Sadhan.</p><p>Riyad Bank is in the midst of its own digital transformation. As a part of this strategy, it launched a virtual assistant service to aid customer care, which can answer customers’ questions about services and products 24/7. Initiatives like this can also reduce costs for the bank. While several banks in the region, particularly in the U.A.E., are reducing the numbers of physical branches, Al-Sadhan feels they are still relevant. The CEO says that transforming the branches rather than closing them down is the answer, which means converting them into “smart branches,” where an interactive environment is created for customers.</p><p>Fintech is another avenue where banks can see both competition and growth. In October last year, Riyad Bank became the first Saudi bank to set up an investment fund to exclusively invest in Fintech startups. Valued at $26.7 million, the fund aims to forge strategic partnerships with entrepreneurs and tech companies, providing Fintech solutions to create new industries and innovative business models.</p><p>“It’s important to keep up with the latest trends in Fintech, which has the potential to streamline existing business processes while catering to the growing number of tech-savvy consumers,” says Al Sadhan.</p><p>While the coming years may be challenging for banks, they will also bring great opportunities in technology, mega-projects, new industries and a transforming society. As Saudi’s banks begin this new phase in a strong position in terms of capital, how they implement their future plans will make the difference between success and failure.</p>