This paper looks at the Saudi Arabian economic system from the perspective of a bank in a view to establish the developmental opportunities and challenges. The Saudi Arabian economy is quite well structured compared to other higher middle income country economies. However it is one of the least diversified. The economy is dominated by hydrocarbons; with oil accounting for abut 45 % of the GDP and about 75% of government revenues (International Monetary Fund 12). This poses a great challenge to the economy in form of vulnerability to oil price fluctuations and regulation. The ability of the Saudi Arabian financial sector to withstand intense shocks in macroeconomic variables has however improved over the last decade. Over the years, the financial sector architecture has been confronted by significant variations in output levels and unpredictable investor responses to regional precariousness as a result of permeating reliance on the hydrocarbons products. This situation has had positive implications for the financial sector dominated by banks. Banks have tried to create a defense mechanism by holding more than adequate capital and liquidity levels. The financial sector has consistently remained profitable with impressive returns on capital even though the sector is open and interest rates are influenced by international levels. The Saudi Arabian Monetary Agency has ensured stability in the financial sector through efficient and effective supervision and monitoring. The regulations are quiet comprehensive and the SAMA put strict measure on that are proactively implemented on risk taking, lending and foreign involvement in the sector. The financial sector is further supported by an effective and modern payment and settlement system. There have been substantial reforms in the sector over the last decade in the banking, insurance, capital markets and real estate sections. This is expected to continue as the economy follows a diversification strategy (International Monetary Fund 6).
The paper also dwells on the analysis of the National Commercial Bank of Saudi Arabia, the pioneer bank in the Saudi Arabian Kingdom. The analysis looks at the banks position in the industry and its strategic plan going forward. The National Commercial Banks analysis is based on the financial statements for the last three years and qualitative information about the bank. This is followed by a one year forecast which is an extrapolation of the last three years performances. The forecast in further analyzed in light of the existing economic conditions and expected changes in the industry, the economy and the middle east region by extension.
Economics of commercial banking
Commercial banking is a section of the financial system and is also referred to as business banking while a commercial bank can be referred to as that bank that offers services such as taking of deposits, providing checking and current accounts, giving loans as well as foreign currency accounts operations. It is usually the most prominent section of the financial sector in most economies. In some economies the laws limits the operations of commercial banks to taking of deposits and issuance of loans without investment management or investment banking. In others commercial banks diversify into many activities including insurance activities. This has been the trend in many economies. Many commercial banks serve both individuals and corporations.
Overview of the banking sector
Saudi Arabia banking industry is one of the biggest and its rate of growth is also one of the highest in the whole of the Arab world or the Middle East region. Only the UAE surpasses the Saudi Arabia Kingdom in terms of total assets controlled by the banking industry. The sector is head in regulation, capitalization and profitability compared to the financial sectors of other Arab countries. Although the decline in oil prices had slowed down the growth in the sector in the last few years, this has changed and growth has resumed. Experts expect the banking sector assets specifically to grow by an average of about 18%, compound annual growth rate, for the next five years.
Saudi Arabian Banks have survived the world financial crisis remarkably and have actually grown their lending as the crisis withers off. Bank lending has expanded at a compound annual growth rate of over 17%, deposits on the other hand were also impressive recording a compound annual growth rate of over 16% for the period between 2004 and 2009. The Kingdom’s banking sector is dominated by private banks. This is in line with the Kingdoms gradual opening of the economy that was initiated by significant privatization. In the region, Saudi Arabian Banking system is also leading in terms of information technology advancement. Service offering and distribution is now significantly now being done over the internet and through mobile phones. This has increased the reach of the banks and improved customer satisfaction. The banks have also advanced substantially into the card technology offering customers with a wide variety of smart cards and credit cards. This has improved transaction processing and the transition towards an integrated payment and settlement system.
The National Commercial Bank
The National Commercial Bank is the oldest and biggest of all the native banks registered to operate in Saudi Arabia. It was the fist bank to be set up by the King. The first name of the bank was ‘‘The National Commercial Bank’’ this was by the Royal Decree 26th of December 1953. The bank was set up with a paid-up capital of U.S. $ 8 million or Saudi Arabian Riyal 30 million. The bank was converted into a Joint Stock Company in 1997. Previously it operated as a general Partnership. This was to facilitate an initial public offer that was scheduled to happen later where the Ministry of Finance on behalf of the government took a major shareholding in the Bank. When the structure of management of the bank changed in 1999, Mr. Abdulla Salem Bahamdan was elected as the first chairman of the newly constituted Board of Directors. Mr. Abdulla was elected again to continue heading the Board of Directors and is currently the chairman. In 2005, Mr. Abdulkareem Abu Alnasr became the banks General Manager, later he became the banks first Chief Executive Officer. The bank applies sound corporate governance principles which keep management separate from ownership. The World Magazine in 2009 named Mr. Abdulkareem Abu Alnasr, the Chief Executive Officer of National Commercial Bank, “Banker of the Year 2009” in Saudi Arabia. This gave him international recognition and repute. On the financial section the bank has registered impressive performance and milestones. The National Commercial Bank’s paid-up capital is Saudi Riyal 15 billion or U.S. $ 4 billion. This makes National Commercial Bank the biggest bank in Saudi Arabia in terms of capital. For the financial year ending 2009 total assets amounted to Saudi Riyal 257 billion which was equivalent to U.S. $ 68 billion. Profits were equally impressive for the same period amounting to Saudi Riyal 4.04 billion or U.S. $ 1.077 billion. Shareholders wealth improved to total Saudi Riyal 29.271 billion or U.S. $ 7.806 billion. The Earnings per Share was Saudi Riyal 2.70 or U.S. $ 0.72 and return on shareholders wealth stood t 14.6 %.
In terms of operational capacity the bank has a huge potential. For the year ended 2009, the National Commercial Bank had 282 operational branches spread in the Kingdom. These branches offer Islamic services in banking exclusively. The customer base has well surpassed the 2 million mark in the kingdom. The bank has both Saudi and non Saudi employees. As at the end of 2009, approximately 89 % of the National Commercial Bank’s 5,399 members of staff were of Saudi descent. The bank has the most extensive network of Automated teller machines amounting to 1489 in the whole country. As of 2009, the bank is also aggressively following its strategy of geographical expansion. Currently the bank has operations in Bahrain, Singapore, South Korea, United Kingdom and Turkey. Due to its modernization strategy the bank has registered impressive progress in diversifying the methods of reaching customers and improving service delivery. Above 90% of the banks transactions were handled through non traditional channels of operation for the financial year to 2009. The banks operations in Turkey were boosted by the acquisition of a majority shareholding in a leading Islamic banker in Turkey. The Bank is has the biggest fund under management in the region which probably makes it the biggest Islamic asset manger in the world. In addition the bank was the first to introduce mutual funds in Saudi Arabia. The bank is also active in social responsibility campaign and environmental sustainability activities.
As the National Commercial Banks Treasurer I will directs financial planning, procurement, and investment of funds for the organization. This has been successful previously as our cash flows demonstrate. Our operating cash flows will continue to improve in the future. This can be partly attributed to the easing of the world economy and the resilience demonstrated by the local economy and partly to the sound cash management policies that we have instituted. The handling of receipt, disbursement of funds, banking procedures, protection of funds, securities handling, and financial instruments dealership has all been streamlined. We have heavily invested in information technology which has earned us a lot of leverage in minimizing operational costs. All our financial needs in the future are secure. This has been achieved through balancing the reduction of liquidity gap and the improvement of the capital reserves. My relationship with the management has improved over time and this is expected to continue. All activities involving financing and investments have been streamlined. I intend to increase the frequency of updates to the management so that decision making can be improved. Looking forward, the Saudi Arabian banking sector is set to improve and we are at the front. This can only mean one thing. More work is ahead. However my office has a very competent staff and we are certain we will lead in the growth of our cash balances and investment returns.
This is true business partner to the CEO and divisional presidents. The person is responsible for assessing organizational performance. I am pleased to report that our performance has had a variance of less than 10 % in the past. This I project will continue in the near future and given the rapidly improving world economic conditions, chances that we will achieve a 100 % in performance against our very competitive targets are very good. This has been a remarkable success. In the past five years our tools have been the benchmark of the industry. However since we intend to expand into regional and later into international markets, I can not overemphasize the importance of innovation. I wish the other departments will support us in this drive. The board finance, audit, and investment committees have given us a very good time in the performance of our activities. Our recommendations in the future are that we increase the involvement of external auditors, and investment advisors so that the quality of our projects can remain high and increasing. Our future prospects as outlined by the treasurer are very good. All our future expansion programs are taken care of in the current financial strategy and we will continue to evaluate even more opportunities. Our financial reporting framework has been streamlined and aligned with the International Financial Reporting Framework. We have even gone further and intend to be preparing financial position and performance summaries weekly so that the management can be able to make their decisions faster.
Our National Commercial Bank has pioneered the development of many Shariah compliant financial services that now meet the needs of over 2 million customers. These include the world’s first Islamic credit card and the first Islamic cash finance (Tawaruq) in the world. This will continue being our approach in the future. Today, NCB has 282 branches in the Kingdom, 1,489 ATMs, and more than 11,000 point-of-sale terminals. Technologically, NCB has led the way in internet banking, with e-services for retail, commercial, and corporate customers. The Bank also launched the first mobile phone banking and SMS services, while its telephone banking is the largest of its kind, now handling millions of transactions annually. All our departments have achieved considerable integration of activities. This will continue in the future.
In line with our corporate strategy the three sub strategies of: Core growth driven by a determination to continually improve service quality – offering tailored banking products through a unique array of channels, Broadening scope involves establishing early leadership in emerging products and customer segments, Geographical expansion is being pursued through acquisitions and strategic alliances in attractive regional markets, creating value by harnessing NCB’s distinct capabilities. In line with the Bank’s vision to become the region’s premier financial services group, further expansion is being considered. The countries in the Middle East and North Africa (MENA) region represent some of the world’s most attractive emerging markets, with a young and increasingly sophisticated population. We will be there in the very near future. The economies of these regions were not very much affected by the recent world recession and building on our easily recognizable and superior brand we expect the market response in these regions to be overwhelmingly positive.
Innovation, speed, and convenience are central to NCB’s consumer finance offering, founded on the principle: ‘wherever the customer is, we will be there’. Customers enjoy unparalleled ease of access to all their financing needs through dedicated finance centers, point-of-purchase facilities at auto dealers and furniture and electronics stores, and an extensive network of retail partners. By excelling in product range and speed of approval, NCB provides an impressive range of tailored Islamic financing packages.
The Bank leads the way in offering personal finance packages with on-the-spot approval and same day cash deposit in customers’ accounts, providing a time-effective solution that fulfils their needs. NCB finance centers are open 14 hours a day, 6 days a week, and their number is expanding rapidly in response to market demand. Customers can also take advantage of convenient lending facilities available from the NCB branch network and the 24-hour customer care unit. Our operational environment is the best in the Kingdom, but we still plan to improve it even further.
Internal Control and Audit
As the Internal Control and Manager in National Commercial Bank, I have been evaluating the organization’s accounting guidelines and controls or procedures. This far the progress has been very good and I have not had any incident if significant deviation from the laid down guidelines. The management has listened to us very well and the operation procedures meet the controls recommended by the International Auditing Standards. Our recommendations on strategy have over the years been integrated within the corporate strategy efficiently. Since the conditions of financial services industry continue to increase in complexity we are embarking on a major research initiative to break down all the regulatory requirements into operational procedures easy to follow. This we hope to accomplish in a couple of years. However this does not pose a risk as the current guidelines have ensured the safety of our assets.
The Banks Financial Statement Analysis
The financial statements of financial institutions like banks usually pose a different challenge in analysis than those of companies involved in manufacturing or service delivery. The analysis of the financial statements of banks needs to take care of the various unique risks that face banks and are not in existence or significant for other types of institutions. The primary business of banks is to take deposits from units with excess or saver and issue loan against these deposits to units with deficiencies in capital for investments. The bank has to pay an interest on the deposits and in turn as for an interest on the loans issued to cover the operational costs and a reasonable profit margin. The variation between the interest paid on deposits and the charge imposed on loans is known as the “spread” and is what gives banks their profits. The seemingly efficient and continuous flow of money within the economy is as a result of the ingenious pooling of money from many small depositors and structuring them into loans to be taken by those with investment opportunities. Banks therefore act as the middlemen between savers and borrowers deriving a profit out of it.
The activity of taking deposits and giving loans exposes banks to many risks like credit risks, foreign exchange risks, liquidity risks and solvency risks among others. The most significant analysis of banks financial statements therefore is directed at trying to see how well a bank protects itself from the above risks. International standards exist upon which a bank can check its position. The most notable ones are those formulated by the Bank for International Settlement (BIS). Local central banks in many countries formulate their own regulations to cater for the country specific interests and Saudi Arabian Monetary Agency does it too.
Analysis of National Commercial Banks Financial Statements for the years 2007 to 2010 key ratios are as follows: (The figures of 2010 are extrapolated from the nine months reports of up to September 2010).
Income Statement Analysis
Figures where not indicated are in SR
ROA or Return on Total Assets
This ratio indicates the profitability of a company with relation to the total assets in the handled by the company. The ratio summarizes the director’s productivity in using the assets in the company. It is an efficiency ratio. The ratio is also referred to as Return on Investment as it measures the return the company makes on the capital invested. It is expressed in percentage form. The formula for calculating ROA is as follows:
Return on Total Assets = Operating Income (Net) / Capital Invested (Total Assets)
National Commercial Bank’s ROA for the years 2007-2010 is as follows:
|Return on Total Assets||2.90%||0.94%||1.65%||1.82%|
The National Commercial Banks ROA ranges between 2.9 % and 0.94 %. The decline in 2008 can be explained by the world financial crisis that hit financial institutions around that time. The conditions seem to be improving as the world economy comes out of the recession. The sources are both utilized to finance the assets used in the normal operations. The Return on Investment ratio provides existing and prospective investors with a single measure that shows how efficient the company is in generating income from investments. The ratio also gives a basis for comparison of companies within and industry and also of a single company’s performance from one year to another. It should be noted that the ratio cannot easily be compared between companies unless the industries in which they practice are comparable.
Return on Shareholders Wealth
This ratio is arrived at by dividing the company’s annual income by the shareholders wealth. It is expressed as a percentage. This ratio indicates the return a company makes on the funds attributable to the shareholders. It is a measure of profitability and is very crucial to shareholders. The income used in the calculation is the income before dividends to shareholders of common stock are deducted but after subtracting dividends due to preferred stockholders.
The formula for calculating the ratio is as follows:
Return on Net worth = Net Income for the year / Net Worth
In other analysis the ratio is still referred to as the return on net worth.
National Commercial Bank’s Return on Equity for the years 2007-2010 is as follows:
|Return on Equity||20.39%||7.65%||13.35%||14.42%|
The return on net worth for the National Commercial Bank reveals a similar trend with return on assets. The decline from 2007 to 2008 followed by a gradual recovery in 2009 to 2010. This coincides with the trend in the world financial situation.
This ratio is very important in assessing a company’s profitability as compared to its peers in the industry. It gives a snapshot of what investors expect to get in a company if they were to hold equity in it. The national commercial bank seems to have a favorable return to its shareholders.
Debt (Long Term) to Liabilities (Total) and Equity
This ratio indicates the percentage of total investment in the company that comes from long term debt. Banks are usually highly leveraged, implying that they rely much on debt to finance their operations. However they have to remain cautious in the use of debt because apart from it being an issue of concern among regulators the higher the percentage of debt the higher the cost of borrowing the bank will have to bear in the markets. The ratio is computed as follows:
Total Long Term Debt to Liabilities and Equity = Total Long Term Debt / Total Liabilities + Shareholders wealth. It should be noted that Total Liabilities and Equity together equals total assets.
National Commercial Bank’s Total Long Term Debt to Liabilities and Equity for the years 2007-2010 is as follows:
|Debt to Total Assets||1.26%||1.18%||1.02%||0.97%|
The National Commercial bank holds very little long term debt. This is characteristic of many Saudi Arabian Banks. The little use of debt capital is a precaution to avoid the effects of volatile interest rates.
Total Loans to Total Assets = Total Loans / Total Assets
The Total Loans to Total Assets Measures the total loans of a bank as a percentage of total assets. This is a liquidity ratio, sine the higher the percentage the lower the liquidity of the bank and the higher the risk of falling into a liquidity crisis. The ratio is calculated as follows:
Total Loans to Total Assets = Total Loans / Total Assets
National Commercial Bank’s Total Loans to Total Assets for the years 2007-2010 is as follows:
|Loans to Assets||42.09%||48.65%||43.56%||45.18%|
The National Commercial bank’s Loans to Total Assets ranges between 42.09 % and 48.65 % for the four year period between 2007 and 2010. Although the loans increase over the same period, the percentage of loans to total assets has a mixed trend. This is an indication that the bank increases its assets at a rate higher than the increase in loans in some of the years. This is a prudent approach to managing liquidity risks.
Shareholders Wealth to Total Assets
This is a ratio commonly used to asses the capital adequacy of a bank. The ratio indicates the percentage of total assets financed by total assets. The higher the percentage the lower the solvency risk of the bank. The ratio is calculated as follows:
Shareholders Wealth to Total Assets = Shareholders Wealth / Total Assets
National Commercial Bank’s Shareholders Wealth to Total Assets for the years 2007-2010 is as follows:
|Equity to Assets||14.19%||12.41%||11.99%||11.99%|
The National commercial Bank’s Equity to Total Assets percentage has declined over the four years. This indicates a declining capital adequacy rate. However this rate is usually closely monitored by regulatory authorities and is therefore still above the minimum.
Common Equity to Loans
This ratio indicates the extent to which equity covers the outstanding loans. It is also a test of capital adequacy. The formula for its calculation is as follows:
Common Equity to Loans = Equity / Outstanding Loans
National Commercial Bank’s Shareholders Wealth to Total Assets for the years 2007-2010 is as follows:
|Equity to Loans||33.70%||25.52%||27.51%||26.54%|
The percentage indicates that the equity loan coverage has fallen from a high of 33.7 % in 2007 to a low of 25.52 % in 2008 but is rising again. This ratio indicates that the coverage is well above the minimum regulatory requirement.
Other capital adequacy Measures
The National Commercial Bank Group’s objective while managing its invested capital is to safely meet the Saudi Arabia Monetary Agency requirements while protecting the Bank Group’s capacity to operate continuously while having a safe capital base for prospective investments. The National Commercial Bank also provides investment advisory and management services to its clients. The offered services stretch to mutual funds that operate within the guidelines of sharia rules. Professional management on these funds is sometimes outsourced from outside to ensure quality is upheld in all aspects. The main basis for monitoring capital adequacy is the established Saudi Arabia Monetary Agency requirements. However the bank ensures that it also meets international standards as it operates even outside the Kingdom borders. Saudi Arabia Monetary Agency requirements state that banks should have a minimum level of the regulatory capital and maintain a ratio of total eligible capital to the risk-weighted asset at or above the agreed minimum of 8%. The following is the National Commercial
Banks figures for the past three years
|Eligible capital in SR||Capital Adequacy Ratio in %|
|Core capital (Tier 1)||28,640,361||25,051,365||29,580,271||18.6||16.1||24.1|
|Supplementary capital (Tier 2)||1,161,279||816,783||1,409,099|
|Core and supplementary capital (Tier 1 and Tier 2)||29,801,640||25,868,148||30,989,370||19.3||16.6||25.2|
Tier 1 capital of the National Commercial Bank Group at the end of the year consists of statutory reserve, share capital, retained earnings, other reserves, and non controlling interests minus treasury shares, goodwill, proposed dividend, intangible assets and other required deductions. Tier 2 capitals comprise a prescribed amount of eligible portfolio (collective) provisions less prescribed deductions.
Effective from 1 January 2008 the National Commercial Bank Group operationalized Basel II in accordance with Saudi Arabia Monetary Agency requirements guidelines. The National Commercial Bank Group applies the Standardized method of calculating Basel II to compute the risk weighted assets and required Regulatory Capital for Pillar -1 (This includes operational risk credit risk and market risk). The Bank Group has a risk management department that ensures the Basel II requirements are complied with. Prudential returns are prepared and submitted quarterly Saudi Arabia Monetary Agency disclosing the Capital Adequacy Ratio of the bank.
Financial statements forecasting is very important to all levels of managers in an organization. Both financial and general mangers use financial statement forecast in their planning process. The financial Managers using the financial statements forecast is able to make the planning for financial needs of the company. The manger can make plans on how much and when to source the finances needed for the smooth operation of the organization. To prepare the financial statements forecasts some conditions must be established and assumptions on them made. The various economic and operational conditions within which the company is operating must be predicted for the next period.
The general manager is assisted by forecast to make operational plans in terms of the expected requirements, human resources, technological capabilities and other operational changes. Potential problem areas and bottlenecks are established in advance and the necessary arrangements made to counter them. Equally advance preparations enable the managers to identify opportunities and prepare on how to take advantage of them. The forecast do not only act as planning tools but also as evaluation tools as the forecasted period arrives. Performances are compared with the forecasts and the variances established. The analysis of variances is a major management tool in that it facilitates the establishment of corrective measures and possible change areas.
The reliability of the forecast is directly affected by the quality of the assumptions made and the comprehensiveness of the analysis of the existing conditions. In the case of the National Commercial Bank of Saudi Arabia, the economic conditions indicate that the bank is expected to grow in the next year. This is based on the assumption that the current trend of emergence from the last financial recession will continue. The bank has posted positive growth in the major aspects in the last three years and this can reliably be expected to continue. The following therefore is the National Commercial Bank financial statements forecast for the major items the next year extrapolating the average growth in the last three years:
Statement of Financial Position
|Total Shareholders Equity||29,609,648||27,535,501||30,860,159||32,527,623||33,663,097|
The year 2010 projections are based on the average growth over the last threes years. This condition is expected to continue since the economic conditions both in the Saudi Arabia economic and the regional economy are expected to continue growing in the next year. The National Commercial bank of Saudi Arabia is one of the most stable companies in the region and its prospects are expected to continue expanding at the rate it has done over the last three years.
Statement of Comprehensive Income
|Net special commission income||6,491,931||7,776,040||8,045,645||8,149,603||8,816,221|
|Income from operations||6,047,634||2,086,077||4,250,328||4,948,965||3,355,801|
|Net income for the year||6,037,515||2,107,105||4,121,359||4,691,448||5,384,628|
|Earnings per share (expressed in SAR per share)||4.01||1.35||2.7||3||4|
The income statement is also expected to expand at the same rate it has expanded in the last three years. The progress is expected to continue in the year 2010. Te earnings per share are expected to recover to the 2007 level by the end of 2010. This indicates a strong growth in the return to shareholders.
The National Commercial Bank has a very good distribution system. In the kingdom of Saudi Arabia, it is the most recognized banking institution and brand. It employs a growth strategy that is centered on the customers. The strategy emphasizes innovation, good customer relations, creativity, and information technology and development sustainability. The bank has led the others on many fronts and continues to lead. It has introduced a very wide array of technologically enabled products and services catering for women special needs. Having been the first in providing mutual fund investments in the country, the bank has also expanded its investment management and advisory services to become the leading Sharia compliant fund manager in the world.
The bank stands head and shoulders above the rest in terms of asset size, employee numbers, performance and sustainability development. Being one of the largest financial institutions in the region the bank has received interest from many analysts. The analysts have given the bank favorable ratings since its establishment. This is attributable to sound risk management policies and prudent capital management policies. The bank’s management has received praises from all over the world as an example of sound management and growth strategies. The bank continues to pursue a robust growth strategy in its core business, geographically and in terms of product diversity. The bank poses unrivalled capital strength in the region and given its past performances in terms of expansion it can only be expected to use this potential to expand even further.
In the years ahead the bank is expected to enter more markets in the region and expand its major business. Returns on the newly rolled out high technology channels are expected to pay back in the next few years. The bank was not affected significantly by the recent world economic crisis. This is attributable to its strong capital base and effective management. The Saudi Arabian financial sector is one of the most well regulated in the region and given the recent history of the Saudi Arabian Monetary Agency, more reform that will make doing business even more easier are underway. The Saudi Arabian population that has a huge young percentage is also growing very rapidly. This is expected to add onto the existing pool of bankable customers expanding the local market.
International Monetary Fund, “Saudi Arabia: Financial System Stability Assessment, including Reports on the Observance of Standards and Codes on the following topics, Monetary and Financial Policy Transparency, Banking Supervision, and Payment Systems.” IMF Country Report No. 06/199, (2006): 5-16. Web.