1.

Introduction

This paper traces aspects of consolidation, competition and systemic stability through half a century of evolution of the Saudi banking system and the differences between Islamic and conventional banking, credit crunch in relation to Islamic banks. The banking system is characterized by strength, stability and resilience supported by consistency in government policies and strong banking supervision.

.history of banking in Saudi Arabia

2. Growth and consolidation The genesis of the banking system

The modern banking system in Saudi Arabia has its roots in the creation in October 1952 of the Saudi Arabian Monetary Agency (SAMA) with primary responsibility for monetary stability. Prior to this Branches of a few foreign banks and some local money changers provided all financial services to meet the needs of the trading community and pilgrims. By 1952, the inflow of royalties from increasing Production and demand for oil had contributed to a sharp rise in government revenues and Expenditures. As this gave a boost to the domestic economy, the demand for financial services rose sharply. The government encouraged a competitive banking environment by allowing new domestic and foreign banks in Saudi Arabia. SAMA.s creation was followed by the licensing of more branches of foreign banks including Banque du Caire, Banque du Liban et d.Outremer and First National City Bank of New York. Some domestic banks were also licensed. The National Commercial Bank was licensed in 1953, and Riyad Bank started operation in 1957 and Bank Al-Watany in January 1958. Following banking problems in 1960, Riyad Bank took over the operations of Al-Watany and the government acquired 38% of the shares in the bank. In 1966, a new Banking Control Law giving SAMA broad regulatory powers was promulgated and a few more foreign banks were licensed. .

Consolidation of the banking industry in the 1970s

The 1970s were a period of rapid expansion of the banking system to keep pace with the significant rise in government revenues and expenditures and the financing of major infrastructure and industrial projects. There was tremendous growth in the commercial banks, with the total assets increasing 35 times from SAR 2.7 billion in 1970 to SAR 93 billion and deposits increasing over 40 times from SAR 1.6 billion to SAR 68 billion. The demand for commercial credit lagged the increasing liquidity banking system and low-cost medium- to long-term credit was easily available from the government lending institutions. Consequently, the foreign assets of the commercial banks grew rapidly from 11% of total assets in 1977 to 45% at the end of 1980. By 1980, there were 12 banks operation; three were branches of foreign banks and seven had substantial foreign ownership and management. The total number of bank branches had risen to 247 and covered almost the entire country. Notwithstanding this growth, significant gaps remained in the provision of banking and financial services. Some of the key gaps were: small businesses with limited access to credit; chequing facilities limited to cash withdrawals; foreign currency transfers only available through money changers; no consumer loans and facilities for small savers; antiquated banking procedures; nonexistent computer technology; and a regionally based clearing house. A major deficiency was the dependence of banks on foreign expatriates. Thus by 1980, Saudi banks and Saudi authorities had a number of deficiencies to rectify.

Saudi banking system

The restructuring of the banking system continued with the 1997 merger of United Saudi Commercial Bank and Saudi Cairo Bank into United Saudi Bank. In 1999, United Saudi Bank merged with Saudi American Bank to form the third largest bank in the Kingdom. This consolidation of Saudi banks is primarily driven by shareholders who wish to maximise share values and believe that size matters. The trend towards mergers may continue as banks may require more capital to invest in technology, in

new products and services and in risk management systems.

. Participation of foreign banks in the banking system

As described earlier, foreign bank presence in Saudi Arabia dates from the very beginning of the banking system. The government had always encouraged foreign banks to open branches within the Kingdom and consequently, by 1975, 10 international banks with 23 branches were established. However, with the Second Five-Year Plan, commencing in 1976, the government promoted a policy of converting foreign banks. branches into publicly traded companies with the participation of Saudi nationals. This policy had a number of objectives. The incorporation and floatation of these banks encouraged broad-based public participation in the banking industry and also contributed greatly to the development of a stock market in the Kingdom. Also it promoted banking activities and the formation of banking habits among the population. By encouraging foreign banks to take large shareholdings in the newly incorporated banks and by offering them management contracts, the foreign partners. position was strengthened. They could not only exercise significant management control but could also benefit from national treatment as accorded to banks fully owned by Saudis During the 1980s and 1990s the participation of foreign banks and foreign shareholders remained substantially unchanged. However, there was some dilution of foreign participation as a result of disinvestment or due to the mergers and consolidation of joint venture banks noted earlier. The joint foreign-Saudi owned banks had assets of SAR 218 billion at end-1998, just over half of the total.

4. Systemic stability

The early years

The first banking problems faced by Saudi Arabia in 1960 also led to the first merger of two domestic banks. Riyad Bank and Al-Watany Bank, which had commenced operations in 1957 and 1958 respectively, faced serious liquidity problems arising from mismanagement and improper loans by board members in both banks. By 1960, Bank AlWatany was technically insolvent and was unable to settle the claims of local depositors. SAMA liquidated the bank and merged its operations with Riyad Bank. By 1961, SAMA required Riyad Bank to reorganise and, on behalf of the government, acquired 38% of its shares. These events tested the government.s resolve to defend the stability of a nascent banking system. The government not only took action requiring mergers but also came in strongly as a shareholder to prevent a bank failure. This sent a clear signal that the Saudi authorities wanted to maintain and support a strong, stable and credible banking system. These early banking difficulties led to a new Banking Control Law in 1966, which gave SAMA broad supervisory powers to license and regulate all banks. Banks were required to meet stringent capital adequacy, liquidity and reserve requirements as well as lending ratios. A system of onsite and off-site prudential supervision was introduced and SAMA strengthened its supervisory capabilities.

The systemic challenges of the 1980s

In 1982, SAMA faced another supervisory challenge when irregularities appeared in the operations of Saudi Cairo Bank. Two senior managers were involved in unauthorised trading in bullion, and the bank had concealed accumulated losses that exceeded its share capital. SAMA took legal action against the managers and required the bank to issue new

shares and double its capital in 1986. The increase was taken up entirely by the Public Investment Fund, which in this case acted not only as an .investor of last resort. but also helped the bank with liquidity and restored it to a healthy position. The systemic challenge faced by the Saudi banking system due to the precipitous drop in oil prices in 1982 has been detailed earlier. As oil prices tumbled and the economy slid into a long slowdown, bank profits suffered, the asset quality deteriorated and non-performing loans increased. SAMA, with the help of other Saudi authorities, took a number of steps to strengthen the banks. These included retention of capital reserves, tax write-offs for loan provisions, extension of the tax holiday for foreign investors, encouragement of bank recapitalisation, provision of liquidity through repos, and investment in new technologies. Differences Islamic banking and Conventional banking : Conventional Bank : banks earn profits by purchasing deposits from the depositors at a low interest rate, then reselling those funds to the borrowers at higher interest rate, based on its competitive advantage at gathering information and underwriting risk. Islamic Bank : same role as an intermediary, but did not receive a set interest rate and not the borrowers who have been appointed for the depositor, the amount of profits based on revenue sharing arrangement with the investors, and also with the borrowers. Conventional system Money is a product besides medium of exchange and store of value. Time value is the basis for charging interest on capital. Interest is charged even in case, the organization suffers losses. Thus no concept of sharing loss. While disbursing cash finance, running finance or working capital finance, no agreement for exchange of goods & services is made.

Due to non existence of goods & services behind the money while disbursing funds, the expansion of money takes place, which creates inflation. Due to inflation the entrepreneur increases prices of his goods & services, due to incorporating inflationary effect into cost of product. Bridge financing and long term loans lending is not made on the basis of existence of capital goods. Rather, they are disbursed on the basis of project feasibility and credibility of the entrepreneur. Government very easily obtains loans from Central Bank through Money Market Operations without initiating capital development expenditure. The expanded money in the money market without backing the real assets, results deficit financing. Real growth of wealth does not take place, as the money remains in few hands. Due to failure of the projects the loan is written off as it becomes non performing loan. Debts financing gets the advantage of leverage for an enterprise, due to interest expense as deductible item form taxable profits. This causes huge burden of taxes on salaried persons. Thus the saving and disposable income of the people is effected badly. This results decrease in the real gross domestic product. Due to decrease in the real GDP, the net exports amount becomes negative. This invites further foreign debts and the local-currency becomes weaker. Islamic system Real Asset is a product. Money is just a medium of exchange. Profit on exchange of goods & services is the basis for earning profit. Loss is shared when the organization suffers loss. The execution of agreements for the exchange of goods & services is must, while disbursing funds under Murabaha, Salam & Istisna contracts. Due to existence of goods & services no expansion of money takes place and thus no inflation is created. Due to control over inflation, no extra price is charged by the entrepreneur.

Musharakah & Diminishing Musharakah agreements are made after making sure the existence of capital good before disbursing funds for a capital project. Government can not obtain loans from the Monetary Agency without making sure the delivery of goods to National Investment fund. Balance budget is the outcome of no expansion of money. Real growth in the wealth of the people of the society takes place, due to multiplier effect and real wealth goes into the ownership of lot of hands. Due to failure of the project, the management of the organization can be taken over to hand over to a better management. Sharing profits in case of Mudarabah and sharing in the organization of business venture in case of Musharakah, provides extra tax to Federal Government. This leads to minimize the tax burden over salaried persons. Due to which savings & disposable income of the people is increased, which results the increase in the real gross domestic product.

Due to increase in the real GDP, the net exports amount becomes positive, this reduces foreign debts burden and local-currency becomes stronger.

Balance Sheet of Conventional Banking (CB):

Assets Loans and advances to customers Cash and cash balances with other banks Investments in associates, subsidiaries and joint ventures Financial assets held for trading Cash and cash balances with the central bank

Liabilities Customers deposits Due to banks and other financial institutions Other liabilities

Sundry creditors Equity and reserves

Balance Sheet of Islamic Banking (IB)

Application of funding Cash balances Financing assets (murabaha, salam, ijara, istisna) Investment assets (mudarabah, musharakah) Fee-based services (juala, kafala, and so forth) Non-banking assets (property)

Sources of funding Demand deposits (amanah) Investment accounts (mudarabah) Special investment accounts (mudarabah, musharakah) Reserves

Equity capital

Credit crunch: definition of credit crunch is An economic condition in which investment capital is difficult to obtain. Banks and investors become wary of lending funds to corporations, which drives up the price of debt products for borrowers. Credit crunches are usually considered to be an extension of recessions. A credit crunch makes it nearly impossible for companies to borrow because lenders are scared of bankruptcies or defaults, which results in higher rates. The consequence is a prolonged recession (or slower recovery), which occurs as a result of the shrinking credit supply.

Islamic bankingWhile the financial crisis wreaks havoc around the globe, the Islamic banks are increasing their reserves as well as attracting new customers. Against all odds, two new Islamic banks were founded in the European centre of Islamic banking, London, last year.

Abdullah Turkistani, Director of an Islamic economic research centre in Saudi Arabia, says the current crisis has affected almost every financial institution, including Islamic banks. But he adds, "If you want to see the negative effects to Islamic banking, it is

almost

negligible

compared

to

what

happened

to

other

banks."

Justice

principle

Islamic banking is based on Islamic law of duties, the Sharia. UK Islamologist Rodney Wilson says Islamic banking is rooted in the principle of justice. "Financial transactions must be fair and parties must treat each other fairly."

Islamic banks are less vulnerable to the effects of the financial crisis because:

The

Islamic

banking

sector

is

relatively

small

and

young

* Islamic banks do not make use of the inter-bank money market (frozen because of mistrust between banks)

* Islamic banks have no money invested in uncovered loans and financial derivatives. Sharianomics

Riba, Arabic for interest, is forbidden. So all transactions involving the charging of interest are taboo.

Emeritus professor of international financing Hans Visser says that in addition, Islamic financing must always be linked to real transactions.

This means money will only be lent for "the purchase and sale of real goods and services. Trade in claims on money not linked to any real transaction is banned, as is the separate trade in risk."

In addition, no money can be invested in activities which are considered impure (haram), such as the production of alcohol, as well as gambling and pornography.

Exotic Most people agree that the credit crisis requires a reorientation on current financial practices. The concept of Islamic banking may appear exotic at first sight, but on second

thought

it

may

not

be

all

that

far

removed

from

ethical

banking'.

Islamic banking has failed to take off in the Netherlands, but has grown steadily in surrounding countries.

In the past few years, Islamic banking grew worldwide by 15 percent a year, and today has an estimated value of about 800 billion US dollars.

Islamologist Rodney Wilson says Islamic banks can serve as an example: "To some extent it is a return to banking fundamentals. So a move away from the reliance on inter-bank and wholesale markets. We may see a model in which banks are much more constrained in what they can do and how fast they can expand by their own ability to attract their resources. I think that is not a bad thing."

However, not everybody is convinced. Professor Hans Visser points out that adopting the Islamic model could block economic developments. Taking out insurance against all kinds of hazards facing international business would become much more difficult.

"The economy would become much more rigid. Greater economic openness has brought enhanced growth but also greater volatility, stronger fluctuations. If you have free markets, you must accept that things go wrong every once in a while.

INTRODUCTION TO AL RAJHI BANK Founded in 1957, Al Rajhi Bank is one of the largest Islamic banks in the world with total assets of SAR 184 billion (US 49 bn), a market capital of over US$4 billion, employing 7,500 associates. With over 50 years of experience in banking and trading activities, the various individual establishments under the Al Rajhi name were merged into the umbrella 'Al Rajhi trading and exchange corporation' in 1978 and it was in this year that the bank was also established as a Saudi share holding company. Deeply rooted in Islamic banking principles, the Sharia compliant banking group is instrumental in bridging the gap between modern financial demands and intrinsic values, whilst spearheading numerous industry standards and development. With an established base in Riyadh, Saudi Arabia, Al Rajhi Bank has a vast network of over 466 branches, 2,750 ATM's, 21,000 POS terminals installed with merchants and the largest customer base of any bank in the Kingdom. As one of the leading and most progressive banks in Saudi Arabia, Al Rajhi Bank recorded net income profit of SAR 6,771 million (equivalent to US$1,8 billion) in 2010. Al Rajhi Bank operates in multiple segments and continues to grow through diversification of income resources and development of the investment and corporate banking sectors which build on the strong retail banking base. The bank also

continues to develop banking programs and projects with a focus on the latest new electronic services and investment products in order to offer innovative banking and investment services especially e-banking. At Al Rajhi Bank, we have achieved leadership through offering new electronic channels that answer customers needs and aspirations, simplifying their efforts whilst saving time. The Bank has also worked on numerous electronic governmental projects in collaboration with many official sectors. In addition to local growth, Al Rajhi Bank ventured into the Malaysian market in 2006 after being the first foreign bank to be awarded a full-banking license. Al Rajhi Bank is a Saudi Arabia-based joint stock company engaged in banking and investment operations in accordance to the Islamic Sharia principles. The Bank offers its services through two divisions: Personal and Business. The Personal division covers current accounts, affluent accounts and private accounts through its Accounts subdivision, and car finance, real estate finance, personal finance and credit cards through its Financing Solutions sub-division. The Business division offers cash management, finance products, small- to medium-size enterprises (SME) and trade finance products through its Corporate Banking sub-division, and treasury services through its Treasury sub-division. Al Rajhi Bank operates through 451 branches in Saudi Arabia and abroad.

In the end of this paper we talk about the brief history if banking in Saudi Arabia, Saudi Arabia has its roots in the creation in October 1952 of the Saudi Arabian Monetary Agency (SAMA) with primary responsibility for monetary stability. However we made clear the difference between Islamic and Conventional Banking. In the other hand we discussed the issue about Credit crunch, and finally we set example for a local bank.

Reference :
www.alrajhibank.com.sa

http://chiefacoins.com/Database/MicroNations/Saudi_Arabian_Monetary_Agency.htm http://www.sama.gov.sa/. http://www.newhorizonislamicbanking.com/index.cfm?action=view&id=10862&sect ion=features http://www.islamic-foundation.org.uk/IslamicEconomicsPDF/Hassanfinancialcrisis-if.pdf