Selected Issues

Abstract

Selected Issues

How Developed and Inclusive is the Financial Sector in Saudi Arabia?1

Continuing to foster financial development and inclusion is a key objective under Vision 2030 to promote economic growth and to increase the resilience of the economy to shocks and in Saudi Arabia. Using a benchmarking exercise, this paper finds that the banking sector is relatively well developed in terms of depth and efficiency. In terms of financial access, however, Saudi Arabia appears to behind peers, especially for SMEs and women. To promote greater financial development and inclusion, policies should continue to focus on underserved segments such as women and SMEs, as has been set out in the authorities’ recent Financial Sector Development Program (FSDP). The authorities should continue to maintain their strong focus on financial stability while pursuing their financial development and inclusion objectives.

A. Background

1. Saudi Arabia is continuing to develop its financial sector to boost growth and contribute to greater economic diversification. The Financial Sector Development Program (FSDP), which was adopted in May 2018, aims at developing a diversified and effective financial sector to support the development and diversification of the economy, and stimulate savings, finance, and investment.

2. A growing body of theoretical and empirical evidence shows that financial development and inclusion exert a powerful positive influence on long-run economic growth. Countries with well-developed financial systems tend to grow faster over the long-term (Levine 2005, and Demirgüç-Kunt and Levine 2008). A well-developed financial system can efficiently mobilize domestic and foreign savings for investment and effectively allocate resources to the most productive sectors, foster sharing of information, and better diversify financial risks. Most types of financial inclusion also help increase economic growth (Sahay and al, 2016). On the other hand, a shallow financial system hampers macroeconomic policy transmission, poses challenges for macroeconomic stability, and does not help promote inclusive growth (Dwight and Radzewicz-Bak, 2012).

3. The objective of this paper is to assess Saudi Arabia’s level of financial development and inclusion and to recommend policies to address identified gaps. The paper is organized as follows: Section B provides an overview of the financial system. Section C benchmarks Saudi Arabia on financial development and inclusion, based on cross-country comparisons and relative to its economic and structural fundamentals. Section D discusses government initiatives to promote financial inclusion and development. Section E provides policy considerations.

B. Structure of the Financial System

4. The financial system in Saudi Arabia is fairly diversified (Figure 1). With assets of about $1.1 trillion (159 percent of GDP) at end-2017, the financial sector includes 24 commercial banks (57 percent of the total); pension funds (31 percent); four government specialized (non deposit-taking) credit institutions (SCIs) (7 percent), investment funds (3 percent); and other financial institutions, including insurance and finance companies (2 percent).

5. The banking sector dominates the financial system. The commercial banks include 12 domestic banks (four of which have large public-sector ownership) and 12 foreign banks (1 percent of total assets), with the four largest banks representing 55 percent of banking system assets.2 Bank cross-border exposures in funding and lending are limited and regionally diversified, with the latter representing less than 15 percent of system assets (FSSA, 2017).

Figure 1.
Figure 1.

Financial System Structure, 2017 1/

(In percent of total)

Citation: IMF Staff Country Reports 2018, 264; 10.5089/9781484374382.002.A003

Source:SAMA1/ Total assets of US$ 1.1 trillion (about 159 percent of GDP)

6. Banking sector assets have remained broadly unchanged as a share of GDP and non-oil GDP over the past decade (Figure 2). Banks’ business model is to intermediate private sector deposits (75 percent of total liabilities; end-2017), with demand deposits accounting for 59 percent of total deposits, for lending (62 percent of total). One third of the assets are in investments, cash and reserves, and only a small proportion from fixed and other assets (Figure 3). Lending to corporates accounts for 34 percent and lending to households for 20 percent of total assets, respectively. Among the latter, mortgage loans comprise only about one-fourth of the total while the remainder is consumer and credit card loans. Direct exposure to the government is limited (6 percent of total assets) while credit to government and public enterprises was 10.6 percent of GDP in 2016.

Figure 2.
Figure 2.

Banking Sector Assets

Citation: IMF Staff Country Reports 2018, 264; 10.5089/9781484374382.002.A003

Source: SAMA.

7. Specialized Credit Institutions (SCIs) provide credit to the private sector. SCIs offer medium to long-term loans to sectors requiring further development; are mostly funded by direct budgetary support; and have no leverage, as balance sheets consist entirely of government equity (Box 1). As of end-2017, SCIs’ total assets were 11 percent of GDP (17 percent of non-oil GDP) compared to 10 percent in 2009 (16 percent of non-oil GDP).

Figure 3.
Figure 3.

Banks’ Assets and Liabilities

Citation: IMF Staff Country Reports 2018, 264; 10.5089/9781484374382.002.A003

Sources: Banks’ financial statements; and SAMA calculations.

Specialized Credit Institutions in Saudi Arabia

Specialized credit institutions (SCIs) play an important role in providing credit in Saudi Arabia. SCIs were established to direct credit to targeted areas of the economy including housing, industrial projects, and small and medium-sized enterprises (SMEs). In particular, the Saudi Industrial Development Fund (SIDF) finances industrial projects; the Real Estate Development Fund (REDF) finances individuals and corporate residential and commercial real estate; the Social Development Bank (SDB) provides interest-free loans for small and emerging businesses and professions as well as low-income citizens; the Saudi Agricultural Development Fund (SADF) finances farmers and agricultural projects;

Until 2015, SCIs were supervised and organizationally linked to the Ministry of Finance which, along with their respective Boards of Directors, was responsible for overseeing their operations. However, the government decided to align SCIs with the relevant line ministries, and as a result: (i) REDF reports to the Ministry of Housing; (ii) the SADF to the Ministry of Environment, Water and Agriculture; (iii) the SDB reports to the Ministry of Labor and Social Affairs, and (iv) the SIDF to the Ministry of Energy, Industry and Mineral Resources.

SCIs are non-deposit taking entities that rely on direct budgetary support and, at the margin, internally generated cash to fund credit activities. A significant amount of credit to the private sector in Saudi Arabia – equivalent to around 18 percent of banking sector credit– is provided by SCIs. However, the financial condition and performance of SCIs are not very transparent (FSAP, 2017).

uA03fig01

SCI Loans and Assets

Citation: IMF Staff Country Reports 2018, 264; 10.5089/9781484374382.002.A003

Source: SAMA.

C. Benchmarking Saudi Arabia’s Level of Financial Development and Inclusion

8. Saudi Arabia’s financial depth and bank profitability are benchmarked relative to its economic and structural fundamentals and a group of peer countries. The benchmarks are: (i) a peer group of oil exporting countries; (ii) other GCC countries; (iii) high income countries; and (iv) statistical benchmarks (expected medians) derived from a regression framework following the World Bank’s FinStats 2017 (Feyen, Kibuuka, and Sourrouille, 2016). Statistical benchmarks are estimated based on structural and economic non-policy fundamentals. By excluding policy-driven factors, the benchmarks determine the level at which Saudi Arabia would be expected to perform in a policy-neutral environment (see Annex 1 for further details).

9. Indicators of financial depth generally suggest the banking system is well developed (Figure 4). Specifically, bank private credit and deposits to GDP are in line with the peer group and the statistical benchmark (expected median), although lower than high-income countries and the average of other GCC countries.3 The results are indifferent to the use of GDP or non-oil GDP.

Figure 4.
Figure 4.

Selected Financial Depth Indicators

Citation: IMF Staff Country Reports 2018, 264; 10.5089/9781484374382.002.A003

Sources: Country authorities; World Economic Outlook; and IMF staff calculations.1/ For Saudi Arabia and GCC, data is number of listed companies per 1,000,000 nationals.

10. Indicators of capital market development offer a mixed picture (Figure 5). Stock market capitalization to GDP is comparable to peers and the statistical benchmark, but the number of listed companies per 1 million people is very low. Furthermore, stock market capitalization (as a percent of non-oil GDP) has declined over the last decade, from around 107 percent in 2008 to 92 percent in 2017. The 10 largest companies represent 60 percent of the total market capitalization (Annex 1). The investor base remains undiversified and dominated by Autonomous Government Institutions (AGIs) while foreign ownership is small, despite the recent increase as restrictions on foreign investors have been eased. Debt markets are underdeveloped, with a benchmark yield curve lacking, no local rating agency, and a limited secondary market. The domestic corporate bond market is small at less than 1 percent of GDP as most companies rely on equity or bank loans for finance (Figure 5).

Figure 5.
Figure 5.

GCC Bond Issuance, 2006–17

(In percent of GDP)

Citation: IMF Staff Country Reports 2018, 264; 10.5089/9781484374382.002.A003

Sources: Dealogic; and IMF staff calculations.

11. When compared to peer groups, the financial system in Saudi Arabia is profitable (Figure 6). The banking system has a lower cost-to-income ratio and a higher return on assets compared to peers. Net interest margins (NIMs) are higher compared to high-income countries and in line with the GCC average and statistical benchmarks. NIMs have been relatively stable due to large proportions of deposits not receiving interest (for compliance with Islamic principles) and a high share of variable-rate loans, which allow changes in banks’ funding costs to be swiftly passed on to customers (FSAP, 2017).4

12. Financial access and inclusion in Saudi Arabia is below that of other peers in the region and high-income countries (Figure 7). Saudi Arabia appears to have a less inclusive financial sector compared to countries of similar income per capita on some measures. (Figure 8, top right panel; see Annex 2 for further details).

  • Physical access has remained stagnant, but the share of population with access to formal financial institutions has increased. Physical financial access (measured by commercial branches per 100,000 adults) has remained stagnant over the last decade and is lower than in high income countries and GCC averages, but the share of the population with accounts at formal financial institutions increased to 72 percent in 2017 relative to 46 percent in 2011.5 It is lower, however, than the high-income countries and GCC average (Figure 7).6

  • Informal finance plays an important in Saudi Arabia. According to the Findex database, the usage of financial services is particularly low as the share of the population that borrowed from a financial institution was around 11 percent in 2017 (Figure 7). In contrast, about 33 percent of adults in Saudi Arabia reported having borrowed informally compared to 13 percent in high-income and 26 percent in GCC countries. Households rely on informal financing channels, where peer financing (whether inside the work place or within the family) remains the dominant source of financing, with bank loans being the residual.

  • The usage of digital banking is also relatively low. High mobile phone and internet penetration facilitate customer reach through digital banking (Box 2). However, the usage of digital banking is low compared to peers in the region, with only 25 percent of Saudi adults using mobile phones or the internet to access an account in 2017 compared to an average of 33 and 52 percent for GCC countries and high-income countries respectively (Figure 8).

  • There is a gender gap in access to finance and it has increased. About 80 percent of male adults had an account at a financial institution in 2017 (75 percent in 2014), compared to 58 percent of female adults (61 percent in 2014). The percent of credit card holders among female adults is around one third of that among males. The usage of loans and mortgages by males is also significantly higher than by females. There is also a large gender gap in e-banking usage (Figure 8). Gender inequality in financial inclusion explains a substantial share of overall inequality in financial inclusion.7 Low female employment and the fact that many households use a single account could be among the explanatory factors.

  • Financial literacy could be improved. Levels of financial literacy among adults in Saudi Arabia are lower than in other GCC countries as well as many developed and developing countries (Figure 8). About 7 percent of adults cite religious reasons for their voluntary exclusion from the financial sector (Global Findex, 2017).

  • Bank lending to SMEs is low. SME borrowing from banks is very low, with an average of 2 percent of total loans, in line with the GCC average, but lower than the 7 percent average in the MENAP region, and other regions (Figure 8).8,9 Several institutional constraints explain low access to finance for SMEs (Box 3).

Figure 6.
Figure 6.

Selected Financial Profitability Indicators

Citation: IMF Staff Country Reports 2018, 264; 10.5089/9781484374382.002.A003

Sources: Country authorities; World Economic Outlook; and IMF staff caculations.1/ Data for 2016 and 2017 is from 12 domestic banks for which data was available.
Figure 7.
Figure 7.

Selected Financial Access Indicators 1/

Citation: IMF Staff Country Reports 2018, 264; 10.5089/9781484374382.002.A003

Sources: Country authorities; IMF FINDEX 2017; World Economic Outlook; World Development Indicators; and IMF staff caculations.1/ The Findex database is based on a worldwide survey covering 1,000 randomly selected individuals in each of over 140 countries associated with the GALLUP world poll, containing comparable information on access to a broad range of financial services and the intensity of their use. The Findex survey questionnaire comprises 44 questions relating to financial inclusion covering in particular access to different types of financial services and u se of financial services, through saving and borrowing, formally and informally, in addition to questions on individual circumstances.2/ For Saudi Arabia and GCC, data is number of branches per 100,000 adult nationals.
Figure 8.
Figure 8.

Financial Inclusion 1/

Citation: IMF Staff Country Reports 2018, 264; 10.5089/9781484374382.002.A003

Source: IMF FINDEX 2017; SAMA and staff calculations; GASTAT; World Bank; IMF Fund Financial Access Survey; and IMF staff calculations.1/ The Findex database, compiled by the World Bank, is based on a worldwide survey covering 1,000 randomly selected individuals in each of over 140 countries associated with the GALLUP world poll, containing comparable information on access to a broad range of financial services and the intensity of their use. The Findex survey questionnaire comprises 44 questions relating to financial inclusion covering in particular access to different types of financial services and use of financial services, through saving and borrowing, formally and informally, in addition to questions on individual circumstances2/ SME lending is based on each country’s own classification. This data is compiled from the IMF Financial Access Survey, World Bank, and country authorities.3/ For GCC, data for Qatar and Bahrain is not available.

Fintech in Saudi Arabia

Technology, in particular Fintech, can lower transaction costs related to access and usage of financial services. Fintech, including mobile banking, e-banking, and e-wallets has become a relatively inexpensive tool to help individuals use banking services and enter the financial market. It can also lower transactions costs for banks and governments by making credit history data and other information on customers readily available.

There is an untapped potential for greater adoption of Fintech. The high share of millennials provides a large pool of potential consumers and growing e-commerce creates demand for digital financial products, while the high mobile phone and internet penetration facilitate customer reach.

uA03fig02

Internet and Mobile Phone Users

Citation: IMF Staff Country Reports 2018, 264; 10.5089/9781484374382.002.A003

Source: ITU; World Bank; and IMF staff calculations.

However, the fintech ecosystem is still in the developing stage in Saudi Arabia. The government aims to make Saudi Arabia a strong Fintech hub and increase the number of fintech companies. However, only a few Fintech-related startups have emerged compared to the rest of the region. The usage of e-banking is also low compared to peers in the region with only 25 percent of Saudi adults using e-banking in 2017.

uA03fig03

Share of Fintech Start Ups

(Percent)

Citation: IMF Staff Country Reports 2018, 264; 10.5089/9781484374382.002.A003

Source: WAMDA Research Lab, 2016.

SME Development

The development of the SME sector is a key priority for the authorities. SMEs and young firms are generally a key contributor to employment and job creation.1 In Saudi Arabia, SMEs, estimated at nearly 1 million, account for around 95 percent of registered businesses, 38 percent of jobs (of which 80 percent are expatriate workers) and 20 percent of GDP, according to the latest GASTAT survey. The majority of SMEs, about 70 percent, are concentrated in low-productivity sectors such as retail and trade, agriculture and fishing, accommodation and food. 88 percent of SMEs are micro firms, with up to 5 employees.

SMEs face several institutional constraints to access to finance. Since their introduction in 2004, the coverage of credit registries (as a percentage of the population) has increased over time. However, overall firm coverage to total population remains low. Borrower and lenders rights are also an issue. Saudi Arabia scores very low relative to its comparable groups on the strength of the legal rights index from the Doing Business Report which measures the degree to which collateral and bankruptcy laws protect the rights of borrowers and lenders and thus facilitate lending, particularly for SMEs.1 This leads banks to charge higher risk premia and impose strict collateral requirements. The poor quality of SME financial statements also leads banks to raise collateral requirements to levels that many SMEs cannot meet. Low levels of financial literacy may also be a factor affecting SME credit demand.

uA03fig04

Doing Business Indicators 1/

(0–1 scale unless otherwise indicated, 100 is the best performance)

Citation: IMF Staff Country Reports 2018, 264; 10.5089/9781484374382.002.A003

Source: Doing Business Indicators.1/ These indicators should be interpreted with caution due to a limited number of respondents, a limited geographical coverage, and standardized assumptions on business constraints and information availability.

A number of other important challenges need to be tackled to support SME’s development. According to a survey conducted by GASTAT, 27 percent of SME managers see workforce issues as an important obstacle to their development and 32 percent see bureaucracy as a major obstacle to starting a business.

1Ayyagari, Demirgüç- Kunt, and Maksimovic (2011) report that formal SMEs account for about 50 percent of employees in developing countries. They also find that SMEs create a greater share of net jobs relative to large firms even after they account for job destruction. Empirical work by Haltiwanger, Jarmin, and Miranda (2010) suggests that start-ups and surviving young businesses are particularly critical for job creation.2 SMEs generally have limited sources of traditional collateral (e.g., real estate) and any use of collateral needs to be underpinned by an effective legal framework that supports creditor rights and facilitates the exercising of that collateral if necessary.

D. Government initiatives

13. Saudi Arabia is introducing reforms to achieve a more inclusive and developed financial sector. The Financial Sector Development Program (FSDP) covers several key pillars including: improving SMEs’ access to finance, supporting Fintech development, promoting financial literacy, increasing national savings, and promoting capital market development.

  • Increasing SME’s access to finance: The authorities aim to increase bank lending to SMEs from around 2 percent to 20 percent by 2030. In order to achieve this target, plans are underway to increase the capital of the Kafalah Program, a partial credit guarantee scheme (Box 4), enable the credit bureaus (e.g., SIMAH and Bayan) to collect SME data, provide alternative SME funding options (e.g., private equity and venture capital, through the “Fund of Funds” and SME Investment Fund), and develop a program to improve the financial literacy of SMEs. The SME Authority was established in October 2015 to coordinate the government’s overall strategy for SMEs and is working on reviewing the regulations to remove barriers to access to finance for SMEs and improving the supply of creditworthy SME businesses. The SME Authority has developed a uniform SME definition, as different definitions of SMEs were previously applied which made it difficult to collect, compare, and consolidate data on SMEs. The recent passage of the bankruptcy law is an important reform that will strengthen borrower and creditor rights. The commercial pledge law was also recently updated, and the collateral registry now covers movable collateral which will allow businesses—particularly SMEs—to leverage their assets into capital for investment. The authorities also plan to build a national online factoring platform to develop factoring solutions for businesses, especially SMEs.

  • Programs are being developed to enhance financial literacy: To increase the overall level of adult financial literacy to 50 percent by 2030, the government is putting in place a financial literacy entity. The entity will coordinate financial education programs to limit the overlaps in initiatives led by different providers, develop financial education content with the Ministry of Education, launch and run major awareness campaigns, and provide consumers with financial planning advice through platforms (e.g., call center, online platform).

  • Fintech initiatives: SAMA signed a deal with U.S.-based Ripple to help banks settle payments using blockchain software. The pilot program supports banks with training to use Ripple’s software to instantly settle payments sent into and out of the country. SAMA is also working with the Central Bank of United Arab Emirates to issue a digital currency that would be accepted in cross-border transactions between the two countries. In January 2018, the Capital Market Authority (CMA) published guidance to enable qualifying applicants to test their FinTech solutions related to securities activities in a lighter touch regulatory framework (Fintech lab). SAMA is also developing its own regulatory sandbox.

  • Capital market reforms: To develop the equity market, the CMA has eased restrictions on foreign investors, strengthened trading infrastructure, taken steps to improve corporate governance including strengthening protection for minority shareholders, and opened a secondary equity market for smaller companies.10 FTSE Russell and MSCI recently announced that Tadawul would be included in its EM indices from 2019. Measures are being taken by the Debt Management Office (DMO) to support the development of the debt market, including by establishing a primary dealer system, allowing some flexibility in the pricing of government debt issuances, developing a sukuk program, announcing a regular issuance program, and registering all government debt securities with the Tadawul. Trading of these securities started in April 2018 and secondary market liquidity should increase once primary dealers are operational. The DMO is also planning to issue shorter and longer-dated bonds to extend the yield curve. These measures will help develop a government yield curve which in turn will support more private issuance. On private issuance, the ability to more easily set up special purpose entities will also help with the issuance of Sharia-compliant instruments. Disclosure requirements for large listed companies have been eased and medium-term note programs permitted.

Government Support to SMEs

SMEs play a vital role in the Saudi economy. The authorities’ focus on enhancing the SME sector as one of the objectives of Vision 2030, aiming to increase the SMEs contribution to the economy from 20 percent of GDP to 35 percent of GDP by 2030. However, SMEs face various challenges, most notably government bureaucracy and limited access to financing from the banking sector (about 2 percent of total lending from banks). In order to solve this issue, the government has designed different programs that support SMEs, among them:

  • Kafalah program: Established in 2006, the partial guarantee scheme guarantees up to 80 percent of the loans to SMEs by banks in case of default. Since its inception, Kafalah has provided guarantees for bank loans to 10,583 SMEs, of which 80 percent are in the construction, trade and services sectors. Since inception, those guarantees have amounted to SAR 10.8 billion (0.4 percent of GDP) and covered on average 55 percent of total loans to SMEs. A royal decree has recently approved a SAR 800 million increase in the capital of Kafalah Program. The program is also being restructured to improve its focus on specific sectors (e.g. tourism) and regions as well as its operational efficiency.

  • Fund of Funds: established under the PIF with a capital of SAR 4 billion. It aims to invest in private equity and venture capital funds on a commercial basis in order to support and incentivize investments, including in SMEs. There is currently very little venture capital (VC) financing to start¬ups in Saudi Arabia compared to the rest of the MENA region.

  • Social Development Bank provides loans for small and emerging businesses and professions as well as low income citizens.

  • Saudi Industrial Development Fund finances SMEs’ industrial projects.

uA03fig05

Kafalah Loans and Guarantees

Citation: IMF Staff Country Reports 2018, 264; 10.5089/9781484374382.002.A003

Source: Kafalah data.
uA03fig06

VC Investment Volumes, 2016

(Percent of total)

Citation: IMF Staff Country Reports 2018, 264; 10.5089/9781484374382.002.A003

Source: WAMDA Research Lab, 2016.

E. Policy Recommendations

14. The financial system in Saudi Arabia is generally well developed, although the use of equity and bond financing is quite limited and financial inclusion could be increased. The authorities are actively working to increase the development and inclusiveness of the financial sector to support their objectives of fostering the non-oil economy and achieving strong and inclusive growth. Many of the policies they are pursuing in the FSDP are aimed at addressing the gaps identified by the analysis in this paper. In addition to, or as part of, the policies being implemented, it will be important to:

  • Address institutional constraints to SME lending. The authorities should continue to focus on improving legal credit infrastructures and ensuring that recently or soon to be introduced laws are effectively implemented. Further development of alternatives to bank finance, particularly expansion in leasing and factoring, private equity, and venture capital, could also help increase access to finance for SMEs and ease funding constraints. The SME authority should help companies fully understand the benefits of improved corporate governance practices, particularly in areas of risk management and audit. Broader efforts to improve the business environment would also help support SME development.

  • Foster financial inclusion through social programs and digital banking. Tying social assistance programs to the opening of a bank account (as was done with Hafiz), while reducing administrative and institutional hurdles could help encourage financial inclusion. In this regard, the citizen’s accounts (introduced in 2017) which provides compensation to Saudi families through the banking system, and the wage protection system (introduced in 2013), which requires most firms in the private sector to pay their employees through the banking system, will help increase financial access. Digital banking can foster financial inclusion by facilitating access to financial services by unbanked populations such as women and remotely-located population.

  • Adopt a targeted approach to financial education. Financial education has a measurable impact if it reaches people during teachable moments, for instance, when they are starting a job or purchasing a major financial product (i.e., mortgage) (Global Financial Development Report, 2014). Leveraging social networks tends to enhance the impact of financial education and could be effective, given high mobile and internet penetration in Saudi Arabia (Barajas et al., 2017). Financial education targeted at Islamic products could be useful as a portion of voluntary financially excluded people cite religious reasons as a reason for their exclusion. Broad efforts to promote financial literacy and savings, and assure investor protection through greater transparency and better governance arrangements would help mobilize funds to the capital markets.

  • Continue to implement policies that will further develop the debt market. The DMO is in a good position to facilitate the development of local debt markets by continuing to develop the sovereign yield curve. The existing regulatory framework for corporate bond and sukuk issuance could be improved by streamlining the public offering route. A clear and consistent treatment of zakat across financial instruments and financial institutions is needed.

  • Enhancing the production of financial services data and measurement. Improved data on unbanked markets/customers is needed to underpin a sustainable expansion in access to finance. SAMA could partner with other institutions such as GASTAT and the SME authority to enhance data availability related to access, usage, and quality.

  • Address policy impediments to Fintech growth. Countries where mobile banking services develop tend to have supportive regulatory frameworks such as legal recognition of electronic signatures and adequate consumer protection. Such regulation should also not impose restrictions on the development of mobile banking, such as limits on nonbanks to use e-money. A comprehensive consumer protection framework and data protection law that apply to financial and non-financial institutions involved in digital finance should also be developed. Continued use of regulatory sandboxes would allow fintech companies and traditional financial institutions to test innovations in a live environment while facilitate better understanding of fintech risks and ensure that regulations are appropriately designed. Developing private equity and venture capital industries would also be useful as these industries have underpinned growth of fintech in advanced economies. On the demand side, financial literacy and trust constitute major constraints to fintech development (WAMDA 2016; Lukonga; 2018).11

15. A detailed analysis of the degree of competition in the financial sector would be useful as the authorities continue to develop their reform program. Assessing whether there are any unnecessary barriers to competition in the financial sector that may limit banks’ willingness to penetrate higher-risk markets would be useful. A diverse and competitive financial sector—one that includes different types of financial providers and financial markets—is helpful in supplying the range of products and services necessary for financial inclusion and development (Love and Martínez Pería, 2012).

16. As they further their financial development and inclusion objectives, the authorities will need to maintain their strong focus on financial stability. Banks in Saudi Arabia are well regulated and supervised and remain liquid, resilient and sound (FSSA, 2017). This is very important, particularly given the reliance of the Saudi economy on volatile oil prices.

Annex I. Benchmarking Exercise

1. We benchmark indicators of financial sector depth and efficiency in Saudi Arabia are benchmarked against (i) a peer group of oil exporting countries1 (ii) the 5 others GCC; (iii) high income countries2; and (iv) statistical benchmarks (expected medians) derived from a regression framework following the World Bank’s FinStats 2017 (Feyen, Kibuuka, and Sourrouille, 2016). Statistical benchmarks are estimated based on structural and economic non-policy fundamentals. By excluding policy-driven factors, the benchmarks determine the level at which Saudi Arabia’s would be expected to be in a policy-neutral environment. The controls include a set of factors that can be viewed as external to policy, at least in the short run. The factors fall under these five types:

  • Economic development factors —Economic development, as measured by GDP per capita, affects financial development, due both to demand effects (the volume and sophistication of financial activity increases with income) and to supply effects (larger, richer economies can achieve economies of scale and benefit from more competition and better infrastructure). To account for potential non-linearities linking economic and financial development, the square of GDP per capita is also included.

  • Population factors —countries with larger populations can have deeper and more efficient financial systems (a scale effect). Financial services can also be provided at a lower cost in countries with higher population density (a network effect).

  • Demographic factors —age dependency ratios, that is, the non-working young and old populations, respectively, as fractions of the labor force, are likely to affect savings and lending patterns.

  • “Special circumstances” —oil exporters may have smaller financial sectors than other countries at similar levels of income, reflecting the fact that oil revenues can boost GDP out of proportion with the country’s overall level of economic and financial development. Offshore financial centers with intensive cross-border operations can also have disproportionately large financial sectors. Landlocked countries encounter structural challenges in accessing international markets, which will impact the composition and performance of the real economy, and, as a result, financial development.

  • Time: global cycle —all available country-year observations are pooled.

2. Maximizing model fit was used as a criterion to select the final set of controls from the large pool of potential controlling factors. Since OLS is sensitive to outliers, median regressions are used instead.

Annex II. Financial Inclusion Index

1. The financial inclusion index is constructed as a composite indicator of the following indicators from the World Bank Global Financial Development Database

  • Account at a formal financial institution (% age 15+)

  • Loan from a financial institution in the past year (% age 15+)

  • Saved at a financial institution in the past year (% age 15+)

  • Saved any money in the past year (% age 15+)

  • Credit card (% age 15+)

  • Debit card (% age 15+)

  • Branches of commercial banks per 100,000 adults

  • Automated Teller Machines (ATMs) per 100,000 adults

2. The Financial inclusion index reduces multidimensional data into a summary index using principal component analysis (PCA). Principal component analysis groups together individual indicators which are collinear to form a composite indicator that captures as much as possible of the information common to individual indicators. The idea is to account for the highest possible variation in the indicator set using the smallest possible number of factors. As a result, the composite index no longer depends upon the dimensionality of the data set but rather is based on the statistical dimensions of the data. Given the wide-ranging nature of the exercise, the first principal component can be interpreted to summarize the latent information on the degree of financial inclusion. The combined information from these various financial indicators embodies around 70 percent of the variance in the data.

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1

Prepared by Abdullah Al-Hassan (WHD), Ali Al-Sadiq (FIN) Anta Ndoye (MCD), Reem alJaber and Walid Alzahrani (SAMA) with inputs from Muhammad Almuzaini (CMA). Research and editorial support was provided by Tucker Stone and Diana Kargbo-Sical. The authors are grateful to the participants at the seminars at SAMA and the IMF for their helpful comments.

2

Saudi British Bank (SABB) and Alawwal Bank struck a preliminary agreement to merge in May 2018. This merger would create Saudi Arabia’s third-largest bank.

3

Credit to private sector is higher if SCIs credit is added.

4

Out of 12 local banks in Saudi, four exclusively offer Sharī’ah compliant products, with the rest offering a mix of Sharī’ah compliant and conventional products.

5

The Hafiz program, started in 2011, aims to support unemployed citizens by helping them find a job and offering them a government allowance. It required enrollees to have a bank account and contributed to the increase in access to the financial sector, especially among females. Indeed, only 15 percent of females had a bank account in 2011, compared to 61 percent in 2014.

6

These numbers are based on the Global Findex Survey, which include Saudi nationals, Arab expatriates, and non- Arabs who were able to participate in the survey in Arabic or English. There is no available information on financial access by nationals only.

7

Aslan et al., 2018 derive Gini coefficients of inequality of financial access from the micro-level data in Global Findex, using the methodology for the computation of income Gini. The financial access Gini is then decomposed into various components to show the contribution of gender inequality to the Gini.

8

This is based on the previous definition from SAMA: an entity with revenue less than SAR 30 million is considered as small and an entity with revenues ranging from SAR 30 to 100 million is considered as medium. Based on the new SME classification, developed by the SME authority, SMEs are now defined as firms with 1–249 employees and/or revenues up to SAR 200 million and lending to SMEs may be higher.

9

Credit to SMEs could be higher if SCIs credit were available and added to bank credit.

10

The Nomu market was launched on 26th February 2017. It is a parallel equity market with lighter listing requirements that serves as an alternative platform for companies to go public, and the investment in this market is restricted to Qualified Investors. It could function as an important vehicle for facilitating the listing of SMEs. One of the main objectives of establishing Nomu is to be an additional source of funding for smaller companies and to increased diversification and deepening of the capital market.

11

The recent MENA survey of fintech start-ups (WAMDA, 2016) identifies customer education as one of the main obstacles to Fintech development

1

Peer group consists of Algeria, Angola, Azerbaijan, Brunei Darussalam, Bahrain, Equatorial Guinea, Gabon, Ecuador, Colombia, Iran, Iraq, Kazakhstan, Kuwait, Libya, Oman, Qatar, Russia, Trinidad and Tobago, United Arab Emirates, and Venezuela.

2

High income countries are Advanced Economies as classified by the IMF.

Saudi Arabia: Selected Issues
Author: International Monetary Fund. Middle East and Central Asia Dept.