Kingdom of Saudi Arabia Banking Perspectives 2020
KPMG in Saudi Arabia March 2020
Foreword
Our evaluation of the key financial and providing incentives and indicators for the past year infrastructure support to achieve these. suggests a positive outlook for The program is aptly supported by Saudi the banking environment in Saudi Arabian Monetary Agency (SAMA) which is defining and shaping regulations Arabia, with promising profit catering to the evolving model of growth fueled by a proactive banking. government and a range of initiatives driven by the regulators. We foresee the banks will continue their preference to finance large public We are pleased to introduce you to the infrastructure projects but higher first edition of our annual Kingdom of volumes and yields are expected from Saudi Arabia Banking Perspectives report growth in SME and mortgage finance. 2020. We have examined pertinent Moreover, non-technological aspects issues and trends affecting global such as workforce diversity, women banking today, with a particular focus on empowerment and ever-relevant Saudi Arabia. cost optimization continue to have a significant bearing on management’s Banks today face profound industry operating style and stakeholder challenges driven by evolving customer expectations. Khalil Ibrahim Al Sedais expectations, digital challengers and increasing regulatory compliance. Banks across the Kingdom would soon Office Managing Partner, Riyadh However, big challenges often mean be striving for a future that is more KPMG in Saudi Arabia big opportunities and therefore, the interconnected, more collaborative and disruptors of today are likely to create a frictionless – one where trust, growth future paradigm that is far beyond the and delivering value are paramount. In usual ambitions. A customer-centric our Kingdom of Saudi Arabia Banking innovation approach, guided by big data Perspectives 2020, our thought leaders and regulatory eminence is reshaping the has delved into the more granular way banks have traditionally operated. aspects of the factors driving the global, regional and local banking landscape. We The government is committed to building look forward to discussing these themes a stronger financial sector, which is with you as part of our endeavors to seek underpinned by the Financial Sector facts and provide insights. Development Program of Vision 2030, defining specific targets for the industry
Ovais Shahab Head of Financial Services Sector KPMG in Saudi Arabia 4 Kingdom of Saudi Arabia Banking Perspectives 2020 Contents
Executive Summary 0
Financial Results 2019 0 Industry Highlights 10 Performance Highlights 12
Banking Environment 1
1. Dynamic Banking Environment: Shifting Sands 16 2. Mergers and Acquisitions: Driving the Change 18 3. SME Lending: Banking on the Untapped Potential 20 4. Restructuring: Imperative or an Opportunity? 22
Regulatory and Compliance 2
5. VAT: More Compliance, more Costs? 26 6. FATF: Focus on effective AML/CTF Regulations 28 7. Shari a Compliance: A Practitioners Perspective 30
Information Technology 32
8. Fintech: Can Banks stay away from Fintechs? 34 9. Cybersecurity: Building Trust 36
Culture and Governance 3
10. Culture, Conduct and Public Trust 40
KPMG in Saudi Arabia 2
Kingdom of Saudi Arabia Banking Perspectives 2020 5 Executive Summary
On a country level, Saudi Arabia The agreement with crypto-currency has witnessed a variety of positive Ripple and the announcement to work developments, fueled by firmer with the UAE on a new digital currency, government spending and economic and the establishment of the Sandbox, growth in multiple sectors, including providing the hard-pressed construction sector several local and international firms a which has posted growth in recent real-life environment to test new digital periods. With the key non-oil drivers solutions, are all testament to SAMA’s such as finance, trade and government positive attitude towards fintech. services posting gains, the medium-term economic outlook continues to remain With an approximate 90% smartphone positive. ownership rate and a tech-savvy population that prefers a mobile interface Although it is one of the biggest for its banking interactions, digital financial sectors by assets in the MENA solutions present a highly competitive region, the Saudi banking industry yet cost effective avenue for streamlining has weathered the storm of recent services, boosting banking inclusion, economic downturn relatively well; an enhancing customer experience and advantageous market, credit environment increasing process efficiencies. and a stringent governance mechanism – with each bank reported to be serving The rapid advancement in digital approximately 2.5 million people on technologies also fuels an increasing average. Overall, total assets across the threat on the cybersecurity front. With listed banks grew by 11.98% during FY an increasing realization that there is 2019 with a healthy 4.46% growth in net no 100% secure environment, banks profits before zakat and income tax. This are looking to continuously develop was coupled with a 10.51% growth in the their cybersecurity infrastructure total deposit base across these banks. As with adequate tools, techniques and such, despite subdued growth in recent processes to be able to detect, protect, years across credit underwriting and respond and recover from cybersecurity deposit acquisition, Saudi banks continue attacks. to be well-positioned to take advantage of the improving economic outlook and The static nature of M&A in Saudi an evolving technological landscape. banking sector has already begun to undergo a shift, with mergers and new A decade after the global financial market entrants poised to shake up the crisis, banks face fresh challenges market structure and competition. If the from new-age disruptive forces driven merger between SABB and Alawwal by technological changes, regulatory Bank in mid-2019 was any indicator of a developments, evolving growth new trend, we expect to see the creation strategies and evolving market demand. of mega financial institutions with high underwriting capacity and profitability. Despite recent challenges, Saudi Arabia has witnessed a robust growth in the In terms of new market entrants, several adoption of financial technology, partly institutions in the GCC and other global due to the banking sector’s cognizance of entities have applied for licenses to its potential to be a major disruptor. operate in the Kingdom.
6 Kingdom of Saudi Arabia Banking Perspectives 2020 The higher pricing power of ‘merged on account of SAMA’s prudence. This is dependency by global financial markets. giants’ and ‘aggressive growth strategies’ epitomized by its continued focus and As a result, banks around the globe are of new entrants would post stiff initiatives to critical areas such as anti- expected to be affected across various challenges for existing market players. money laundering and counter-terrorism aspects in a significant way, ranging financing (AML/CTF), cybersecurity, from legacy contract management In the regulatory landscape, SAMA, the responsible lending and financial to financial reporting issues and from Kingdom’s monetary policy regulator, inclusion. valuation bases to changes in future continues to play a vital role in supporting business and pricing models, processes, the overall financial sector. In addition, For banks, the ensuing regulatory systems and strategies. SAMA started with an objective to further strengthen compliance and the financial impact a data gathering exercise for an initial the sector, the government launched the of potential noncompliance have assessment of the sector’s readiness Financial Sector Development Program ramifications in the form of increasing and expectation of potential impacts of (FSDP) as part of Vision 2030. FSDP cost of compliance which some experts this change. aims to enable financial institutions to estimate could rise to 10% of revenue. support private sector growth, without This has implications for how banks While lending to the corporate sector has contradicting the strategic objectives approach data governance with a need to traditionally been the preferred growth of maintaining stability in the financial move towards sophisticated automation, tool for most Saudi banks, the Kingdom’s sector. According to SAMA, money leveraging on technology made available increasing banking penetration, housing supply (M3) reported an increase of by regtechs. demand and improved credit reporting 7.1 percent y-o-y, which is attributed to system are facilitating strong credit factors such as increase in time and The area of financial reporting has also growth across the retail and SME saving deposits, currency outside banks had its fair share of developments for the segments. It is up to the corporates now and because of government’s efforts banking sector in recent years. The most to align their strategies and work with to move out of deflation. Moreover, in notable change was the implementation the disruptive forces to cater to evolving line with the Vision 2030 objectives, the of International Financial Reporting market demand and potential, while government remains committed toward Standard 9 (IFRS 9) that resulted in a maintaining robust governance. implementing initiatives to bolster the fundamental change in the computation economy and attract both foreign and and recognition of credit losses for domestic investment. 2018, demanding to be a continued area of management’s judgement at year- From a fiscal policy perspective, the end. The other developments include zakat and tax related developments, implementation of IFRS 15, IFRS 16 and such as the introduction of VAT and the presentation of zakat and tax in the prior year zakat and tax settlements, statement of profit or loss as against had a significant impact on the banking changes in equity. The latter, though a industry, not only from a commercial, presentation matter, had implications reporting and compliance perspective for reported bottom line of comparative but also in terms of pricing and business figures in 2019 and hence earning related models. With financial services income KPI going forward. being VAT exempt, a skewed input-output ratio has ramifications for banks’ medium Another key development on the horizon to long term cost optimization and profit is the imminent transition from Interbank strategies. Offer Rates (IBOR) to Alternative Reference Rates (ARR) in the western From a risk and compliance perspective, markets. This long overdue change, it is widely acclaimed that the stability of instigated by a series of scandals, has the Saudi banking sector is primarily sealed the fate for Libor after decades of
Kingdom of Saudi Arabia Banking Perspectives 2020 7 Financial Results 2019
8 Kingdom Of Saudi Arabia Banking Perspectives 2020 Kingdom Of Saudi Arabia Banking Perspectives 2020 9 Industry Highlights
Net profit before zakat and tax Total assets
4.5% 12.0%
Impressive growth in bottom line Total assets edged up to US$ 652 despite prevailing challenges billion fueled by strong growth in loan book
ECL allowance for loans Capital adequacy ratio
7.5% 0.9%
Total ECL allowance has increased Capital adequacy ratios reduced due to organic growth in loan book marginally, yet still continue to be and certain M&A activity well above minimum regulatory requirements
Coverage ratio 8.0%
With improving credit quality, coverage ratio witnessed a decline from 168% to 160%
10 Kingdom of Saudi Arabia Banking Perspectives 2020 ROE ROA
1.2% 0.2%
High growth in total assets and net equity relative to bottom lines resulted in slight decline in ROA and ROE
Loan book quality stage1 stage 2 stage 3 90.8% 7.0% 2.2%
2019 loans with significant increase in credit risk and those which were credit impaired represented 7% and 2% of the total loan book respectively
Total customer deposit
10.5%
Improving economic environment and recent developments contributed towards a healthy growth in deposit base
Kingdom of Saudi Arabia Banking Perspectives 2020 11 Performance Highlights
Net income (in SAR billion) and net special commission income ratio (NSCR*, percentage) 2019 v/s 2018
14.0 96.8% 12.9 120%
12.0 11.3 10.3 10.8 100% 78.3% 10.0 81.0% 77.0% 75.7% 82.5% 80% 8.0 75.6% 72.8% 63.6% 70.6% 6.2 58.4% 5.5 60% 6.0 4.7 4.9 3.6 3.6 4.6 40% 4.0 2.8 3.3 3.3 3.3 2.5 1.4 1.5 2.0 1.1 1.0 1.1 20% 0.3 0.0 0% AIB ANB ARB BAJ BB BSF NCB RB SABB SAIB SB
Net income, 2019 Net income, 2018 Participant average, net income, 2019
NSCR, 2019 Participant average, NSCR, 2019
ROE/ROA (percentage) 2019
25.0% 22.1%
20.0% 18.5% 14.7% 15.4% 15.0% 12.5% 12.5% 9.7% 11.0% 10.2%
10.0% 5.8% 5.0% 2.9% 1.3% 2.5% 2.1% 1.9% 1.6% 2.0% 2.3% 1.2% 2.4% 0.3% 1.8% 0.0% AIB ANB ARB BAJ BB BSF NCB RB SABB SAIB SB
2019: ROE 2019: ROA Partcipant average ROE, 2019 Partcipant average ROA, 2019
Total assets and loan book (in SAR billion) 2019
600.0 507.3 500.0
384.1 400.0 282.3
300.0 249.7 265.8 265.5 255.6 183.4 178.1 174.0 200.0 131.8 154.7 141.6 94.8 118.8 125.7 100.8 86.1 100.0 86.5 49.7 59.4 57.1
0.0 AIB ANB ARB BAJ BB BSF NCB RB SABB SAIB SB
Total Assets Loan book Participant average total assets Participant average loan book
Total coverage ratio (percentage) 2019 v/s 2018
400% 342.0% 350% 303.0% 300% 260.0% 235.5% 250% 180.2% 179.0% 177.3% 175.2% 200% 161.1% 136.1% 149.9% 140.5% 138.1% 141.5% 151.0% 127.2% 140.3% 150% 118.7% 108.5% 112.0% 100% 71.6% 66.7% 50%
0% AIB ANB ARB BAJ BB BSF NCB RB SABB SAIB SB
Coverage ratio, 2019 Coverage ratio, 2018 Participant average coverage ratio, 2019
Legend: Alinma Bank AIB Bank Al Bilad BB Saudi British Bank SABB Arab National Bank ANB Banque Saudi Fransi BSF Saudi Investment Bank SAIB Al Rajhi Bank ARB National Commercial Bank NCB Samba Bank SB Bank Al Jazira BAJ Riyadh Bank RB
12 Kingdom of Saudi Arabia Banking Perspectives 2020 Net impairment charge (in SAR billion) 2019 v/s 2018
3.0 2.6 2.5
2.0 1.8 1.5 1.4 1.4 1.3 1.5 1.2 1.0 1.0 1.0 1.0 1.0 1.1 1.0 0.7 0.5 0.5 0.4 0.5 0.3 0.2 0.2 0.1 0.2 0.0 AIB ANB ARB BAJ BB BSF NCB RB SABB SAIB SB
Net impairment charge, 2019 Net impairment charge, 2018 Participant average, net impairment charge, 2019
Total deposits (in SAR billion) and loan to deposit ratio (percentage) 2019 v/s 2018
400.0 120.0% 353.4 318.7 350.0 312.4 293.9
300.0 80.0% 250.0 194.5 192.2 200.0 180.2 142.1 142.1 132.8 148.4 169.8 170.2 150.0 130.5 40.0% 102.190.1 100.0 57.2 69.1 63.7 62.7 51.8 66.8 50.0
0.0 0.0% AIB ANB ARB BAJ BB BSF NCB RB SABB SAIB SB
Total deposits, 2019 Total deposits, 2018 Participant average total deposits, 2019 Loan to deposit ratio, 2019
Loan, stage-wise composition (percentage) 2019 1.9% 6.1% 2.1% 0.9% 1.2% 2.7% 1.8% 1.9% 3.2% 5.6% 2.3% 100% 6.8% 3.4% 5.9% 2.8% 4.6% 12.3% 7.6% 14.1% 9.3% 12.0% 8.4% 80%
60%
95.7% 95.3% 91.3% 88.1% 92.3% 93.1% 40% 85.6% 86.3% 84.7% 84.8% 86.0%
20%
0% AIB ANB ARB BAJ BB BSF NCB RB SABB SAIB SB
Stage 1* Stage 2 Stage 3
Income/(loss) by segment (percentage) 2019 9.6% 2.7% 6.4% 3.1% 5.8% 5.9% 6.7% 100%
27.8% 21.5% 80% 25.2% 34.8% 27.1% 28.9% 31.5% 36.1% 36.6% 19.0% 60% 72.5% 39.0% 26.9% 22.5% 46.1% 169.8% 28.5% 40% 35.4% 48.1% 33.0% 56.7% 14.4% 41.5% 44.6% 20% 37.4% 23.6% 41.1% 25.0% 35.6% 182.4% 28.2% 13.9% 0% -4.2% -28.0% -10.6% -189.1% -20%
-40% -63.2% AIB ANB ARB BAJ BB BSF NCB RB SABB SAIB SB -60% Consumer Corporate Treasury Others
Disclaimer: This report is solely for information purposes and prepared based on financial numbers as reported in the published financial statements of the respective banks as available on Tadawul. Accordingly, KPMG does not and shall not assume any responsibility for the information presented herein or the nature and extent of use of this report. ROE is the ratio of net income to total equity. ROA is the ratio of net income to total assets. Net special commission income ratio is the ratio of YTD net special commission income to YTD total special commission income. Coverage ratio is the ratio of total ECL for loans and advances to total NPL. Loan to deposit ratio is the ratio of total loans and advances to total deposits. Stage 1 exposure also includes purchased credit impaired loans. ** SABB financial numbers for 2019 are based on its published financial statements which include its post merger consolidated results.
Kingdom of Saudi Arabia Banking Perspectives 2020 13 Banking Environment
14 Kingdom Of Saudi Arabia Banking Perspectives 2020 Kingdom Of Saudi Arabia Banking Perspectives 2020 15 Dynamic Banking Environment: Shifting Sands
Despite a challenging global and Saudi banks have faced a challenging Though lending to the corporate sector economic environment over the recent has traditionally been the preferred regional environment, Saudi years. The decline in oil prices, which route to margin for the Kingdom’s banks have performed reasonably began in late 2014, led to concerns financial institutions, expansion of the about reduced government spending bankable population, advances in risk well in 2019 and continued to and muted private sector demand. The assessment practices and the advent of invest in technology and people process of economic reform, while new technologies have allowed banks to to assist in the growth of the welcomed as a necessary measure for make greater inroads into the retail and long-term growth and stability, has led to commercial segment. Banks have shown banking sector. more market uncertainty. enough flexibility allowing them to shift their focus and tap the retail market to For the past few years, banks are drive growth. The government’s focus on reporting lower lending opportunities as housing projects has also helped their the companies adopted a wait-and-see cause. stance towards expansion plans. The knock-on effects of the oil price decline The sector is also opening up to new and economic uncertainty were the main entrants with a number of foreign factors for the slow recovery in credit banks looking to open their branches in extension. While the banks remained Saudi Arabia. In addition to new market profitable, the loan book growth was entrants, the banking sector is also limited, and the banks were more looking to transform with the mergers of focused on retaining and restructuring some of its biggest institutions. existing credits rather than expanding the credit base to more risky avenues. Signs of recovery in Q3 2019
Certain regulatory changes have further Saudi banks have reported a better-than- affected the muted lending environment. expected performance for third quarter SAMA introduced tighter corporate of 2019 as lending picked up on the lending rules designed to limit a bank’s back of mortgage financing in the retail exposure to a single customer to 15% sector driven by a variety of government of its Tier-1 capital against the previous initiatives to increase home ownership. In limit of 25%. Further, the implementation Q3 2019, the eleven Tadawul-listed banks of IFRS 9 in 2018 changed the way of made a cumulative profit that was 13 calculating potential impairment of loans percent higher than in the same period from a historical one to a forward-looking in 2018. This performance indicates that one. The resulting increase in impairment Saudi banks have successfully managed allowance, impacted banks’ solvency to offset any decline in net interest positions and shareholders’ equity and margins ensuing from falling interest impacted their overall credit strategy. rates globally by solid growth and internal efficiencies Sector resilience A positive development for the sector as Overall, Saudi banks were able to remain a whole was the fact that lending picked profitable throughout the low growth up due to rising government-supported period, demonstrating the sector’s economic activity and growth in the resilience despite economic challenges. private sector. The rise in long-term
16 Kingdom of Saudi Arabia Banking Perspectives 2020 loans by 14.4 percent comparing sector that the country continues to to previous year, was the biggest demonstrate its willingness to reform standout of the quarter indicating that and to diversify away from its petroleum economy is recovering. This positive economy, as investors will be keen economic development should gradually to see a continuation of the progress translocate to other parts of the already made. economy. The recovery is led by the government as lending to public sector The challenges for Saudi banks in 2020 and quasi-government institutions rose include growing loan books outside by 25 percent per annum. of SME lending and mortgages, containing any increase in cost of funds Outlook for 2020 if oil prices remain weak, driving cost efficiency through digitization, and The inclusion of Saudi Arabia in the countering competition from digital MSCI Emerging market (EM) index and payment platforms. Saudi banks are the Aramco IPO, are likely to have a well-positioned to take advantage of long-lasting positive effect on the Saudi opportunities arising from the recovery market’s overall depth and liquidity in the oil prices and the anticipated profile. acceleration of economic growth. Kashif Zafar The listing of Saudi Aramco, in addition Senior Director, Audit to other funding sources, should provide T: +966 1 1874 8500 meaningful capital to support the E: [email protected] government’s investment plans.
The anticipated increase in overall credit Kashif Zafar is a Senior Director based growth in 2020 supported by increase in in KPMG’s Riyadh office and specializes in the audits of financial services-based both project lending and the mortgage entities including banks, insurance market should counter any adverse companies, investment banks and funds. effects to overall profits coming from He has been associated with KPMG for margin compression and zakat taxes. more than 21 years and has worked in Capitalization levels are above regulators’ KPMG offices in Pakistan and Ireland stringent requirements, leaving before joining the office in Saudi Arabia potential for increased lending. Saudi 12 years ago. Kashif gained deep insights retail mortgages are likely to remain a of the Saudi financial services sector key driver of credit after expanding 31 through working with all the major banks percent year-on-year during the third in the Kingdom. quarter of 2019, compared with total- loans growth of 4 percent.
Conclusion
Overall, 2019 has shown signs of growth for the financial sector, especially in the second half and largely driven by mortgage lending. It is critical for the
Kingdom of Saudi Arabia Banking Perspectives 2020 17 Mergers and Acquisitions: Driving the Change
Across the GCC, large banks are In today’s era of significant economic creating the Kingdom’s third largest bank change, companies continue to look for by assets. At the same time,the National consolidating to gain pricing partners that can leverage their abilities Commercial Bank (NCB) and Riyad Bank power and market share. To for cross-selling, accessing new markets entered into negotiations that were called and customers and other synergies to off in December 2019. While this merger achieve credible success with enhance financial performance and gain would have created the Kingdom’s these mergers and acquisitions, competitive advantage, boosting the largest bank and the Gulf’s third largest they need to be cognizant of combined market share. Over the past lender; the positive side is that the two decade, we witnessed a tremendous banks will continue their contribution determining prospects and amount of activity in the field of mergers to the economy in their own ways and growth. and acquisitions where companies joined provide healthy competitive environment. forces and achieved increased value for shareholders. There was, however, also While experts believe that this increase a number of transactions that could not in M&As is ‘credit positive’ for the achieve the desired objectives, resulting region, it is vital to identify the instigators in value destruction due to inappropriate thereof in both regional and local banking planning or process breakages. sector. As such, the following factors are pertinent to note: While Saudi corporations have engaged ---- Across GCC and especially in Saudi in successful M&As over the years, Arabia, growth of the banking sector reaping significant benefits, most is largely dependent on GDP growth notably Almarai and Western Bakeries, and government spending. Low oil and NADEC and Al Safi Danone, the prices in recent years have adversely local banking sector has been largely impacted government spending, slowed devoid of any major M&A activity up until down economic growth and intensified recently, where a flurry of M&A activity competition for deposits and borrowers. among banks in the GCC emerged. --- Too many banks often serve small What’s driving M&A? populations in the region. Many banking systems in the GCC are also dominated In recent years, the region’s M&A by a few large banks with many smaller landscape witnessed the creation of the banks competing for the rest of the largest bank in the UAE with the merger market. These situations fuel the need of National Bank of Abu Dhabi and First for merged, more stable and competitive Gulf Bank.This was followed by the entities. three-way merger involving Abu Dhabi — Most GCC banking systems are Commercial Bank, Union National Bank heavily reliant on government deposits and Al Hilal Bank during 2019 resulting and competition is high, resulting in in ACDB Group.There is also activity pressure on margins. Consolidation will across other GCC countries, notably the result in the banks having greater pricing progressing merger of Kuwait Finance power. House with Bahrain’s Ahli United Bank. — Mergers are expected to improve In Saudi Arabia, the Saudi British Bank profitability in the long run due to (SABB) and Alawwal Bank successfully common synergies. completed the merger in June 2019,
18 Kingdom of Saudi Arabia Banking Perspectives 2020 Despite integration challenges in the Finally, it is crucial to proactively identify early stages, merged banks will gain the financial reporting impacts of all market share and benefit from greater M&As. pricing power and cost synergies through improvement in efficiencies and Defining success steps rationalization of operations. As the sole measure of quantitative The merger of SABB and Alawwal Bank performance of success, both before resulted in the following outcome at the and after an M&A, key matters such as time of completion of the merger: asset valuations (especially goodwill), impairment of assets and off-book — Second largest lender in Saudi Arabia asset/liability recognition, alignment as per corporate book size with 15% of accounting policies, pre-existing market share relationships and restructuring costs must be considered. While considering — Home finance market share of 16% these, the significance of professional and credit card balance market share of advisors that can support management 19% across the full M&A journey cannot — FX income market share of 12% be emphasized enough. It has been proven time and again that with the Ovais Shahab — Significant growth in distribution right professional support, various Head of Financial Services Sector network with 143 branches and over groups have successfully tackled T:Ovais +966 5 979 Shahab 1636 1,500 ATMs merger challenges such as management E:Head [email protected] of Financial Services Sector alignment, due diligence and valuation KPMG in Saudi Arabia — Enlarged balance sheet capacity and sensitivities as well as process, system capital base to support transformational and culture integration through setting up Ovais Shahab is a Senior Director heading the Financial Services Sector for Saudi infrastructure and privatization projects integration committees and developing Arabia and the Levant Cluster. He has — Pooled-in staff talent and experience integration blueprints. a wealth of assurance and advisory from both the merging entities experience, gathered over 22 years In conclusion, it can be said that in lieu of his association with various KPMG However, with all their potential benefits, of the various benefits discussed earlier, offices. During his 15+ years with the many M&As have been seen to fail despite economic recovery across Saudi practice, he has led successful in achieving their intended objectives most Gulf regions and positive growth engagements with leading flagship or worse, led to the demise of both forecasts for 2020, experts anticipate relationships in the sector. His sound parties. As such, banks need to be wary consolidation of banking entities via credentials have enabled him to advise of the critical factors that underpin a M&As to continue. and successfully collaborate with the successful M&A. In this respect, robust regulators SAMA, SOCPA and CMA on merger planning, including a detailed However, the timing and success various milestone projects. readiness assessment, is fundamental. of finalization are largely dependent In addition, management of stakeholder on regulatory direction, stakeholder expectations is equally paramount. reception, experienced advisors and most importantly, proper planning, Apprehensions of what the future holds, execution and management alignment. especially in terms of potential staff redundancies, need to be tackled well, not just for overall employee morale but also for the sustenance of brand image.
Kingdom of Saudi Arabia Banking Perspectives 2020 19 SME Lending: Banking on the Untapped Potential
While the government in light Over the last few decades, small and and trained human capital, marketing medium enterprises (SMEs) have not challenges, poor access to international of Vision 2030 is taking various been a key priority area for Saudi Arabia markets, limited access to technology initiative such as introducing from a policy, financing and development and bureaucratic hurdles. perspective. However, with their growth multiple programs to promote and successful contribution to the Forward looking government investment and support eminence advanced nations, SMEs have caught the strategy attention of policymakers in the Kingdom. building in the SME sector, the Recognizing the strategic importance of directive for the banks is to drive The overall employment contribution of the SME sector, the Saudi government SMEs, Saudis and expats together, is has launched multiple programs this vision further by adopting 43%, and 5% to the total exports. SMEs to solve its recurring issues and a customized approach towards currently contribute 21% to the GDP leverage its growth potential. It has and one of Vision 2030’s objectives is to recently established the SME General SME lending and further diversify increase this to 35% by 2030. Authority (Monsha’at), which aims to its income sources. enhance the role of SMEs. It has also Factors limiting growth in the past roped in multiple institutions which provide different levels of support for There are multiple reasons for SME’s low development of the sector. The Saudi contribution to the GDP. The continued Industrial Development Fund (SIDF) reliance on the oil economy is one factor, is focusing on growth of the industrial along with the lack of an effective policy sector SMEs and has developed a environment for SMEs in the past, business resource center, modernization access to financing sources, inadequate center and financing facilities for SMEs. managerial skills, access to skilled The Ministry of Finance has launched SME loan guarantee program ‘Kafala’, to 3% facilitate bank lending to SMEs. Real 3% Estate Construction The Financial Sector Development 7% Program (FSDP) has outlined many Other services initiatives, such as raising the share of SME loans as a percentage of total bank loans by 2020, raising the level of private 10% equity and venture capital financing Agriculture, forestry and fishing Breakdown of 47% to SME funding, introducing fintech Wholesale SME activities and retail, companies to facilitate SME financing repair of motor by sector vehicles and and expansion and helping SMEs to get 11% motorcycles listed in the Nomu parallel market. Hospitality and F&B SMEs in Saudi Arabia are financed 11% through commercial banks and Manufacturing government financial institutes such as the Social Development Bank and SIDF. Banks adopt a cautious lending Source: Monsha’at approach for this sector. Banks are
20 Kingdom of Saudi Arabia Banking Perspectives 2020 apprehensive to lend to SMEs due to low — Enhancing customer service revenues per client, high risk of business failure, governance issues, insufficient — Deploying non-traditional sources of collateral, absence of audited financial information such as checking account statements. SMEs also face challenges transaction history, ATM usage, in securing bank financing due to their relationship tenor, and third-party lack of knowledge of banking products, information such as utility bills and rent high profit rates and checklist-based payment for qualitative assessments approach adopted by banks. In addition — Adopting risk-based pricing at sub- to the above, the legal and regulatory segment or customer level to maximize framework for SME lending also needs portfolio profitability to be strengthened. Conclusion Banks showing ingenuity towards SMEs Diversifying income sources through SMEs is an important element to Banks need to adopt a customized and enhance the private sector contribution differentiated approach toward SME to GDP and provide jobs to the growing lending. They should look at identifying young population. Banks can play a Ankit Shah high growth SME industry segments pivotal role in meeting the financing gap Associate Director, Advisory and strive to attain market leadership faced by this sector. in these. This would enable them to T: +966 1 1874 8500 increase their competitiveness by E: [email protected] specializing in select products. Banks can reduce their overall risks and increase Ankit Shah is Associate Director at profitability at a customer and book level the Global Strategy Group in KPMG’s by adopting the following: Riyadh office. He has more than 12 years of experience in business strategy — Developing differentiated offerings for and advisory services. He has worked micro, small and medium segments extensively on assignments in corporate strategy, market entry, financial feasibility, — Adopting appropriate insight-based business plans in the in the financial customer segmentation strategy services sector.
— Selection of cost-effective distribution channels
— Maintaining a wider and distributed customer reach
— Comprehensive approach for pricing and product development
— Adopt quantitative and qualitative credit risk scoring and rating tools to radically improve the consistency of credit decisions
Kingdom of Saudi Arabia Banking Perspectives 2020 21 Restructuring: Imperative or an Opportunity?
Regardless of which school of shareholders – undervalue the risks 1- Diagnosis and drop their guards. Banks tend to economics you belong to, the extend under-collateralized loans and The prerequisite to any such step carries consensus in the 21st century misprice assets or risks, hungry for a change or adjustment of stakeholders’ fees and eager to further grow their attitude, a resolve to act in good faith for is that the economic prospects portfolio and market share. Bankers get the sake of the company, and a strong of a country lie primarily in its paid high commissions for originating focus on one goal; that of saving the company and overcoming the current ability to offer entrepreneurs and loans, but never for collecting the loans back. As soon as the cycle turns the and upcoming challenges. Egos must business owners an enabling peak, demand for goods drops, margins be put aside. Management and board of directors must act in full transparency environment to take risks and tighten, firms become under pressure, and repayment of borrowed money by articulating and confronting the create jobs. becomes at risk. Only then does a problems. A culture of honesty, empathy company start realizing it is in distress, should reign in, replacing one of reprimand and blame. The diagnosis is In one respect, entrepreneurship is an but also, only when a loan payment built primarily on the identification of (i) almost heroic activity and deserves is missed or delayed, does the bank internal factors such as working capital much recognition by society. Similarly, formally recognize its client is facing mismanagement, underperforming but to a lesser extent, the capital serious issues. sales, etc. and (ii) external factors such deployment by business owners, The reality is that businesses rarely as change in regulations, recession, or investors, is a necessary and go from prosperity to failure in one litigation, new market forces, etc. An imperative activity for the growth and step. Companies’ boards and the advisor’s most important role in this step survival of an economy. Saudi Arabia management must work together is to get the truth about the underlying and other countries in the region have with banks to recognize early signals issues and deal holistically with the developed new legal frameworks of commercial and financial distress. complexity of restructuring a business, to protect the private sector, The sooner the company recognizes by asking deep and sometimes recognizing the need to create wealth patterns of inefficiencies and disruptions, embarrassing questions, by determining by encouraging local businesses acknowledging its current or potential whether an observed difficulty or and attracting foreign capital. Local underperformance and takes aggressive problem is cause or effect, by deploying companies, entrepreneurs, and measures accordingly, the more likely diagnosis tools such as cross-sectional international investors should feel safe it is to survive the downturn, and grow analysis, financial ratios assessment, taking financial risks. Banks play a stronger afterwards. dashboard cash-flow models, tailored fundamental role in the development interviews with team leaders, by of the private sector and the economy. Management and shareholders must reviewing internal policies and Like investors, lenders assess the have the courage to look the tiger in eye procedures, by appraising the decision- risk of lending and demand a fee in and embrace the need for a turnaround making processes, and by mapping return. But unlike the return on capital early, including a drastic change in the business and operating models injected by entrepreneurs, investors business or operating model. They processes to the existing business and shareholders who have all their must consider preemptive disruptive capability (capacity, infrastructure, team capital to lose and must wait in line market force and use certain short- sizes, governance). The sooner the before receiving a dime of profit, term and longer-term restructuring recognition and diagnosis, even if it is lending returns (interest) are naturally and turnaround tools to transform the believed to be preventive, the quicker the lower as they bear significantly lesser business from an under-performing causes of financial distress are identified. risk. Interest payments are senior in company into a potentially top performer. the capital structure, they are due on While recognition is the business’ 2- Design and implementation of specific dates irrespective of business responsibility, banks and advisors short-term and longer-term solutions performance and are very often along have a role to play through their close with loan principal secured by assets. relationships with decision-makers. The optimal solutions to the diagnosed problems would typically include a When business is doing well, As such, following the recognition investors are eager to invest, and combination of top-down and bottom- phase, companies must carry out up approaches. A top-down approach banks rush to lend. Good economic three main restructuring tasks: times induce complacent behaviors could include a design of large-scale while stakeholders – banks and
22 Kingdom of Saudi Arabia Banking Perspectives 2020 quarterly objectives such as a cost- 3- Identification of funding sources recognition of distress signals, to the saving and efficiency program (e.g. cost implementation of solutions and finally cutting by 45%), a shift in strategy (e.g. It takes money to sustain operations and the rehabilitation or rebirth of the focus on younger customer segment), time for transformation to take effect. A business. an adjustment or transformation of the major challenge is finding resources to business model (e.g. digitization of sales, keep a business going while it is being asset light model), a simplification of transformed and restructured. Raising the operating model (e.g. outsourcing capital for a company in distress can be of procurement). Considering recent difficult, time consuming and expensive. changes of the regulatory and taxation The advisor and the stakeholders would landscapes (e.g. Saudi markets opening need to race against the clock to find to global investors, privatization reforms, more creative solutions that can come VAT implementation, increased labor in the form of fixed assets divestiture, and energy cost, etc.) such objectives aggressive receivable collections, must ensure the company is able inventory liquidation, or more generally to develop economy of scale and cash cycle optimization. The advisor must compete with global players. A bottom- identify the excess assets and implement up approach typically includes highly an efficient use of the remaining ones. impactful initiatives such as the layoff To the extent such assets were funded of non-performing highly paid staff, by debt, their liquidation is a great relief. or the reverse engineering of sales As the company progresses in taking numbers of a loss-making product, corrective measures and achieving resulting in a Required Sales Target planned milestones, the advisor would which, if not achievable, would trigger help showcase the future re-birth of Firass Hathout the prompt exclusion of such product. the business to equity investors for Director, Head of Deals Strategy, What is also required is a balancing act new capital injection and/or to banks Structuring and Restructuring between meeting short-term saving for existing debt rescheduling or Solutions and investing in long-term performance. restructuring, renewal of working capital Cutting staff across a highly performing facilities, and potentially new lines of T: +966 55 90 878 90 sales team is suicidal for the business financing. E: [email protected] especially if sales targets were not met in the past due to shortage of Conclusion Firass Hathout is a Director and and products. The immediate closure of Head of Deal Strategy, Structuring and an under-utilized cash bleeding plant, A successful restructuring is a win for Restructuring Solutions for Saudi Arabia the sale-lease-back of warehouses, everyone, and an unorganized collapse and the Levant Cluster. He has over and the focus on working capital and liquidation on the other hand is 16 years of experience in investment enhancement are all short-term wins certainly an outcome the banks wish banking, structuring and private equity portfolio management in the US, Europe and great sources of much needed cash to avoid at any price. The current and and the Middle East, across various in the initial turnaround phase, while recently enacted bankruptcy law in Saudi Arabia leveled the playing field by offering sectors and types of institutions. the capital investment in the expansion With KPMG’s global restructuring and businesses some protective options and of a profitable product line should be turnaround team, his team’s priority implemented as soon as the funding room to work out agreeable restructuring is preparing the private sector in the source is identified. solutions with banks. An unprecedented region for upcoming market volatility and collaboration amongst all stakeholders disruptions. As solutions are designed and through the formation of restructuring implemented, the stakeholders must team or committee, comprising of not lose sight of their customer value representatives from the company’s proposition and should maintain an management, its shareholders, the banks outward view towards their client base and the restructuring and turnaround and competitors. External disruptions advisors who come with commercial, are far more lethal and inflict permanent financial and technical know-how, is of damage. vital importance, starting from the early
Kingdom of Saudi Arabia Banking Perspectives 2020 23 Regulatory and Compliance
24 Kingdom of Saudi Arabia Banking Perspectives 2020 Kingdom of Saudi Arabia Banking Perspectives 2020 25 VAT: More compliance, more costs?
VAT regulation in Saudi Setting the context How it works?
Arabia allow banks for a Value added tax (VAT) has been part of In broad terms, banks make a mixture of VAT deduction if an expense the global taxation system for more than taxable (fees, commissions, discounts) half a century, originating in France and and exempt (margin-based, interest is put to a mixed use, ie. spreading to well over 150 countries bearing, sales of securities) supplies. an expense is made for around the world. Often described as Taxable supplies entitle the business ‘a simple tax’, VAT has had a profound to deduct VAT incurred on business both taxable and exempt impact on business in areas as diverse expenses in full whereas exempt supplies. Such exempt as supply chain and human resources supplies prohibit such deduction in because it is transactional in nature. full. Immediately, a cost arises where activities in the industry the business makes exempt supplies impact cost and profitability. VAT was implemented in the Kingdom because VAT deduction is blocked. The on 1 January 2018 and thus far, only VAT regulations in Saudi Arabia allow Effectively managing VAT the UAE and Bahrain have joined Saudi a VAT deduction if an expense is put and implementing the right Arabia in implementing VAT. Qatar, to a mixed use (that is, the expense is Kuwait and Oman are scheduled to used to make both taxable and exempt steps will help banks in introduce the tax by 2021. The standard supplies) but only to the extent that it Saudi Arabia in complying rate of VAT is five percent with certain can be demonstrated that there was specified goods and services qualifying some taxable use. and handling costs to be taxed at zero percent or to be VAT successfully. exempt. Typical examples of mixed-use expenses would be overheads, centralized Over the past two years, our costs such as office accommodation, understanding of VAT and its impact on accounting, trading systems, information certain industries has developed rapidly. systems, legal. Saudi VAT regulations It is clear that industries such as banking stipulate how taxpayers can calculate have been more impacted by the the amount of VAT that can be deducted introduction of the tax than others. where the expense is put to a mixed-use.
The banking industry is complex and Currently, the approach adopted in Saudi broad, traditionally encompassing retail, Arabia is that the taxpayer determines corporate and investment banking the deduction percentage annually and services. The industry is now disrupted makes an adjustment retrospectively to by fintech and convergence with non- VAT returns already submitted — either traditional competitors such as telecom paying additional VAT to the authorities operators and global technology players or receiving a refund. The taxpayer must such as Apple and Samsung entering also apply this percentage going forward the market. In this region, Shari’a law for one year. prohibits the earning of interest and therefore specific structures are required to provide debt financing which must be compliant with this law. All these factors influence the application of VAT in the industry.
26 Kingdom of Saudi Arabia Banking Perspectives 2020 The calculation is based on a pro rata The exempt activities in the industry formula as follows: have a direct impact on costs and, consequently, pricing and profitability. Value of taxable supplies It can be very difficult for banks to link expenses directly to either taxable or exempt supplies and therefore a value of Y% significant proportion of expenses can value of exempt be described as mixed-use. Typically, taxable supplies banks deduct a low percentage supplies X 100 (15–25 percent) of mixed-use VAT and The resulting percentage should be must invest a lot of time and effort to applied to the value of mixed-use VAT. manage this cost.
Banks must also determine how much Further impact VAT can be deducted on the purchase of capital assets according to the In a continuation of this chapter taxable use of the asset over time. reviewing the impact of VAT on banks The adjustment periods are six years in Saudi Arabia, we shall be releasing in respect of moveable tangible or a series of articles focusing in more intangible capital assets and 10 years detail on how the banks manage VAT in respect of immovable capital assets in terms of the cost of funds, product which are permanently attached to pricing, systems costs, and overall land or real estate. This requirement profitability. We shall also review the adds another layer of complexity to the more subjective areas of the tax such compliance obligations of the taxpayer. as direct attribution, the proportional Accessing the data necessary to enable calculation and the application of the compliance can be a challenge given the capital assets adjustment provisions in multiple systems and huge volumes of the Implementing Regulations. data which are common to this industry. Undoubtedly, the introduction of VAT has Nick Soverall had a significant impact on the banking Head of Indirect Tax industry from a reporting and compliance perspective but also in terms of pricing T: +966 5 8340 1111 E: [email protected] and business model. For example, an outsource model (call center, IT support) will now create additional VAT costs if Nick Soverall leads the Indirect Tax and expense relates to exempt activities. Tax Data Analytics practice for KPMG In Saudi Arabia. He has over 30 years of We believe that the approach to experience in consulting on indirect tax matters in the UK, sub-Saharan Africa effectively manage VAT in the industry and now the GCC. Previously, he led the will evolve as it becomes pressing indirect tax practice in South Africa for to comply and manage costs. In this another big 4 firm. He has advised clients sense, Saudi Arabia is following in the in all areas of indirect taxation including footsteps of taxpayers operating in more technical, strategy, planning, dispute established and developed VAT regimes. resolution and contract negotiation. He led the team that undertook the largest VAT implementation in the GCC.
Kingdom of Saudi Arabia Banking Perspectives 2020 27 FATF: Focus on effective AML/CTF Regulations
Full membership of the Financial As a full member of FATF, there is payments and transactions, the use Action Task Force (FATF) is both expected to be further impetus to of Artificial Intelligence (AI), Robot a recognition of the progress enhance and increased effectiveness Process Automation (RPA) and related the Kingdom has made, and of AML/CTF rules, processes and new capabilities that have entered into also raised the bar in terms associated measures. the domain of financial services. This of expectations for the future. increases the challenge in ‘connecting Specifically, the FATF mutual evaluation Consequently, SAMA is both the dots’ between different entities in a report noted that SAMA is committed bank’s systems and between different strengthening standards, urging to requiring all financial institutions banks to take their own measures transactions to effectively identify risks, within the Kingdom’s jurisdiction to such as: in anti-money laundering and implementing recommendations for counter-terrorism financing (AML/ combating money laundering and the — Identifying links and correlations CTF) and enhancing monitoring financing of terrorism issued by FATF. between different fraud (or suspected and oversight at system-wide SAMA is, therefore, likely to provide fraud) instances over different and individual banking institution further focus around standards, timeframes, to identify new AML level. In parallel, SAMA is also monitoring and risk oversight around schemes, identify and analyze trends in focusing on regulatory reforms AML/CTF issues. AML cases. to proactively set the direction in response to rapid changes Based on our extensive work across the — Identifying suspicious connections in business models resulting sector, we expect that this is likely to between bank employees and/ from advancements in use of encompass: or branches and customers, such technology in banking sector, as irregular clusters of transactions — Enhanced supervision and monitoring, performed by specific tellers, family or which are creating new threats in so far as it related to existing AML and other relations between bank employees but also new solutions to prevent, related regulations and standards. and customers. detect and monitor fraudulent behavior. — A more hands-on focus on key areas — Tracing money paths and identifying of risk, including likely enhancement suspect links between customers, In June 2019, Saudi Arabia was accepted enforcement actions. as the 39th – and first Arab member of potential undisclosed relationships between customers used to bypass the Financial Action Task Force (FATF), an — New standards and developments, for AML, know-your-customer (KYC) or anti- inter-governmental body established in example in the context of SAMA’s focus bribery and corruption (ABC) restrictions, 1989, responsible for setting standards on e-banking and digital banking related and fictitious customers. and promoting effective implementation market provision. of legal, regulatory and operational — The identification of suspicious mobile We explore below what this will measures for combating money or online transactions, transactions mean for leadership teams in financial laundering, terrorist financing and other suspected of being designed to bypass institutions related threats to the integrity of the transaction cap restrictions, special international financial system. The full Further focus on key risks and key approvals. membership was granted after the risk indicators, including more Kingdom had observer status for almost effective use of technology A key priority is the integration of four years. Saudi Arabia joining FATF is a intelligent automation and innovative significant milestone and demonstrates AML/CTF threats and the risk landscape technology into the existing technology the Kingdom’s sustained and institutional are continuously evolving, largely due infrastructure. Financial institution engagement on combating terrorist to changing business models and digital leaders could explore and leverage new financing. developments like automated technology capabilities to automate their
28 Kingdom of Saudi Arabia Banking Perspectives 2020 compliance activities alongside similar important for banking sector entities transformations being undertaken by in the Kingdom to effectively account their business counterparts. For instance, for the output of TFTC initiatives and robotic process automation (RPA) can take necessary steps to enhance assist in retrieving data for money- and revise their AMT/CTF monitoring laundering investigations and scanning arrangements. public databases for changes to laws, rules and regulations. Machine learning Focus on strengthening can be used to identify risks using public application of existing AML/CFT information and historical outcomes arrangements of previous investigations. Meanwhile, In the short term, institutions in the cognitive technology can be used, banking sector may want to prioritize the capable of mimicking aspects of human judgment to, for example, interpret following: transaction activity. 1- Remediating the areas for It is imperative for banks to enhance development identified through Omer Tauqir their risk identification efforts, and as part the recent assessment of the AML Senior Director, Head of Forensics of that there are possibilities to support program. Financial institutions should Practice better harvesting of data across systems prioritize a review of the compliance risk and take a multichannel approach to assessment framework aimed to ensure KPMG in Saudi Arabia it covers all business areas and enables fraud, compliance and operational risk T: +966 54 119 7537 management. them to identify and adequately prepare E: [email protected] for money-laundering risks. These are Accounting for emerging insights continuously evolving with the entry of from the Terrorist Financing new financial products and players in Omer Tauqir is a Senior Director in KPMG’s Riyadh office and responsible Targeting Center (TFTC) the competitive market, as well as with for the Forensics Practice in Saudi Arabia Fintech developments such as digital The Terrorist Financing Targeting Center and the Levant Cluster. He joined the finance and cryptocurrency. Secondly, firm in February 2018, bringing more than (TFTC) is a multilateral initiative between they should implement a monitoring two decades of experience in forensic, the United States, Saudi Arabia and the program to validate that the annual internal audit and risk services, working other GCC countries. The TFTC’s goals compliance plan, transaction monitoring with governments, financial authorities are to: and KYC processes address regulatory and private sector entities around the requirements and are aligned with the world. He holds a master in professional — Identify, track, and share information firm’s risk profile accountancy from UCL and is a fellow regarding terrorist financial networks. member of ACCA. 2- There should be a greater focus — Coordinate joint disruptive actions. on effectiveness by ensuring that — Offer support to countries in the key risks are clearly understood, and region that need assistance building mitigation measures are designed and capacity to counter terrorist finance implemented to ensure compliance with threats. the regulatory provisions on AML and sanctions. TFTC identifies and develop lists with targeted sanctioned entities. It will be
Kingdom of Saudi Arabia Banking Perspectives 2020 29 Shari’a Compliance - A practitioner’s perspective
With an increase in complexity The world has observed several financial framework, however, in most cases crises in recent years. Each crisis IFIs tend to deal with Shari’a risk and volume of Islamic financial highlighted the inadequacies of the separately. This separation is mainly products, Islamic Financial existing financial systems and calls for driven by human resource constraints scrutiny of the conduct of the key players. and sensitivities around interpretational Institutions (IFIs) are in need for a In an attempt to provide an alternative, aspects of Shari’a guidelines. well-defined internal and external Islamic Financial Institutions (IFIs) across There have been several research assurance process to manage risk the world, have made efforts to develop comparable financial products while papers authored in recent years by of Shari’a non-compliance, and retaining the deep commercial wisdom academics and Shari’a practitioners, defining various approaches to managing seek maximum Shari’a obedience. of Shari’a principles as well as the high ethical standards it holds. Shari’a compliance risks. Most of these highlight the need for an internal as well However, with increasing complexity as external assurance process. and volume of Islamic financial products, there is growing concern among market Internal assurance over Shari’a participants, regulators and industry compliance commentators that the IFIs need not only The currently most widely adopted be genuinely Shari’a compliant but also to approach is to establish independent be viewed as such. bodies of knowledgeable agents. These Risk of Shari’a non-compliance bodies are usually internal to IFIs and part of its governance structures. They Shari’a risks for an IFI emanate from include Shari’a Supervisory Boards an actual or perceived non-compliance (SSBs) and Shari’a Review units. SSBs with an acceptable interpretation of consist of Shari’a scholars responsible the Shari’a. These risks are manifest to provide guidance and support to in various ways and are broad in their IFIs in all aspects of their Shari’a risk emergence, occurrence and impact. management.
Shari’a compliance risks affect IFIs in all Shari’a review units are usually manned stages of their lifecycle, starting from by individuals with knowledge of conceptualization of Islamic instruments, Shari’a as well as contemporary audit followed by structuring the products, and compliance methodologies. These legal documentation, selling and market review units report to SSB on a pre- conduct, execution and implementation, determined frequency and support recovery and mechanisms of SSB in providing their annual Shari’a dispute resolution, restructuring and certification to IFIs. renegotiations and lastly, accounting and disclosure. By observation and talking to industry specialists, it becomes very clear that In order to address these risks, IFIs there is scarcity of qualified, trained endeavor to develop a framework for and experienced resources to conduct Shari’a risk management. In some cases, Shari’a compliance work. Internal Shari’a Shari’a risk management is embedded review units are evolving continuously with the IFI’s overall risk management and going through the ‘learn as you go’ phase.
30 Kingdom of Saudi Arabia Banking Perspectives 2020 This, coupled with limited authoritative Islamic Index and Dow Jones Islamic literature on Shari’a compliance Index, contribute toward better Shari’a review methodologies, including governance for publicly traded IFIs. documentation, sampling and quality assurance standards, creates significant Conclusion challenges for such units and SSBs. Compliance with Shari’a principles Absence of a universally/regionally remains the cornerstone of each and accepted qualification for a reviewer is every transaction undertaken by IFIs. another impediment in the progress. Customers, shareholders, investors, External assurance over Shari’a board members and regulators are compliance keen to seek the highest level of Shari’a compliance. There are improvement While use of SSBs and Shari’a review opportunities and a right mix of internal units provides stakeholders with much and external assurance process should needed comfort, need for independent be put in place to achieve this. and external reviews cannot be ignored. While external auditors’ main focus is Auditing profession, in general, is very toward true and fair view of the financial well regulated and the robustness of statements, their knowledge of the Muhammad Tariq its methodologies, along with high business of IFIs and auditing experience Head of Audit documentation, sampling and quality and independence prepare them to play T: +966 559 590498 assurance standards, prepares them to a significant role in providing assurance E: [email protected] play a significant role. over Shari’a compliance. For them to play a role in this space, a regulatory push is However, external auditors need to needed. Muhammad Tariq leads the Audit develop a general knowledge of Shari’a practice for KPMG in Saudi Arabia and and specific knowledge of fatwa issued concurrently holds this position for by SSBs to be able to perform this task. KMPG MESA, and previously served in this role in the United Arab Emirates. They would also need a regulatory push He has over 25 years of professional to take an active role in this space. The experience including 13 years in GCC Accounting and Auditing Organization region. His sector experience includes of Islamic Financial Institutions (AAOIFI) banking, insurance, private equity and family businesses. Tariq is also heavily makes it mandatory for external auditors involved in quality assurance and to look at Shari’a compliance aspects of engages with regulators and academia the business and include comments in on a regular basis. He leads KPMG’s the report on the financial statements. Islamic Finance group and has delivered However, this is limited to a few many trainings on this subject. jurisdictions only.
Shari’a ratings and Shari’a indices
External rating agencies can play a positive role in providing assurance over Shari’a compliance. Similarly, Islamic stock market indices like FTSE Global
Kingdom of Saudi Arabia Banking Perspectives 2020 31 Information Technology
32 Kingdom of Saudi Arabia Banking Perspectives 2020 Kingdom of Saudi Arabia Banking Perspectives 2020 33 Fintech: Can Banks stay away from Fintechs?
The emergence of fintechs and The financial services industry is evolving global and local regulations, undergoing a paradigm shift. Emerging while ensuring a seamless customer the disruption caused by them technologies are providing new ways centric client engagement. Financial thereon cannot be overlooked to enhance the customer experience, institutions see fintech as a major part of responding to regulatory change, the digital future. by the Saudi financial service underpinning new payments or digital industry. For banks to remain delivery models, making service delivery Fintech – friends or foes? relevant, they need to break faster and more cost effective, or improving the efficiency of back-office While financial institutions recognize the silos and chalk out a clear functions. A myriad of fintech solutions fintech is a substantial disruptor, banks are orienting themselves to define how collaboration plan to enhance available, or in development, are helping to rapidly reinvent the entire value chain they should approach and adopt fintechs overall customer experience and of financial services. in their businesses. Leading financial institutions globally are pursuing many increase process efficiencies at The evolving ecosystem ways of either partnering with fintechs the same time. to resolve specific issues or acquiring The swift evolution of fintech has forced them with a view to prudent investment traditional banks to face a new reality for the future. However, closer to home wherein products, services and business in Saudi Arabia, many banks are in the models that have worked in the past are early to middle stages of evaluating how no longer relevant or considered as a fintechs can help them with their issues viable option in the digital world. Legacy related to front-end omnichannel-based IT infrastructure has to be replaced or customer servicing for increasing process augmented by newer, more efficient efficiencies and regulatory compliance. technologies. To survive and thrive in One thing clearly emerging is that local today’s digital generation, banks need Saudi banks are now open to the idea of to recognize the need to reinvent the evaluating how fintech solutions can help way they manage their business. Their them rather than seeing them as a threat competitors are evolving too, and it is not and investing in-house technologies as in just fintechs knocking on the customers’ the past. Banks are now rapidly looking door through various channels, but at embedding the adoption of fintechs technology companies, telecoms, postal in their overall business and digital services, retailers, global and niche strategies. companies which are all looking for ways to provide what customers are SAMA launched ‘Fintech Saudi’ with demanding from their financial services the objective to make the Kingdom a providers which may no longer be a bank. pioneer in the fintech sector, in line with Vision 2030. Key regulations on digital Remaining competitive in this constantly signatures and customer versification changing environment is an enormous will further facilitate in the buildup of the ask for banks. This is driving banks to digital banking ecosystem. undertake major transformation journeys to transition from complex legacy There is no shortage of opportunities, technology environments to more agile but selecting the most appropriate one operations and creating more efficient is imperative to success in implementing compliance processes that fully satisfy these new technologies for banks.
34 Kingdom of Saudi Arabia Banking Perspectives 2020 To be able to succeed in today’s fast financial institutions are able to search evolving digital world, banks need to for a specific company or solution, or define a clear fintech strategy that aligns they can use the platform’s proprietary to organizational objectives, considers ‘Innovation Challenge’ capability to current assets and capabilities, and present specific problem statements to includes an execution plan for addressing the global fintech market and receive gaps and managing a transformation that recommendations on solutions from may never have a defined end point as fintech innovators. fintech will continue to evolve. There is not one clear-cut strategy or roadmap It is clear that banks can no longer be which can be deployed off the shelf engulfed in their own silos, oblivious when it comes to defining the individual to the rapid changing developments fintech plans for banks. happening around them in the fintech world. Banks would need to adopt and Banks would need to ensure that adapt fintech strategies developed fintech opportunities are well defined specifically for them to enhance their and fully aligned to their overarching overall customer experience, increase business strategy. Leading banks have process efficiencies and comply with established specific fintech strategies everchanging regulations. Banks would Rajesh Prasad that consider their business objectives, be better off exploring ways and means Advisor, Financial Services Advisory customer expectations, market position, to collaborate with fintechs rather than organizational structure and culture, the seeing them as a threat and trying to T: +966 55 469 4596 geographies in which they operate, and fight them off. The sooner the banks E: [email protected] the fintech opportunities and solutions can see fintechs as their ally rather than available to them, together with buy competition, the sooner they will be able Rajesh Prasad is based in KPMG’s Riyadh in and support from the executive to confidently embark on the banking of office and is the lead for financial services leadership. the future journey together. advisory engagements in the Kingdom. He has over 22 years of experience in the Conclusion Middle East in strategy and operations consulting for financial institutions. He For banks struggling to decide which has worked across the financial services solution is best suited to help them sector spanning both conventional and solve their business issues, help is close Islamic banks, finance and investment at hand with KPMG’s Matchi platform, companies. He has a special interest a leading global fintech innovation and in assisting financial institutions with matchmaking platform that connects their digital and customer centric financial institutions with leading-edge transformation programs. financial services technology solutions and companies worldwide. Matchi’s database includes over 3,500 fintech solutions. Using the Matchi platform,
Kingdom of Saudi Arabia Banking Perspectives 2020 35 Cybersecurity: Building Trust
Saudi Arabia aims to achieve an Large amounts of sensitive information financial sector member organizations is processed, transferred and stored by with special focus on the banks. e-payments target of 70% by 2030, multiple parties on different platforms Since then, SAMA has been underpinned by SAMA’s strategy and devices, some are more secure continuously raising the bar and than others and some are not secure at developing suitable techniques for for payment systems and the all. For malicious actors this is a huge achieving the objectives of cybersecurity Financial Sector Development opportunity for large financial gains. and protecting the sector’s information assets. In May 2017, SAMA released Program (FSDP). Cybercrime has become one of the its Cybersecurity Framework for the most organized crimes across the globe. member organizations of the financial The cybercrime reported losses are sector regulated by SAMA to effectively dramatically increasing and In 2021, identify and address risks related to cybercrime damages might reach US$6 cybersecurity. SAMA is also aware of trillion what would be equivalent to the the increasing demand on cyber talents GDP of the world’s third largest economy and the challenges faced by the financial according to the World Economic Forum sector entities in finding the right cadres Global Risk Report 2020. in this filed. SAMA responded to this challenge by launching a specialized The fast-paced and dynamic cybersecurity program which has been cybersecurity threat landscape across the running for three years now globe and the Middle East region creates (Secure 17, 18 and 19).This twenty- a challenge for the financial sector in weeks program provides the trainees Saudi Arabia to prepare and respond with scientific training and practical to the ongoing waves of cybersecurity application, visits and various activities in attacks. the field of cybersecurity by international Now is the time for banks to create a specialized bodies in this field. resilient cybersecurity infrastructure In June 2019, SAMA issued the Financial that can empower them to identify, Entities Ethical Red-teaming (FEER) protect, detect, respond and recover Framework which is intended as a guide from cyber threats. This is essential to for the financial sector entities within draw investments by creating a secure Saudi Arabia in preparing and executing financial services ecosystem and to controlled attacks (i.e. threat intelligence enhance customer’s trust and confidence based red teaming tests) against in the Saudi financial sector. their production environment without To begin with… exposing sensitive information with the help of certified and experienced Red Teaming Providers. Being aware of these challenges and threats, the financial sector started this As per a recent publication from journey many years ago when SAMA the Financial Stability Institute (one recognized the importance of protecting of the bodies hosted by the Bank the financial sector information of International Settlements BSI), assets through regular cybersecurity SAMA FEER is one of only six similar assessments covering the people, frameworks issued around the world. process and technology aspects of the This is only another indicator that SAMA
36 Kingdom of Saudi Arabia Banking Perspectives 2020 and the Saudi financial sector are very businesses to work together to ensure aware of the challenges and are acting that security is embedded in the design upon them to increase the readiness of of new products, systems and solutions. the sector. Also, to make sure that business decision makers are made aware of the Together, SAMA and the banks are risks incorporated with the adoption of working as one team through a strong specific technologies that are immature governance structure toward achieving or vulnerable. the ultimate objective of maintaining a trusted, resilient and secure banking Conclusion sector in Saudi Arabia. There is no 100% secure environment. Maturity level Cybersecurity is a state of mind in addition to having the adequate tools, The current cybersecurity maturity of techniques and processes to be able most of the banks within the Kingdom to detect, protect, respond and recover are between maturity level 2+ and 3, from cybersecurity attacks. Building implying that they have been structurally a secure and trusted environment by implementing their cybersecurity design, which is periodically tested Ton Diemont controls. Some banks are potentially and improved, will benefit the overall Director, Cybersecurity even reaching level 4, where they business trust and enhance the economy also need to demonstrate that the by gaining the confidence of customers T: +966 56 860 8393 cybersecurity controls are periodically and investors. E: [email protected] evaluated regarding the effectiveness of the implemented controls. Ton Diemont is a Director based in KPMG’s Riyadh office with over 25
Need of the hour years of experience in cybersecurity, IT and Operational Risk Management The digital era and the increasing and Financial Services. He has adoption of emerging technologies worked over 21 years with leading financial institutions in the including, but not limited to, cloud, Netherlands. In the six years before artificial intelligence, internet of things, joining KPMG, he served as CISO blockchain, and robotics increase and Corporate Head of IT Risk in the attack surface and enable more various companies. sophisticated cybersecurity attack techniques that require an agile and adaptive cybersecurity defense mechanism. Banks and financial entities are expected to adopt the most recent technologies and provide the best and smoothest experience for their customers who are not easy to satisfy and retain. It is therefore a joint responsibility of the CISOs and
Kingdom of Saudi Arabia Banking Perspectives 2020 37 Culture and Governance
38 Kingdom of Saudi Arabia Banking Perspectives 2020 Kingdom of Saudi Arabia Banking Perspectives 2020 39 Culture, Conduct and Public Trust
As the country adjusts its focus Much has been done in recent years — The various rate-rigging episodes, with Vision 2030, all industries, by the senior management of banks most notably affecting LIBOR, have and banking regulators to enhance impacted institutions in London, New including financial services, are risk management frameworks and York and elsewhere, and have led to expected to inculcate a sense governance practices. Notwithstanding landmark developments to fundamentally these measures, problems continue to rethink and change mechanisms for the of positive culture and conduct occur which impact public trust in the setting of risk- free rates, the impact of via stronger management sector and the reputations of previously which will continue to reverberate for esteemed institutions. Fines for many years. frameworks that can reduce the compliance and conduct breaches have — Most recently, money-laundering risk of misconduct and protect become almost the norm. Moreover, fair treatment of customers by the industry scandals have rocked several Nordic the value of the brand. can no longer be taken for granted, banking institutions. These cases are necessitating a considerable regulatory by no means the first involving the response in some jurisdictions. An uncovering of significant financial crime emerging theme is that the culture of compliance deficiencies, and follow on banking institutions is at the heart of from the record of a US$9 billion fine how employees are inclined to act, and along with a criminal conviction, imposed more needs to be done to enhance upon BNP Paribas several years ago for corporate cultures to better serve the anti-money laundering and sanctions interests of shareholders, customers compliance deficiencies. and depositors. — The recent Banking Royal Trust can take many years to earn, Commission in Australia shone a light but can be lost in an instant. on a litany of unsavory practices, from overcharging of customers to provision We now have a list of case studies over of biased and unsound financial advice, the last decade which underscore this and poor customer complaints handling theme. and resolution protocols.
— The global financial crisis of Tone from the top 2007–08 was brought on, in large part, through unsafe and unsustainable A theme running through each of these mortgage underwriting practices, and case studies is that at some level, an assumption that through financial employees in the institutions involved engineering and redistribution of risk, knew that their conduct was not befitting the institutions engaging in this initial and was inappropriate. In some cases, activity would avoid the inevitable the senior management and the board losses. A secondary issue was the lack had knowledge of the matters and chose of transparency regarding the risks to turn a blind eye, arguably because when these contracts were packaged the profits from operations were strong. into structured financial instruments for In other cases, boards and senior onward sale. Many market participants management may not have been willfully in this activity have paid a hefty price negligent, but should have exercised through regulatory fines and other better oversight and monitoring of measures to offer redress to investors. activities.
40 Kingdom of Saudi Arabia Banking Perspectives 2020 In almost all cases, the consequences The Saudi Arabian context have been extreme, with CEOs, other senior management and chairmen often This is a time of significant change in removed from their roles, in addition to the banking industry in Saudi Arabia. the monetary fines and other sanctions. The Vision 2030 agenda requires many But, in addition to this accountability industries, including the financial services impact, institutions have often paid for sector, to play a supporting role. Areas the shortcomings for many years after of focus include sovereign debt raising, the events through large remediation project financing, home financing and projects and significant distraction of private savings. We are witnessing bank management time. consolidation, in part improve positioning to meet these challenges. There are “I may have the right to do this, also the threat and opportunity of digital but is it the right thing to do?” disruption, both for existing institutions and new entrants as new license It can be argued that something must approvals are granted for both local and have been wrong with the culture of the foreign banks. Increasing competition industry and its players to lead to the can be one of the factors which drives kind of behavior which has given rise to poor conduct, as institutions and their the quantum of misconduct across many employees feel the pressure to deliver Phil Knowles jurisdictions. results. Senior Director, Audit T: +966 5 0008 4324 — Was it caused, at least in part, by The backdrop of these industry E: [email protected] aggressive targets and unbalanced challenges makes it a good time to financial incentives for employees? consider the impact of culture and conduct in Saudi Arabia’s banking Phil Knowles is a Senior Director based in — Were boards cognizant of the risks? KPMG’s Riyadh office. He specializes in industry. At the micro level, individual audits of local and international corporate — Why were monitoring and reporting institutions can be better positioned to and retail banks and asset management mechanisms ineffective? avoid costly and distracting incidents firms. He has 25 years of experience which damage the brand and reputation. in the financial services sector gained Regulators, including in the USA, the At the macro level, the safety and through his work in the assurance and Netherlands, Hong Kong and Singapore, soundness of the sector will be bolstered advisory practices of KPMG in Sydney, have started to turn their attention to by it. And this is important to ensure that London, Dubai and East Africa. He also these topics, in addition to international trust and confidence in the industry are worked for Standard Chartered Bank in bodies such as the Financial Stability maintained during this period of growing Dubai and Singapore. Board. The G30 has gone as far as calling competition and change. for sustained and comprehensive reform of banking conduct and culture. Strong Bank Culture
Assessment Incentive and feedback Governance mechanisms Systems
Feedback loop for Avoid over-reliance on Processes to regularly review lessons learned sales/revenue targets the effectiveness of cultural enhancement initiatives Internal escalations Factors behavioural indicators into scorecards Consider a board-level Monitoring of key committee (chaired by an Include adherence to corporate parameters independent director) covering values in scorecards Customer feedback culture and conduct Balanced use of incentives and Develop detailed guidance Staff feedback disincentives on expected conduct and behaviour of employees
Kingdom of Saudi Arabia Banking Perspectives 2020 41 KPMG in Saudi Arabia
42 Kingdom of Saudi Arabia Banking Perspectives 2020 KPMG in Saudi Arabia was established through its member firm KPMG Al Fozan & Partners and has operated in the Kingdom since 1992.
This early commitment to the Saudi Arabian market, together with our unwavering focus on quality, has been the foundation of our accumulated Al Khobar industry experience, and is reflected in our appointment by some of the Al Khobar Kingdom’s most prestigious companies. As Saudi Arabian businesses join the eddah global economy and international companies seek to enter the Saudi market, KPMG’s blend of international expertise and local knowledge makes us well positioned to serve our clients in this increasingly complex, but exciting market.
KPMG operates through a national leadership with dedicated regional teams, which enables our network of professional talent, our technologies and our products and solutions to quickly 119 come together to meet clients’ needs. Partners & Directors KPMG has made a significant investment in Saudi Arabia over the last five years with a number of professional staff being seconded to the local firm from across the globalnetwork.
The firm has grown to be one of the largest professional service providers in 1,279 the Kingdom. During the last few years, it has achieved record growth, reaching our Total employees current workforce of 1,279 people across the Kingdom, based in three offices in Riyadh, Jeddah and Al Khobar.
Kingdom of Saudi Arabia Banking Perspectives 2020 43 Contact us
Khalil Ibrahim Al Sedais Ovais Shahab Rajesh Prasad Office Managing Partner Riyadh Head of Financial Services Sector Financial Services Advisory E: [email protected] E: [email protected] E: [email protected]
Ovais Shahab Head of Financial Services Sector KPMG in Saudi Arabia
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