Middle East Economic Survey

VOL. L

No 41

08-October-2007

SAUDI ARABIA

How Big Is “Islamic Banking”? – A Snapshot From Saudi Arabia

By Andrew Cunningham

Andrew Cunningham is Managing Director, Head of Middle East and Balkan Programs at the Financial Services Volunteer Corps, a US-based not-for-profit company which works to strengthen financial sectors in transitioning and emerging markets. He can be contacted at acunningham@fsvc.org. In this article he examines Islamic banking in Saudi Arabia where nearly half of bank credits were structured to be Shari΄a-compliant at end-2006.

Opinions abound about the size of the Islamic finance market and the rate at which it is growing, but such opinions are frequently unsupported by hard data and often fail to specify which part of this increasingly variegated sector the speaker is referring to.¹ During the 1980s, the bulk of Islamic (or, as we should more properly say, “Shari΄a-compliant”) finance was conducted through banks, but during the 1990s much of it moved into mutual funds, either managed off balance sheet by banks, or managed by dedicated fund managers. More recently we have seen the rise of Sukuk issuance, whereby borrowers seek to access the debt markets directly.

The size of Sukuk issuance is fairly easy to estimate since Sukuks are discrete instruments which are usually publicly issued and registered with financial authorities. Furthermore, we know that all bonds sold as part of an issue are Shari΄a-compliant since the same terms and conditions apply to all bonds sold in the issue. So, for example, the law firm Trowers & Hamlins estimated that non-sovereign Sukuk issuance totaled $4.57bn in the first half of 2006.

Estimating the size of Shari΄a-compliant mutual funds is more difficult, but we can still arrive at a reasonable estimate of money being managed in funds which are open to the public. Shari΄a-compliant funds advertise themselves as such, and by definition, we know that 100% of the money invested in them is being managed in a shari΄a-compliant manner.²

Failaka Advisors, which has pioneered the monitoring of Shari΄a-compliant funds, estimated that 218 funds existed at the end of 2006 and that equity funds held about $14bn under management. Various publications have their own listings with estimates of funds under management. Of course, even Failaka cannot capture Shari΄a-compliant funds being managed within a “private banking” portfolio, and it is fair to say that such privately managed portfolios are substantial.

Banking Sector

When we turn our attention to banking, the issue we face is that many banks – and, in the Middle East, the vast majority of banks – conduct conventional business alongside Shari΄a-compliant business. As a result, it is difficult to know how much Shari΄a-compliant business the banks are doing.

We can easily work out the market share of Shari΄a-compliant banks within a banking system by, for example, dividing the total deposits held by Shari΄a-compliant banks into the total deposits held in the system as a whole. But that does not tell us the share of Shari΄a-compliant deposits within the system, since many of the other, “conventional,” banks will have some Shari΄a-compliant deposits as well.

The Saudi banking system provides a window onto the size of one aspect of the Shari΄a-compliant market: credit facilities extended by banks. In the notes to their accounts, Saudi banks quantify the amount of their loans and advances which is structured in a Shari΄a-compliant manner, and since Saudi banks present their financial statements in a highly consistent manner we can be reasonably confident that they are using the same or very similar criteria when making this disclosure.³

It is difficult to assert either that the Saudi banking system is representative of banks as a whole in the Gulf region or that it is not – one may intuitively believe that Saudi banks use Shari΄a-compliant instruments more frequently than, say, Omani banks, where Shari΄a-compliant banking was until recently officially frowned upon, or in the UAE, parts of whose society have a distinctly Western air, but such intuition would be difficult to substantiate with hard numbers, and easy to undermine with anecdotal counter-arguments. However, what one can state with confidence is that the Saudi banking system is by far the largest in the region, and that therefore any trend which occurs in the kingdom cannot but have significance when reviewing trends in the region as a whole: at the end of June 2006, Saudi banks accounted for 46% of all private sector deposits held by GCC, and 25% of all private sector deposits in Middle Eastern banks (excluding Palestine and Iraq).⁴

Saudi Banks

Of the 11 Saudi banks reporting results at the end of the 2006, three (Al-Rajhi, Al-Jazira and Al-Bilad) represent that all their operations are conducted in a Shari΄a-compliant manner. As a result, all of their “loans and advances” (termed “investments” by Al-Rajhi and Al-Bilad) are Shari΄a-compliant. The other banks, with one exception, include a reference to the size of Shari΄a-compliant facilities as part of the note to the loans and advances item on their balance sheet. The exception is Arab National Bank, which makes no reference to Shari΄a-compliant facilities under “loans and advances”.⁵

At the end of 2006, 45.4% of Saudi banks’ credit facilities were extended through Shari΄a-compliant facilities. Stripping out the three wholly Shari΄a-compliant banks, we see that 34.7% of loans and advances extended by the eight “conventional” banks were Shari΄a-compliant. Equivalent figures for end-2005 were 43.3% and 28.5%.⁶

Saudi British Bank leads the pack with just over half of its credit facilities being Shari΄a-compliant, closely followed by National Commercial Bank with 44.5%. Riyad Bank and Samba Financial Group had 38.2% and 33% respectively. The proportion of Shari΄a-compliant credit facilities increased during the course of 2006 (see Appendix for end-2005 figures). The percentage of the portfolio which was Shari΄a-compliant at Saudi British increased by 7.5% during 2006, and three other banks showed increases of around 6% – Saudi Hollandi, Banque Saudi Fransi and National Commercial Bank. Bank Al-Jazira had some conventional facilities at the end of 2005 (5.6% of its portfolio), indicating that its conversion to a fully Shari΄a-compliant institution was not complete at that point.

Most Saudi banks also disclose the types of Shari΄a-compliant facilities which comprise their portfolios. Al-Rajhi and Bank Al-Bilad show stark differences in the types of instrument through which they are extending credit (see Table 2). Most of Bank Al-Bilad's facilities are extended as Murabaha instruments, and nearly all of the remainder as Bei Ajal. In contrast, Al-Rajhi's portfolio comprises mainly installment sales and Mutajara.

Most of the conventional banks state the instruments used in their Shari΄a-compliant portfolios although they do not quantify the amounts. Through the system as a whole, Murabaha is by far the most commonly used instrument. Three banks represent that they use Istisna΄a. None of the banks refer to holdings of Sukuks. This is because Sukuks have an underlying structure which conforms to one of the other types of financing: “Murabaha Sukuk”, “Musharaka Sukuk”, etc.

Some of the “conventional” banks state that they hold Shari'a-compliant instruments as part of their investment portfolio. This investment portfolio appears on the balance sheet after amounts due from banks and other financial institutions and before loans and advances; it accounts for a material part of the balance sheet; and it comprises mainly fixed and floating rate securities. Explicitly Shari΄a-compliant instruments form only a small proportion of this portfolio. National Commercial Bank reported Musharaka investments of SR203mn out of a total gross investment portfolio of SR58,095mn at the end of 2006; Samba Financial Group reported Mudaraba investments of SR1,060mn out of a total of SR37,682mn; Banque Saudi Fransi reported “Islamic securities” of SR15mn out of a total of SR18,128mn, and Saudi Hollandi reported SR288mn of Musharaka investments out of a total of SR10,463mn. Of course, some other investments could conform to the rules of the Shari'a (such as an equity investment) even if they are not explicitly structured as such. Al-Rajhi, Bank Al-Bilad and Bank Al-Jazira do not report credit facilities ("loans and advances") separately from their investment portfolio – it is the same line item in their balance sheet.

Table 1

Shari΄a-Compliant Credit Facilities Of Saudi Banks, 31 December 2006

*     Saudi Hollandi does not state whether this figure is net or gross. All other banks disclose net figures and some additionally disclose gross.

Source: Annual Reports.

Table 2

Types Of Shari΄a-Compliant Credit Facilities Used By Two Saudi Banks: End 2006

(% Of Total Credit Portfolio)

Source:  Annual Reports.

Table 3

Use Of Shari΄a-Compliant Financial Instruments By Saudi Banks, As Disclosed In Their Annual Report For 2006

1.     Annual Report states that products are, “mainly Murabaha and Tayseer.”

2.     Annual Reports of Banque Saudi Fransi and Saudi British Bank do not specify which instruments are used.

3.     Annual Report makes no mention of Shari΄a-compliant instruments under the note detailing loans and advances.

Appendix

Shari΄a-Compliant Credit Facilities Of Saudi Banks, 31 December 2005

* Saudi Hollandi does not state whether this figure is net or gross. All other banks disclose net figures and some also disclose gross.

Source:  Annual Reports.

Notes:

1.  For example, one Asian Central Bank states in its 2005/2006 Annual Report that, “Islamic finance has a current market size of around US$300 billion internationally and is growing rapidly at about 15% per annum.” In mid-2007, a partner with a leading US law firm involved in the structuring of Islamic products estimated the market at between $100mn and $150mn and confidently estimated its rate of growth at 35-40%.

2.  This article makes no judgment on the criteria which must be fulfilled for an instrument or an institution to be Shari΄a-compliant. I assume that all instruments or institutions which assert that they are Shari΄a-compliant are indeed that.

3.  The banks do not disclose in a full and consistent manner the proportion of their deposits which are managed in a Shari΄a-compliant way. Most, though not all, of the “conventional” banks state the value of their time deposits which are managed in a Shari΄a-compliant way.

4.  The Gulf Cooperation Council comprises Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates.

5. However, the bank says, in Note 2.u. to the Financial Statements, that it offers certain non-interest based products to its customers.

6. These figures include Arab National Bank’s (ANB’s) total net loan figure in the denominator, although there are no Shari΄a-compliant facilities included for ANB in the numerator, since, as already mentioned, ANB makes no reference to Shari΄a-compliant facilities in the part of its financial statements dealing with its loans and advances. If we strip out ANB from the denominator, the proportion of Shari΄a-compliant facilities for the system as a whole rises to 50.5% (2005, 47.5%) from 45.4%.