The International Monetary Fund (IMF) has advised the Saudi government that the country's Banking Control Law (BCL) needs urgent updating to include new provisions to give the Saudi Arabian Monetary Agency (SAMA) greater operational independence. The Fund, in its latest Financial Sector Assessment Program (FSAP) Update on Saudi Arabia published late April 2012, which largely concentrates on whether SAMA is in compliance with the Basel Core Principles For Effective Banking Supervision, stressed that "the (Saudi Arabian banking) legal framework is old. The BCL has hardly been changed since enactment in 1966. It should be updated, especially as it provides for much less formal independence and authority for SAMA than is exercised in practice." According to the IMF, the Saudi authorities are resisting any suggestions to changing the BCL because "there would be more risk than benefits in amending it." In its official response to the FSAP, which was conducted at the request of the Saudi government, Riyadh maintained that while the authorities are broadly in agreement with the overall findings, they have reservations on certain aspects of the assessment. The assessment has rightly acknowledged that Saudi Arabia confronted the global financial crisis from a position of strength and that there have been significant improvements in banking regulation and supervision since the 2004 FSAP. However, according to Riyadh, "the assessment has somehow not fully reflected several actions taken by Saudi Arabia to strengthen the supervisory framework. The authorities were expecting the assessment to focus more on qualitative aspects of Saudi Arabia's regulatory and supervisory framework, keeping in view the local and regional context and taking into account the ground realities." The Saudi authorities also believe that the existing BCL is serving its purpose well and provides the necessary legal framework for implementing international standards and for taking all the required supervisory actions. For example, in exercise of powers under this law, SAMA has already implemented Basel-II /Basel-III and all other relevant international standards. Disagreements and differences between the IMF/World Bank and its member countries are common and in some instances legendary. Emerging countries, for instance, have for a long time been critical of the World Bank's controversial SAP (structural adjustment program) with its single-minded pursuit of spending on infrastructure, curbing public expenditure and doing away with subsidies including on basic foods and commodities. At the same time the Bank has been woefully impotent to do anything about the two biggest and most pernicious agricultural subsidizers in the world - the US with its EEP for wheat and the European Union's Common Agricultural Policy (CAP). The BCL, maintains the Fund, could be updated to remove the need for government approval to license banks and impose sanctions, issue regulations, conduct inspections, and put SAMA's present autonomy in practice on a statutory basis to ensure it remains effective. This is a valid argument. In a mature economy and financial market, it is not the business of government to licence banks and financial institutions. This should be left to the banking authority, in this case, SAMA. In the case of the capital and money markets, it is the Capital Market Authority (CMA). The reason is simple. Government departments such as the Ministry of Finance do not have the in-house expertise and infrastructure to approve or authorize banks. The job of government departments is to provide and facilitate the necessary legal and regulatory framework for the banking regulatory to carry out its duties effectively and professionally and to provide the political and resource oversight and support to the regulator. When governments run the banking sector then it is usually the beginning of a slippery slope for political and other reasons. Take for instance Iran immediately after the onset of the Islamic Revolution in 1979. One of the first acts of Ayatollah Khomeini was to nationalize all the banks in Iran. The rationale was to stem the outflow of funds from the country especially those held by opponents of the regime and by the ousted Shah and his family. However, within a few years successive governments quickly learnt to exploit state control of the banking system with the result lines of credit from the banks were extended largely to individuals and corporates that were loyal to the Revolution. At the same time the profit rate for the banks were set by the Bank Markazi (central bank) with the result that savings accounts were giving ordinary savers a negative rate of return and thus removing the incentive to save. Nobody is suggesting that the Kingdom's control of the banking system is anywhere near to what it was in the Khomeini era. But the trend in international regulation is toward effective and independent regulation based on sound frameworks, oversight, monitoring and enforcement. Nevertheless, the latest FSAP Update also stresses that the prudent licensing approach implemented by SAMA could benefit from a legal definition of SAMA's objectives and improved disclosure of its expectations for new banks. There are no published objectives for supervision, an omission that should be addressed in the law. Only two banks have been licensed in the last few years - Bank Al Bilad and Alinma Bank, both of which operate under Shariah financial principles. New foreign bank branches however remain marginal players except for HSBCAmanah/SABB and Standard Chartered Saadiq, both of which largely concentrate on Islamic banking products. However, the suggestion that SAMA should publish its detailed criteria for licensing new banks, fully align them with objectives focused on safety and soundness, and withdraw the requirement that new licensees should "add value," is more contentious. Many countries including South Africa, India and Malaysia have certain conditions for certain categories of bank authorisations. This is to protect the orderly development of the local banking industry; to ease in measured liberalization of the financial sector as opposed to arbitrary liberalisation; and to mitigate local market conditions. The mindset of the IMF/World Bank is toward a propensity to treat markets as the same. Very often in the past local political, socio-economic and cultural factors were either ignored, marginalized or overlooked. The World Bank Group will argue that this is not the case and that assessments are carried out on their individual merits and according to proven methodologies. On the Basel principles, the FSAP concludes that SAMA has made substantial efforts to introduce Basel II, including recent strides in banks' risk management by an improved regime for large exposures and connected parties. Much of the assessment and the recommendations are also a result of the aftermath of the widespread bank losses in the Kingdom and elsewhere caused by the 2009 failure of Al-Gossaibi & Bros. Co. and the Saad Group, two large well-established family groups. This failure, according to the FSAP Update, may have been weaknesses in credit risk management. At the time SAMA's response was that the above failure was a market failure and not one of regulation and supervision. However, there is no doubt that the above failure did dent foreign confidence in the Saudi banking sector. One Asian bank for instance, which had exposure to the Al-Gosaibi/SAAD Sukuk offering, confirmed that it would not be investing in the Kingdom unless the above default is resolved. SAMA, nevertheless, did respond to the default by ensuring that losses of Saudi banks and investors were fully provisioned and by spearheading a dialogue with the banking industry to identify relevant lessons. "In a system characterized by high single-name concentration, attention to individual large exposures should be intensified, in particular during on-site inspections. The possibility for SAMA to allow large exposures of as much as 50 percent of capital, which was recently used, should also be removed (with the maximum exposure capped at, for example, 25 percent of capital)," emphasised the IMF. Other observations by the IMF on the Saudi banking sector include: a) Saudi Arabia confronted the global financial crisis from a position of strength. A strong policy response moderated the impact of the crisis. b) Commercial banks are the largest sector of the financial system accounting for 85 percent of the sector's contribution to GDP. c) As in the case of other Gulf Cooperation Council countries, loan portfolios are concentrated, reflecting limited lending to sectors such as small- and medium-scale enterprises (SMEs) and housing. d) The banking sector is fairly concentrated around a few banks. The seven largest banks have a combined share of assets of 85 percent and the dominant shareholders of the three largest banks are government entities, the fourth largest is linked to a family business group, and the next three have ties to major international banks. e) The banking sector overall is well capitalized and profitable. __
