Saudi Arabia
MONEY AND BANKING
Until the mid-twentieth century, Arabia had no formal money and
banking system. To the degree that money was used, Saudis primarily
used coins having a metallic content equal to their value (full-bodied
coins) for storing value and limited exchange transactions in
urban areas. For centuries foreign coins had served the local
inhabitants' monetary needs. Development of banking was inhibited
by the Quranic injunction against interest. A few banking functions
existed, such as money changers (largely for pilgrims visiting
Mecca), who had informal connections with international currency
markets. A foreign bank was established in Jiddah in 1926, but
its importance was minor. Foreign and domestic banks were formed
as oil revenues began to increase. Their business consisted mostly
of making short-term loans to finance imports, commercial trading,
and businesses catering to pilgrims.
The government issued a silver riyal in 1927 to standardize the
monetary units then in circulation. By 1950 the sharp increase
in government expenditures, foreign oil company spending, and
regulation of newly created private banking institutions necessitated
more formal controls and policies. With United States technical
assistance, in 1952 the Saudi Arabian Monetary Agency (SAMA) was
created, designed to serve as the central bank within the confines
of Islamic law.
The financial system has developed several layers intended to
serve a number of multifaceted economic, exchange, and regulatory
roles. At the apex was SAMA, which set the country's overall monetary
policy. SAMA's functions also included stabilization of the value
of the currency in an environment of openness with respect to
exchange transactions and capital flows. The central bank used
a number of monetary policy instruments for this purpose, including
setting interest rates for commercial banks, which have been kept
close to comparable dollar rates, the management of foreign assets,
and the introduction of short- and medium-term government paper
for budgetary and balance of payments purposes and to smooth fluctuations
in domestic liquidity. SAMA also regulated commercial banks, exchange
dealers, and money changers and has acted as the depository for
all government funds; it paid out funds for purposes approved
by the minister of finance and national economy.
SAMA's charter stipulated that it would conform to Islamic law.
It could not be a profit-making institution and could neither
pay nor receive interest. There were additional prohibitions,
including one against extending credit to the government. This
latter prohibition was dropped in 1955, when the government needed
funds and SAMA financed about one-half of the government's debt
that accrued in the late 1950s. From 1962 to 1983, the budget
surplus did not require such action and all the government's debt
was repaid. In 1988 SAMA was once again required to bolster government
reserves, which had been sharply reduced to finance fiscal deficits,
through the sale of Government Development Bonds. These bonds
had varying short- and long-term maturities, with yields competitive
with international interest rates. As a result of persistent government
deficits, the stock of these bonds had grown to well over SR100
billion in 1991. Most of these bonds were placed with autonomous
government institutions; however, close to 25 percent were purchased
by domestic commercial banks.
In 1966 a major banking control law clarified and strengthened
SAMA's role in regulating the banking system. Applications for
bank licenses were submitted to SAMA, which submitted each application
and its recommendations to the Ministry of Finance and National
Economy. The Council of Ministers set conditions for granting
licenses to foreign banks, however. The law also established requirements
concerning reserves against deposits. Several restrictions continued
to inhibit SAMA's implementation of monetary policy. It could
neither extend credit to banks nor use a discount rate because
these measures were forms of interest. SAMA had little flexibility
in setting reserve and liquidity requirements for commercial banks.
Its primary tool for expanding the credit base consisted in placing
deposits in commercial banks. (OT)
By the 1980s, new regulations were introduced, based on a system
of service charges instead of interest to circumvent Islamic restrictions.
As of the early 1990s, banks were subject to reserve requirements.
A statutory reserve requirement obliged each commercial bank to
maintain a minimum of noninterest-bearing deposits with SAMA.
Marginal reserve requirements applied to deposits exceeding a
factor of the bank's paid-in capital and reserves. Moreover, banks
had to hold additional liquid assets-- such as currency, deposits
with SAMA beyond the reserve accounts, and Government Development
Bonds--equal to part of their deposit liabilities. SAMA used two
other instruments to manage commercial bank liquidity. The Bankers'
Security Deposit Account (BSDA) was a short-term instrument with
low yield, rediscountable with SAMA and transferable to other
banks. In November 1991, SAMA issued the first treasury bills,
which were short-term, usable for both liquidity management and
government deficit financing, and designed gradually to replace
the BSDAs.
Twelve private commercial banks operated in the kingdom, providing
full-service banking to individuals, and to private and public
enterprises. Eight of the banks were totally Saudi-owned. Four
were joint ventures with foreign banks. In 1975 the government
adopted a program of Saudi participation in ownership of foreign
banks operating in the kingdom. In December 1982, the last of
the foreign banks merged with a Saudi bank. The commercial banks
operated more than 1,000 branches throughout the country and a
widespread network of automated teller machines. The range of
bank activities grew markedly during the 1970s and 1980s. Beyond
providing credit and deposit facilities, they engaged in securities
trading, investment banking, foreign exchange services, government
finance, and development of a secondary government bond-treasury
bill market.
For years money exchangers remained an anomaly in the Saudi banking
system. They had operated for centuries in Arabia, particularly
for pilgrims to Mecca. Most were family businesses, some of which
had grown very large since World War II, conducting most kinds
of banking activities in many areas of the country. Although licensed,
the money-exchange houses remained largely unregulated. Most money
exchangers operated under sound business practices; however, a
series of fraudulent and speculative practices in the 1980s prompted
SAMA to establish regulations for money-exchange houses. One of
the larger such operations was converted to a commercial bank
in 1987.
Because commercial banks favored short-term lending to established
firms and individuals, the government created special credit institutions
to channel funds to other sectors and groups in the economy. The
Saudi Arabian Agricultural Bank was formed in 1963 to provide
development financing and subsidies to the agricultural sector.
The Saudi Credit Bank was formed in 1971 to provide interest-free
loans to low-income Saudis who could not obtain credit from commercial
banks. The Public Investment Fund was created in 1973 to help
finance large public ventures. The Saudi Industrial Development
Fund was established in 1974 to provide interest-free, medium-
and long-term financing of up to 50 percent of the cost of a private
sector project. The Real Estate Development Fund, also founded
in 1974, was designed to encourage private sector residential
and commercial building, partly through interest-free loans to
low- and medium-income Saudis for up to 70 percent of the cost
of a home.
The government budget provided almost all the funds for these
specialized credit institutions and continued to increase their
capital requirements until the mid-1980s, when budgetary problems
necessitated cutbacks. For the most part, these funds were self-
financing during the latter half of the 1980s. A significant departure
from such self-financing was the government's substantial subvention
to the Real Estate Development Fund in 1991 to allow a one-year
moratorium on payments, which was a gift by King Fahd to his citizens.
The Saudi financial system also consisted of three autonomous
government institutions, included because of their significant
role in providing financing for budgetary shortfalls, deposits
with SAMA, and foreign currency holdings. These included the Pension
Fund, the General Organization of Social Insurance, and the Saudi
Fund for Development.
For much of the 1980s, the stock exchange, created in 1983, was
largely viewed by domestic investors as a vehicle for long- term
investments. Since the Persian Gulf War, this situation changed
markedly because the exchange has attracted investors seeking
shorter-term investments. Share prices and trading volumes have
grown sharply and by early 1992 had reached unprecedented levels,
sparking fears of overvaluation. The official stock market index,
which had remained relatively dormant in the late 1980s, and had
dropped from 108.7 at the end of 1989 to 98.0 in late 1990, roughly
doubled to 187.7 by the close of 1991. The value of shares traded
grew from SR135 million at the end of 1990 to SR1.8 billion by
the first quarter of 1992. The number of shares traded doubled
from 15 million for the whole of 1989, to 29.2 million in 1991.
Three factors propelled this level of stock market activity.
First, following the Persian Gulf War, confidence in the Saudi
economy spurred by high oil prices and greater confidence in the
regional geopolitical situation prompted domestic investors to
repatriate foreign funds. Second, low international interest rates,
combined with similar returns of domestic savings rates, increased
the attractiveness of the stock exchange. Third, the number of
companies trading on the exchange increased markedly as they attempted
to boost domestic investment following several years of depressed
economic conditions. Moreover, the tight government budget prompted
some public enterprises to obtain capital on the domestic financial
markets rather than from the state.
The Saudi stock exchange was not open to foreign investment and
only shares of Saudi companies could be traded. The exception
to the former rule was the right of citizens of GCC member states
to purchase Sabic shares from 1984. In 1991 the Arab National
Bank, partially funded by Jordanian capital, received permission
to launch a stock fund, of which foreigners might purchase a portion.
Despite growth in the stock market, the percentage of shares traded
as a percentage of total market value of shares outstanding has
been estimated as no more than 5 percent, very low by international
standards. This lack of market depth resulted from the high proportion
of shares owned by institutions rather than individuals and the
concentration of ownership in a few hands.
Data as of December 1992
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