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WEEKLY NEWSLETTER
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Saudi Arabia
Index
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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