Depositor risk is now a thing in Saudi Arabia

Izabella Kaminska

| Nov 06 12:23 | Comment | Share

http://ftalphaville.ft.com/2015/11/06/2144251/depositor-risk-is-now-a-thing-in-saudi-arabia/

 

Changes are afoot in Saudi Arabia’s financial system.
According to the Financial Stability Board’s latest review, the Saudi Arabian Monetary Agency, which manages the kingdom’s foreign exchange reserves, is in the process of bolstering its defences (as it was recommended to do by the FSB in previous reviews).On that front, laws are being implemented to expand SAMA’s existing powers as well as to introduce new ones, among them:

….new powers for SAMA to write down and convert liabilities (bail-in); impose temporary stays on the exercise of early termination rights and moratoria on the enforcement of claims against a firm in resolution; and dispose of assets of that firm. The new law also introduces clear rights of appeal to judicial authorities for persons affected by resolution actions, coupled with restrictions on the scope of judicial review and the remedies available to prevent resolution actions from being suspended or reversed.

Another key change is the planned introduction of a limited deposit insurance system as of January 1, 2016, as per the recommendation from the February 2012 FSB peer review, to replace the implicit one that stood before it. As the FSB notes:

The introduction of an explicit deposit insurance system (DIS) on 1 January 2016 as a “pay box” within SAMA indicates the authorities’ commitment to implement the internationally agreed standards. Once fully implemented, the scheme is expected to further enhance the financial safety net. SAMA has adopted a number of good international practices codified in the IADI Core Principles, such as explicit public policy objectives and mandate of the Depositor Protection Fund (DPF), compulsory membership and legal protection for the DPF.

Indeed, the impression from the FSB report is that the pre-existing “implicit” deposit guarantee may have overstretched itself:

An important issue that needs to be addressed is the Supreme Economic Council’s statement in 2008 that the authorities continue to ensure the safety of local banks and bank deposits. This is perceived to provide an implicit full coverage to all depositors and is inconsistent with the objective of setting up a limited deposit protection system that promotes market discipline and avoids moral hazard. In view of the entry into force of the DPF, the authorities need to decide how best to withdraw this implicit guarantee without any adverse impact on depositor confidence. Drawing on the experience of other countries, one option in this regard may be to adopt an explicit transition period that starts with higher coverage levels that could be reduced to the target level over time. Since the DPF is a new scheme, SAMA intends to undertake shortly a program to educate the public and stakeholders on its main features. This public awareness campaign, which would be undertaken in close cooperation with banks, should ideally address the issue of the implicit deposit guarantee as well as emphasise the advantages of a DIS in an international context and highlight its role in enhancing financial stability.

Put another way, SAMA is about to start educating the population on the concept of depositor risk, something it’s never had to do before because it was always assumed Saudi financial institutions would never be allowed to fail.
While Saudi Arabia had previously studied the establishment of an explicit deposit scheme, it never adopted it in the belief that its system was sufficiently resilient to not need one.
The 2012 FSB review, however, advised such an implicit framework could one day expose taxpayers to significant losses in the event of severe systemic disruption, thus the adoption of an explicit scheme to enhance market discipline was to be recommended. Nevertheless, according to the report, the Saudi authorities still feel initial funding or back-up support for a DPF are unnecessary. Instead, SAMA will aim to set up an ex-ante fund to be built up gradually from the premiums charged to the industry. But the FSB disagrees:

SAMA should consider enhancing the funding arrangements of the DPF by: (1) specifying a target fund size; and (2) establishing a back-up line of credit in order to ensure that DPF resources can meet deposit pay-out requirements in a timely manner.

Meanwhile, says the FSB, there’s still insufficient transparency on the true nature of Saudi Arabia’s cross border linkages. As per the IMF-World Bank’s Financial Sector Assessment Programme (FSAP):

…while Saudi banks’ cross-border linkages appear to be small, there was limited detailed data around this issue; it recommended that developing better cross-border data on the financial activities of banks and corporates should be a priority for SAMA.

The FSB’s peer review adds that Saudi banks have large investment portfolios since they are net placer of funds in the international financial markets. On which note (our emphasis):

In response to the FSAP recommendation to enhance data on cross-border financial activities of banks and corporates, SAMA has started collecting International Banking Statistics. In the meantime, SAMA uses other metrics to monitor cross-border activities and their associated risks, including banks’ net foreign assets and liabilities, their exposures related to foreign operations and overall capital flows.

And with respect to the potential risks associated with such linkages, there’s this:

As previously noted, recent FSC [Saudi Arabia's internal financial stability committee] discussions about emerging vulnerabilities and risks have focused around margin lending; the scope and coverage of the LTV ratio; the interaction of oil prices, government spending and non-performing loans (NPLs); and insurance solvency ratios. In addition, the recently-published FSR25 highlighted risks related to higher market volatility as a result of normalisation of US monetary policy; the growth in real estate lending during 2013-14; reliance of banking sector on short-term deposits; concentration of equity market capitalisation in the banking and petrochemical sectors; and corporate risk aversion. Separately, the FSC has requested FSD (Saudi’s Financial Stability Division) staff to establish regular outreach with risk managers at regulated banks, in coordination with BSD, and ascertain major risks at those firms. However, the FSC has not yet examined the interactions between macroprudential and fiscal policies in its deliberations.

This implies we could be getting significantly more information on Saudi Arabia’s international portfolio flows some time soon.
As the FT reported in September, SAMA has pulled up to $70bn from global asset managers over the last six months. It’s unclear how such a capital drawdown from the international financial system may have impacted global liquidity availability, especially once the multiplier effect is factored in.