Saudi attempts to get a grip on runaway credit

As the price of oil continues to rise unabated, the Kingdom's coffers are awash with money. Saudi Arabia's finances have never been so good, but there is one blip on the horizon. Personal debt has proved to be a headache for the Saudi Arabian Monetary Agency (SAMA), but that may change. According to one high-level bank executive who has followed SAMA's attempts to tackle the retail crunch over the past four years and who asked to remain anonymous, the agency is set to introduce tougher legislation to let banks deal with individual debtors. The era of unrestricted, high-risk retail lending may be over.

"The whole retail boom started in 2002," explains Mohammad al-Tuwaijri, managing director and head of JP Morgan Saudi Arabia. "You have to consider that interest is low and the retail market constitutes around 30 to 40 percent of profits for the banking sector here in Saudi."

One of the driving forces behind retail lending was the stock market. Up until 24 months ago, the Saudi stock market was one of the best performing bourses worldwide. Driven by the possibility of making huge profits in a short period, many Saudis took out loans of up to 15 times their salaries and placed their money in shares. Unfortunately, as one Saudi who took out 700,000 riyals explains, day trading did not lead to a promised fortune.

"I went to my company's bank, applied for the cash and after a few days the sum was deposited in my account. It was in 2005 I think," says Mohammed, one unlucky Saudi investor. He took out the loan to invest in the go-go stock market, planning to pay the monthly note from his expected profits. But then the market crashed, wiping out 85 percent of his capital. "I paid a big amount of money back to the bank, and then I couldn't cough up any more," he adds.

The problem the banks face is two-fold. Laden with surplus liquidity, they sought out new markets - individual borrowers. However, Saudi's legal framework heightens the problems banks may face if those borrowers can't pay back their loans.

"What it boils down to is what kind of security can you get [from your investments]," says Julian Johansen, a legal partner with Allen & Overy who's based in Riyadh with Abdulaziz Al Gasim Law Firm. "The general principle in Saudi is that you cannot enforce security against a borrower unless you have a court order, unlike in England where you get a self-help remedy (i.e., not court based) to get what is secured to you."

The loan system works through employers and payrolls. Saudi nationals would usually take out a loan through their company's financial firms, however, if that person moved to a different company and hence to a different bank, the first bank would have little recourse. That's what Mohammed was able to do when he took a new job. "I transferred my payroll to a different bank. ... My first company's only commitment to the bank is to inform them that I've left." After that, it transferred his remaining pay to his new bank.

Both SAMA and the Kingdom's banks have signaled their intent to work together to resolve what may be a looming crisis. JP Morgan's al-Tuwaijri claims that his company is reconsidering its position on risk management, leading to more awareness about whom firms are lending to. "People have learnt lessons," he says. A set of new laws has also been added, including one that covers mortgage lending.

However, the most obvious solution - a credit agency, with a formal code of conduct that shares information between banks - is still a while off, Johansen reckons. "There are, at the moment, some developments underway to introduce an enforcement law to streamline the enforcement process," he says. "But there will still be a need for a court order. The means for obtaining that court order will become much easier and there will be special enforcement judges who will have wide ranging powers to restrain against assets."

In the absence of individual credit reports, banks keep an informal black list, he continues. "It's a small market, you have to remember. But one or two things we've looked into is privacy rights for individuals. ... There are no formal data protection laws, as found in the EU." On that continent, he added, corporations are prevented from using certain information in debt collection.

One of the Kingdom's leading human resources experts believes that the government should look outside of the financial sector for the answer. "It's all about the corporate interest for the banks, naturally," says Khalid AlHarithi, administration director at Alwataniya. "The Ministry of Labor is the party that should monitor the system and enforce compliance." There also needs to be some kind of additional "support structures" to ensure banks and the public cooperate to resolve the issue of borrowing beyond their means. "I don't think the Ministry has gone far enough in playing a part," he continues. "They need to step in to help."

That doesn't necessarily mean borrowers who get in over their head will get a helping hand, though Mohammed hopes it will. Despite doing his best to pay back his loan, he's still mired in debt. How much does he owe now? "A bigger amount that what I took!"

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Saudi attempts to get a grip on runaway credit