Saudi Arabian Monetary Agency

In this special feature Central Banking presents a survey of the Saudi Arabian Monetary Agency, its roles, operations and development as a central bank, SAMA has overseen momentous changes in the Saudi economy since its establishment in October 1952. Over the last 50 years SAMA itself has undergone a dramatic transformation from issuer of bimetallic coins and pilgrim receipts in the 1950s, to the recent development of real-time payments and moves towards a single Gulf currency.

The survey begins with a wide-ranging interview with the governor, Hamad Saud Al-Sayari. This is followed by an article looking at SAMA’s role in the Saudi economy. Later articles discuss the conduct of monetary policy, development of the banking system, and the approach and methods of reserve management. The final article outlines the organizational structure of SAMA.

In a wide-ranging interview, Hamad Saud Al-Sayari, governor of SAMA since 1983, discusses the evolution of the agency, its role in developing financial markets and the challenges it faces.

How would you describe the development of SAMA’s role since you became governor nearly 20 years ago?

In light of the substantial economic developments in Saudi Arabia over the last two decades, SAMA's role has evolved in tandem with the evolution of the domestic financial market. First, SAMA has taken numerous steps to develop a sound and effective banking system to serve the economy well, as well as to maintain domestic price stability and the real value of the Saudi riyal. Also, as the sole agency of monetary policy formulation and implementation, SAMA has chosen to make use of various instruments of liquidity to influence money market conditions. In addition, as the regulatory and supervisory authority, SAMA has established a strong regulatory and supervisory framework, which meets international financial standards and codes. SAMA also acts as a financial sector ombudsman, strengthening market practices for transparency, and consumer and investor protection. It also plays a role in customer complaint and dispute resolution with the banks.

Moreover, SAMA has taken the lead in developing technologically sophisticated payments and settlement system, which has led to an efficiently functioning financial market. SAMA also operates and supervises the key payment systems, including the automated cheque-clearing house, Saudi Payments Network (SPAN), which is a national ATM switch, and the Saudi Arabian Interbank Express (SARIE), which is an interbank payment and settlement system. Furthermore, recognising the importance of training and developing of human resources in the banking system, SAMA has invested in upgrading the skills of its staff members through training and higher education. SAMA has substantially contributed through its Institute of Banking (IOB) to the training of the banking community, by offering specialised courses in various fields.

Finally, through Saudi Arabia's membership in the international financial organisations and fora as the IMF, World Bank and BIS, SAMA regularly contributes to and participates in the initiatives aimed at promoting global financial stability. SAMA acts as a bridge between these international organisations and regional groupings of central banks.

Going back before that, how did SAMA react to the vast inflows of foreign exchange in the 1970s?

During the 1970s, foreign exchange inflows far exceeded the absorptive capacity of the domestic economy including the cost of building domestic infrastructure. Saudi Arabia's strong fiscal and balance-of-payments position was reflected in the riyal's appreciation against the dollar. With the pattern of foreign exchange reserves accumulation in the 1970s SAMA's focus was to recycle and diversify assets in developed markets. Furthermore, in the early 1980s, SAMA participated in the IMF's Enlarged Access to Borrow (EAB) facility committing an aggregate amount of SDR11 billion to the Fund.

Apart from reserve management, the domestic challenge was to curb inflationary implications of government spending as well as imported inflation. This challenge was largely met by keeping the riyal value appreciated and denominating major

What has been your experience of fixed exchange rates and the defence of a peg?

In our experience, the dollar / riyal peg has so far worked well for the following reasons:

It has to be recognised that each monetary system imposes different constraints on the economy. Given the fixed exchange rate arrangement, money market adjustments come through the forward market but the level of domestic interest rates in a disinflationary environment has not been a drag on the economy. The long-term stability of the currency has been quite comforting to local businesses, investors and the government alike in terms of their budget planning and investment.

In realising the above-mentioned objectives, SAMA seeks to work with the government in maintaining price stability through low domestic inflation and fair valuation of the Saudi riyal in terms of its nominal and effective exchange rates. In its role as an adviser and banker to the government, SAMA receives / makes payments on behalf of the government, manages official foreign exchange reserves, and government debt and provides the government with advice on matters of economic and financial relevance.

SAMA's mandate as banking regulator / supervisor enables it to maintain financial stability through prudent application of the Banking Control Law and SAMA regulations. SAMA also implements financial standards and codes set by international organisations for strengthening market practices. Therefore stability of prices as well as that of the financial system are paramount for SAMA.

There are no direct controls (such as credit, foreign exchange and interest rate) in SAMA's implementation of monetary policy. The central bank is free to select its operating procedures and to determine the choice of instruments. Reserve requirements are applicable to banks' deposit liabilities but they are not used in managing system liquidity. As is the case with most central banks, SAMA accommodates day-to-day interbank liquidity requirements through its repo window. At times repos are augmented by foreign exchange swaps in managing system liquidity. Interest rates play a subsidiary role in SAMA's monetary policy implementation as they are affected by dollar interest rates by virtue of the riyal peg to the dollar. SAMA meets any erratic movements in money market rates through active intervention.

SAMA is also involved with market supervision. What role has SAMA played in developing the financial markets in Saudi Arabia?

In its capacity as the central bank and the financial supervisory authority, SAMA has played an important role in developing the financial markets in the Kingdom. Over many decades SAMA has followed and implemented policies to ensure a growth oriented economic environment. Despite the turmoil in the global economy / markets and volatility of oil prices in the 1990s, SAMA managed to maintain domestic market stability which ushered in double-digit growth in the financial sector.

SAMA has established a strong supervisory infrastructure that promotes clear rules and regulations for the financial system and ensures a level playing field. SAMA's supervision of the banking and share market fully meets international standards emanating from the Basel Committee on Banking Supervision and the International Organisation of Securities Commission (IOSCO).

SAMA has taken a leadership role in developing a modern and technologically sophisticated payments and settlements infrastructure to support banking and share market activities. This has contributed significantly to the efficiency and growth of the financial markets and profitability of financial institutions.

The payments system is of crucial importance to an economy. What system does SAMA operate at present? Are there plans for the future?

SAMA has always recognised the critical importance of the payment systems for an efficiently functioning financial market and for the national economy. Consequently, it has created a world-class payments and settlements infrastructure in Saudi Arabia. SAMA has a dual role as a central systems operator and the supervisory authority for the key payment systems. These include the automated cheque-clearing house established in

1986, and the Saudi Payments Network (SPAN) in 1990. The latter is a national ATM switch that provides all customers access to their bank accounts with any bank in the Kingdom. SPAN was extended in 1993 to link with electronic funds transfer at the point-of-sale (EFTPOS) terminals. This has significantly enhanced the use of payment systems, in the Kingdom and boosted card technologies.

In 1997, SAMA implemented the Saudi Arabian Interbank Express (SARIE), which is an interbank funds transfer system with real time gross settlement (RTGS) features. SARIE is the backbone of the Saudi payment systems infrastructure, which permits banks to manage their liquidity efficiently and to provide a range of services to their customers.

SAMA also operates the electronic trading and settlement system for shares. A new version of this system "Tadawul" was introduced in 2001 for handling the rapid growth in the securities market. This system has dematerialised share trading and has a T+0 settlement features.

In recent years, Saudi banks have introduced home-banking, internet banking, telephone banking and other electronic services. Looking ahead, we see an opportunity for Saudi banks and the financial system to play a key role in the development of e-commerce. Technology based projects for B2B and B2C commerce are being conceptualised. Banks as the leading financial institutions with direct access to the payment and settlement systems will have pivotal role to play in such initiatives. SAMA's role in these future plans is one of support and supervision.

Countries all over the world are under pressure to upgrade safeguards against money laundering and financing of terrorism. How has this pressure been felt in Saudi Arabia? What has been your response?

While international efforts to fight money laundering and financing of terrorism have increased significantly following the events of September 11, in Saudi Arabia the history of prevention of such activities goes back well over the past two decades. For example, rules that prevent non-residents from opening bank accounts have existed since the 1970s. Furthermore, as early as February 1990, Saudi Arabia ratified the 1988 UN Convention against "Illicit Traffic in Narcotics and Psychotropic Substances”. This was followed by close collaboration with the Financial Action Task Force (FATF) leading in 1994 to the first " Anti Money Laundering Conference" in Riyadh. Also in 1994, SAMA issued comprehensive guidelines to Saudi Banks on prevention of money-laundering activities.

Subsequently, in 1998, the Saudi government issued extensive rules that included procedures and measures for implementing the 1988 UN Convention. Also, in 1999, the Saudi cabinet approved the implementation of the 40 recommendations of the FATF. Under Saudi laws money laundering is deemed a criminal offence with specific penalties. The government has created a committee of all relevant ministries and government agencies that deal with money-laundering issues.

As far as combating financing of terrorism, the government has taken several initiatives including the following:

In addition, Saudi Arabia is cooperating with all international initiatives in these areas, particularly emanating from the UN and with organisations such as the FATF and the IMF. Saudi Arabia has invited the FATF to carry out an evaluation, in 2003, against its 40, plus the additional eight, recommendations.

In line with the general trends in the Muslim world, there is a growing demand in Saudi Arabia for banking products and services that comply with Islamic Shariah principles. This is recognised by the Saudi authorities who have encouraged Saudi banks to offer non-interest based banking products and services. Currently, all banks in Saudi Arabia offer Islamic banking services and their business in this area has grown rapidly.

There are no restrictions on Saudi banks to choose any viable organisational model for delivering such activities. These range from a bank that offers all its products and services on Islamic basis to others which provide these through designated branches, units, departments or through investment and mutual funds.

I would like to emphasise that while we recognise the special characteristics of Islamic banking activities, the supervision and regulation we exercise are consistent with those for normal commercial banking. Consequently, capital adequacy, liquidity and other supervisory requirements are applied to these activities. SAMA also practices both on-site and off-site supervision and requires banks to report these activities through special prudential returns. It is important that strong corporate governance standards are applied by all banks offering these products and that the risks related to Islamic banking are identified, reported and managed by the banks.

How real are the prospects of a Gulf monetary union? What would be the benefits for Saudi Arabia?

In fact the present exchange rate structure and uniform policies in the Gulf Cooperation Council (GCC) countries augur well for a Gulf Monetary Union (GMU). With the recent agreement by the GCC central banks to use the dollar as the anchor currency, the prospects of a monetary union with a single currency appear quite encouraging. The 22nd summit of the GCC ratified establishing a GCC customs union by January 2003 and the use of the US dollar as a common denominator, criteria for economic convergence by 2005 and a single currency by 2010. The proposed GMU is expected to promote intra-regional trade and enhance efficiency of the financial sector in the GCC through policy / market integration, elimination of currency risk and business cost effectiveness. At the macro level, pursuit of a strict discipline in economic policy formulation and implementation should enhance market perception of the GCC economic block and its risk profile. In the grand scheme of things, the potential benefits and gains accrue to all participants.

What, for the central bank, have been the effects of ongoing instability in the Middle East?

Political instability in general tends to hamper normal activity with implications for growth and investment Saudi Arabia has incurred huge direct and indirect economic costs from two Gulf wars and ongoing conflicts in the Middle East. Fluctuations in oil prices and fiscal imbalances have from time rendered volatility in domestic liquidity and money market conditions. Against this backdrop, SAMA remains engaged in managing system and domestic liquidity through its policy instruments. SAMA views price stability and financial stability as highly complementary in the context of policy management. Our focus has, therefore, been to maintain exchange rate stability and effective banking supervision.

OPEC plays an important role in ensuring oil market stability and maintaining the interests of the oil producers and consumers alike. Saudi Arabia, as a moderator, seeks to work for the greater good of the global economy, and believes that volatility in oil prices is neither in the interest of producers nor consumers. All OPEC members are developing countries and they rely on oil as a main source of income. It is in OPEC’s interest to seek stability of oil income for sustained economic growth.

Saudi Arabia has officially about $19 billion in foreign currency reserves. Is there a target level? What influences this?

Saudi Arabia has no specific target level for its foreign exchange reserves. However, official reserves are maintained at a prudent level for covering the country's imports for several months. Saudi Arabia makes a distinction between its gross foreign assets and official foreign exchange reserves, which are liquid, totally unencumbered and readily available for balance-of-payments purposes.

SAMA's foreign exchange reserve management is disciplined and dynamic process. Global economic and market factors influence our diversification and asset allocation strategies. SAMA's dual role as a central bank and asset manager transpires into emphasising liquidity (cash flow management) and return (investment of surplus funds). SAMA's investment style has been relatively conservative, with an emphasis on credit quality, liquidity, diversity of portfolio and risk-adjusted return.

Based on the structural reforms, which are being expedited to enhance Saudi Arabia's growth potential, we expect our GDP growth to move up to 3-4% per year in the next five years, with its positive impact on job opportunities for Saudi citizens, economic diversification and more attractive investment environment. These reforms include the following:

What are the benefits of your membership of the BIS? Do you personally attend the meetings? What should be the role of the BIS in the future?

The BIS has a very important role in international banking and finance. As the world economy becomes more open and integrated the need for cooperation and discussion among central banks and the international financial community becomes more pronounced. The BIS helps central banks in various countries by promoting discussion and facilitating decision-making processes between central banks, by acting as a counterpart for central banks in their financial transactions and as an agent in connection with international financial operations.

In addition, the Basel Committee on Banking Supervision has helped in strengthening global system for monitoring and supervising commercial banks. The committee's development of international standards and codes is well regarded by central bankers. The BIS also gives central banks technical assistance and training relevant to the work of its members as it regularly organises meetings of experts on specific subjects, such as information technology, security, internal management procedures and specific legal and market issues of interest to central banks. The BIS conducts studies and holds meetings and seminars aimed at creating a better understanding of the implications of promoting central banks policies, all of which help promoting financial stability and enhancing security of financial transactions throughout the world economy. Yes, I personally attend the bimonthly and annual meetings of the BIS, which bring together member central bankers for discussion of various relevant issues.

Regarding the future role of the BIS, I think the BIS should continue focusing on its main activity of collaboration and coordination between central banks of the G10 as well as the non-G countries. The BIS's long-established record of achievements will enable it to meet the challenges of the new economy.

What steps should be taken to improve management by the international community of sovereign debt crises?

The existing sovereign debt system lacks adequate incentives to ensure timely and orderly restructuring of unsustainable sovereign debts. Since sovereigns issue debt through a variety of instruments, it makes it difficult for the debtor to get all creditors to agree collectively on a restructuring agreement when its debt obligations exceed its payment capacity. This reinforces the tendency for debtors to delay restructuring until the last possible moment, which, in turn, results in a drain on reserves, causing uncertainty and loss of asset values to the detriment of debtors and creditors alike. This is what the sovereign debt crisis is about. As per the current thinking of the experts on the subject, the international community is required to put in place a market-based sovereign debt restructuring mechanism that helps:

c. Provide incentives for a debtor with unsustainable debts to approach its creditors promptly for restructuring agreement.

Integral to such a mechanism are clauses on majority restructuring, a temporary stay on creditors litigation, and priority financing during the period of the stay. The clauses can be introduced either through wholesale statutory reform or through contract in all international sovereign bonds.

To set up the exact modalities of the mechanism, the subject is under study by international financial institutions as well as financial experts. The recent meeting of the IMF's International Monetary and Financial Committee has agreed on one element of that strategy; the adoption of the collective action clause.

In a dynamic and rapidly changing global environment, like other central banks, SAMA faces many new challenges. For example, increasing liberalisation of financial markets is leading to growing competition in the Saudi financial system, both domestically and on a cross-border basis. In this regard, SAMA's priority is to ensure that the financial system continues to develop in a sound, stable and credible manner for the greater benefit of the Saudi economy and the consumers.

With the expected promulgation in the near future of the Saudi Capital Markets Law and the Insurance Law, SAMA will exercise its supervisory role in a changing environment and possibly under new supervisory arrangements and structures. With the advent of many non-bank financial institutions, that will provide niche and specialised financial services, greater vigilance and surveillance will be required. Furthermore, SAMA will continue to face new challenges from growing sophistication and complexity of its financial institutions. These will arise from deployment of new information technologies and computer systems and introduction of innovative products and services.

On another front, the global supervisory environment will be more demanding, particularly with respect to the development and implementation of international standards such as the Basel Core Principles, IOSCO Standards and International Accounting Standards. These will require significant attention, focus and commitment of financial and human resources. SAMA will be challenged to stay in the forefront of the rising expectations of financial markets.

The post-September 11 scenario has brought new pressures for all central banks and supervisors in terms of enhancing their policies, procedures and institutional structures to combat money laundering and terrorist financing. This is a global challenge and SAMA will need to play its role in the international arena, through continuous strengthening of laws, regulations and procedures in this area and by enhancing cooperation with other authorities. In short, SAMA must ensure that the financial system remains a vibrant sector of the economy. In this respect, we will continue to respond to ongoing challenges through pragmatic policies.

Hamad Saud Al-Sayari was appointed governor of the Saudi Arabian Monetary Agency on April 14, 1983. He is also chairman of the board of directors of the Saudi Arabian Monetary Agency and member of the board of the Public Investment Fund, and Gulf Investment Corporation. Born in 1941, he was educated at the University of Maryland, USA, taking an MA in Economics. He taught economics at the Institute of Public Administration, Riyadh, then was secretary general of the Public Investment Fund; director general, Saudi Industrial Development Fund; and then controller general, and vice-governor of the Saudi Arabian Monetary Agency.

SAMA's role in the Saudi economy

Since its inception in 1952, SAMA has overseen momentous changes in the Saudi economy as well as taking an active role in the development of the banking sector and capital markets.

SAMA was established by the issuance of royal decrees number 30/4 /1/1046 and 1047 on April 20 1952, and was officially inaugurated on October 4 1952. SAMA's objectives as set out by its charter include the following:

Over time SAMA has evolved into a full-fledged central bank, with additional roles of managing official foreign assets and government debt, acting as the financial sector supervisor and for operating and supervising the payment systems. From 1973 to 1982, SAMA's focus was to contain inflationary pressures in the booming economy and oversee the development of the banking sector. During the second half of the 1980s SAMA's priority was to address deteriorating balance-of-payments position, introduce money market reforms and manage government debt. Foreign exchange reserve management has been a key function entrusted to SAMA since its inception.

SAMA is required by its charter to promote and maintain domestic price and exchange rate stability. In coordination with the government, SAMA has achieved both these objectives. The inflation rate has remained at less than 1% over the last 15 years and the exchange rate has been stable at SR3.75 to the US dollar since June 1986. The full convertibility of the riyal since 1961 and no restrictions on capital flows have been conducive to creating a stable business environment for the private sector and attracting foreign direct investments.

One of the major responsibilities of SAMA has been to promote growth of the domestic banking industry. Since the 1950s a number of foreign and domestic banks have been licensed to meet the expansion of economic activity and the need for banking facilities. Currently there are 11 Saudi banks of which eight are joint-venture banks, with some 1,200 branches spread throughout the Kingdom and in a few overseas locations. Under the supervision and guidance of SAMA, banks have made significant progress in terms of products, services, technological sophistication and capitalisation.

The Banking Control Law, enacted in 1966, has vested SAMA with broad supervisory powers. These include powers to issue regulations, rules and guidelines in light of international and domestic supervisory developments. The law stipulates stringent provisions for capital adequacy, liquidity, reserve requirements, loan concentration, amongst others. The law also provides for banks to submit regular financial and statistical statements to SAMA, and for the central bank to carry out on-site and off-site banking supervision.

SAMA has set up, in cooperation with the commercial banks, a number of advanced and sophisticated payments and settlement systems. These have contributed significantly to improving the level and quality of customer service, reducing costs, enhancing efficiencies and strengthening controls. The sophisticated technological platform bodes well for a quantum leap in electronic banking and financial services over the next few years.

SAMA has also played a crucial role in the development of the Saudi capital market. Together with other relevant ministries, SAMA has been part of the policy-setting mechanism and also the market supervisor. Furthermore, it has been the operator of a state-of-the-art securities trading and settlement system. The contribution of the capital market to the growth of the Saudi economy has been no less significant. Over the last ten years mobilisation of funds for investments through the stock market has grown at a phenomenal pace. At the same time, the mutual funds industry and the government bond and Treasury bill markets have also expanded rapidly.

Since its creation in 1952, SAMA has played an important role in contributing to Saudi Arabia's economic progress through a sophisticated infrastructure, a strong regulatory system and well managed institutions that adhere to high standards of stability, discipline and transparency.

Saudi Arabia's position as a prominent non-G10 member of the IMF and the World Bank and a shareholder of the Bank for International Settlements provides SAMA officials with many opportunities to participate in global forums focusing on financial stability and market supervision. The governor of SAMA regularly attends the bi-monthly policy meetings of the G10 governors. Senior SAMA officials also participate in the G20 deputies meetings and other international forums.

Prospects for Gulf Monetary Union

SAMA is actively engaged in efforts to strengthen financial stability in the region and in the global financial markets. At the pan-Arab and GCC level, SAMA is a leading participant in the fora of the governors of the central banks and monetary agencies of Arab countries and the committee of the central bank governors of the GCC countries. SAMA officials also represent Saudi Arabia in various inter-Arab and inter-GCC fora including the Arab Monetary Fund. SAMA plays an important role in supporting the development of banking supervision standards and practices. It is a member of the Arab Banking supervisors' committee and of the GCC banking supervision committee. The governor of SAMA is the permanent chairman of the latter committee. Given SAMA's active participation in the Basel fora, it acts as a bridge and a conduit for passing on information between the Basel committee and the regional committees.

Global supervision

SAMA is active in the global supervisory arena and is currently a member of the "Core Principles Liaison Group" of the Basel Committee on Banking Supervision. This group of G10 and non-G10 countries is working on important supervisory issues including the new Basel capital accord, cross-border supervision and other issues. SAMA is also represented as an observer on the Basel committee’s accounting task force, which collaborates with international accounting bodies engaged in developing accounting standards for the banking industry. As one of the few emerging market countries on this committee, SAMA plays an important role in providing views on various technical issues from a non-G10 perspective.

More recently SAMA has participated along with some other Islamic countries to form the Islamic Financial Services Board, which has the development of supervision standards and practices for Islamic banks and products and services as its objectives. This new entity will help promote Islamic banking and finance and enhance its credibility and stability.

Fighting financial crime

SAMA is playing an important role in the global fight against money laundering and terrorist financing. In this context it is cooperating with many international organisations including FATF, the IMF, the World Bank and law enforcement agencies, both on multilateral and bilateral basis. SAMA is also actively participating in various regional committees and fora working on these subjects.

This article presents the objectives, instruments and recent developments in SAMA’s operating framework of monetary policy.

Institutional framework and objectives. SAMA is entrusted with the conduct of monetary policy. With a pegged exchange rate regime in Saudi Arabia, targeting the exchange rate in an open economy makes monetary policy subservient to exchange rate policy. Any decoupling of riyal interest rates from dollar interest rates (particularly in the event of lower riyal rates) tends to provoke an outflow of foreign exchange with an adverse impact on official foreign exchange reserves. The operational target of SAMA’s monetary policy is system liquidity management. The dollar/riyal exchange rate is an intermediate objective. The ultimate policy objective is to maintain price and financial stability.

Policy instruments. SAMA uses the following instruments to influence money market conditions in the pursuit of its monetary policy objectives:

Cash reserve ratio. According to article 7 of the Banking Control Law, banks are required to maintain a percentage of their customers' deposits with SAMA as prescribed cash reserves. SAMA last adjusted the reserve requirements from 12% to 7% on current account liabilities in February 1980 and kept unchanged the requirements on savings/time deposits at 2%. In Saudi Arabia the availability of indirect instruments of liquidity (repos and foreign exchange swaps) has diluted the role of reserve requirements in managing liquidity, although the instrument itself is still regarded as central to our monetary policy.

Statutory liquidity ratio. Banks are also required to maintain a minimum amount of specified liquid assets equal to 20% of their demand and time liabilities (known as the statutory liquidity ratio). Liquid assets include cash, gold, interbank deposits of less than 30 days and Saudi government bonds.

Placement of public funds. As part of its regular money market operations, SAMA exercises its discretion in using the government institutions' funds at its disposal to place with the banks. In the absence of open market operations involving outright purchases and sales of securities, such placements have been supplemental to primary instruments of liquidity.

Repos: SAMA uses the repo window to fine-tune system liquidity. It is often the marginal changes in bank liquidity which have the greatest impact on short-dated rates. SAMA's short-term focus of policy implementation makes the overnight repo rates, which broadly reflect overall money market conditions, a policy signal to the market. Banks use repos to meet unexpected clearing shortages and to temporarily facilitate their secondary market-making operations.

Foreign exchange swaps. Foreign exchange swap transactions serve the purpose of influencing capital flows, thereby reducing the disruptions to monetary policy emanating from the foreign exchange market. Swaps have been used to provide emergency liquidity to the banking system during the Gulf crisis and in times of speculation against the riyal.

Transmission Mechanism. Credit availability in Saudi Arabia has a limited impact on the transmission mechanism of monetary policy, as demand for money is relatively inelastic to interest rate changes. The wealth-effect argument has its limitations in Saudi Arabia due to limited collateralization of assets and hence limited impact on bank credits of a decline in financial asset prices.

Monetary policy constraints stem from the dominance of fiscal policy in the Saudi economy and the riyal peg to the dollar. In a fixed exchange rate regime, interest rates act as the residual equilibrating element. It is rather difficult to pursue a discretionary (ie, autonomous) policy without affecting the delicate linkage between the administered exchange rate and official foreign exchange reserves.

To summarize; the conduct of monetary policy in Saudi Arabia has been largely influenced by the exchange rate regime which seeks to maintain a fixed parity against the dollar, with changes administered as necessitated by domestic price considerations (revaluation of the riyal in the 1970s) and balance-of-payments considerations (devaluation of the riyal in the 1980s).

In the 1990s, the riyal remained quite stable except for sporadic speculation (1993,1998 and 1999) due to low inflation and the dollar's strength for most of the 1990s. The dollar has been the anchor and intervention currency due to the predominance of dollars in Saudi Arabia's receipts and payments. In our experience as an open economy, exchange rate targeting has worked well so far, but there are certain costs in it as an exchange rate can be attacked as opposed to inflation or monetary targeting.

Management of reserve assets

SAMA employs tranching as a means of managing diversification of assets to improve the return on its reserve portfolio.

Historical Perspective. The practice of reserve management by central banks has changed significantly over the last ten years. Once characterized by passive short-term investment strategies to preserve principal value and maintain maximum liquidity, many central banks now make more active use of a broad range of instruments. They have extended portfolio durations, and have developed performance benchmarks. SAMA is entrusted with managing the government's foreign assets. The investment committee, headed by the governor, discusses asset allocation, portfolio performance and market dynamics for finalizing investment deliberations. The investment department has functional responsibility of preparing and implementing investment programmes as well as monitoring and managing external managers.

Evolutionary Phase. SAMA's experience of reserve management dates back to the early 1970s. Prior to the first oil boom of 1973, SAMA's foreign investments remained largely confined to bank deposits. Asset allocation at that time meant deposit allocation among major international banks. During the 1970s, SAMA was faced with the challenge of managing massive reserves acquired from higher oil revenues and reinvestment of assets. Given market limitations of the 1970s in terms of liquidity and absorbing capacity,

a well-diversified portfolio by country, currency and assets was designed. As the markets became more developed and liquid in the 1980s, the use of secondary markets became more pronounced.

SAMA's investment style. In its reserve management, SAMA distinguishes between treasury requirements (government cash-flow needs) and investment of surplus funds. SAMA's dual role as a central bank and asset manager has meant that it places emphasis on liquidity as well as on return. Once liquidity and secondary liquidity have been created, the remaining assets are invested in bonds and equities.

SAMA's investment objectives emphasize safety, liquidity and risk-adjusted return. Diversification has the potential to improve return relative to liquidity in portfolios maintained for that purpose. The emphasis on return has given rise to portfolio benchmarking (performance measurement) in order to evaluate both internally and externally managed portfolios.

Credit criteria. For bank deposits a minimum of "C", rating by Fitch IBCA is required. Investment in securities is restricted to sovereign, sovereign guaranteed, agencies, supranational and corporate obligations, which are rated AAA or AA by Moody's and S&P. A small portion of assets may be invested in A-rated bonds.

Currency composition. There are broadly defined currency limits in the context of liquidity requirements and the principle of diversification. The dollar is used as the base currency, given its importance to Saudi Arabia in terms of the country's revenue and expenditure pattern as well as the importance of the dollar in international trade and finance. For this reason, the dollar dominates the currency composition, followed by a few major currencies. Currency allocations are not linked to trade flows.

Asset mix. The most immediate role for reserves is to finance current expenditure, and this means holding a certain proportion of the funds in cash and short term deposits. In its top down approach, SAMA goes through a regular process of asset allocation based on the risk reduction benefits of diversification and risk-adjusted return.

Benchmarks. The choice of benchmark reflects the required diversity of assets and the risk tolerance. SAMA's benchmarks are as follows:

SAMA's assets are partially managed by externally hired money managers. The principal objective is to seek optimal return on assets approved under SAMA guidelines. SAMA has a blend of global, regional and domestic portfolios in equities and fixed income securities. Mostly these are actively managed accounts, with a few indexed portfolios. With professional money managers, SAMA tends to gain from diversification, investment style, research and the scope of performance. Unlike internally managed portfolios, managers have greater discretion to operate within the framework of SAMA guidelines. Portfolios are managed and measured on a total return basis. Funding and disfunding of portfolios are either for performance or for asset allocation reasons.

Securities lending and swaps. Swaps are undertaken to restructure the portfolio in terms of maturity or credit quality and improve SAMA's overall liquidity. In line with the industry trend, SAMA has securities lending arrangements with its custodians on a revenue sharing basis.

SAMA has been actively involved in regulation and supervision, and has taken the lead in the development of the payments system in Saudi Arabia.

SAMA's broad supervisory powers are derived from its 1957 charter and the 1966 Banking Control Law. The charter specifies that one of the functions of SAMA is "to regulate commercial banks and exchange dealers". However, it is the Banking Control Law that details SAMA's supervisory responsibilities. These include receiving and reviewing applications for banking licenses and making recommendations to the minister of finance and national economy for grant of such licenses after approval by the Council of Ministers. The law also requires that the founders and members of the board of directors of banks should be "persons of good reputation".

The Banking Control Law also specifies a number of regulatory requirements, such as the ratio of deposits to be maintained by the banks with SAMA. Currently these are set at 7% for demand and 2% for time deposits and can be increased or decreased. The banks are prohibited from lending to anyone person or entity in excess of 25% of their reserves and paid in capital. SAMA can, in the public interest, increase this limit up to 50%. Banks are not permitted to lend to their directors or auditors without 100% collateral. Banks are also required to ensure that their deposit liabilities do not exceed 15 times their capital and reserves. Banks' liquid assets are to be maintained at 15% of their deposit liabilities, and if deemed necessary, can be increased by SAMA. They are currently set at 20%.

The laws prohibit mergers of banks without permission from SAMA, and all banks are required to appoint two external auditors registered in Saudi Arabia to conduct their annual audits. The central bank has authority to require any information from any bank and to conduct on-site inspections. SAMA also requires banks to submit regular financial and statistical information in the form of prudential returns for off-site supervision. The law imposes confidentiality rules on banks and specifies penalties for any violations of the law. SAMA is permitted to issue rules and regulations with the approval of the minister of finance and national economy.

Secondary legislation (ie, regulations), issued by the minister of finance and national economy and SAMA, cover a range of subjects such as regulations for the money changing business, regulations for investment funds and rules for banking service charges. In addition, extensive SAMA regulations have been issued on a variety of subjects including risk based capital adequacy, managing credit, liquidity and foreign exchange risks, credit classification and provisioning, bank security procedures, prevention of fraud, money laundering, contingency planning etc.

SAMA also issues rules and guidance to banks that are derived from international best practices and banking supervisory standards on a wide range of subjects aimed at strengthening banking operations and inculcating a strong risk management culture. In this regard, in recent years, rules have been issued on management of credit risk and loan accounting, liquidity, electronic banking, operational risks, etc.

SAMA has issued a series of directives to the banks with regard to corporate governance, In 1982, SAMA issued a "Clarifying Memorandum on Powers and Responsibilities of Members of the Board of Directors of Saudi Commercial Banks” and in 1988, SAMA issued guidance on “Internal Controls in Commercial Banks”. In 1990, SAMA issued “Accounting Standards for Commercial Banks in Saudi Arabia”. SAMA also issued detailed guidance to the Banks in 1994 on the “Role of the Audit Committees” to support the legislation for all corporations to form audit committees. In 1996, SAMA issued rules on “Special Examinations”, and subsequently conducted such inspections in all banks. These rules and regulations taken together provide a strong infrastructure for corporate governance in the Saudi banking system.

The sustained long-term growth and development of the Saudi banking system has been supported by a comprehensive system of banking supervision. SAMA practices both on-site and off-site supervision of banks and is very active in international supervisory forums. Over the years, SAMA has been recognized for fostering soundness and stability in the domestic financial market.

As a central bank and a banking Supervisor, SAMA has always recognized the important role that payment systems play in the development of the domestic financial market and the national economy. Consequently in the 1980s SAMA decided to take the lead in establishing a comprehensive and integrated electronic payments infrastructure in Saudi Arabia. This was essential for a rational and consistent national strategy for payment systems that could ensure that financial benefits will accrue to all market participants from a collaborative approach, instead of expensive and redundant competition.

In 1986 SAMA started with the automation of the cheque clearing system. This was followed in 1989 by all banks joining the international SWIFT payments system. A major step in creating an electronic infrastructure was the implementation of the Saudi Payments Network (SPAN) in 1990. This was a national ATM switch that linked all banks and provided access for bank customers to their accounts with any bank in the Kingdom. In 1993, SPAN was enhanced to link it with electronic fund transfer at point-of-sale system, thus further expanding its service to the customer and the economy. By June 2002, there were 2,768 ATMs and 22,738 point-of-sale terminals.

In 1990 SAMA also established an Electronic Shares Information System (ESIS) that permitted screen based shares trading and settlements. In 2001, this system was replaced by the Tadawul System that encompasses trading of shares, bonds, mutual funds and other investments. The new system is a dematerialized share trading system with T+0 settlement features. However, the most important development in the payment systems happened in May 1997 in the form of the Saudi Arabian Riyal Interbank Express (SARIE). This is an inter-bank electronic funds transfer System with real time gross settlement (RTGS) features. It provides banks with the ability to constantly manage their interbank liquidity and balances with SAMA. The system has advanced features such as 24-hour operation, full collateral and ability to deal with same day as well as forward value payments. This system can be thought of as the "backbone" of the payments infrastructure in the Kingdom. SAMA's role as an operator and a supervisor has ensured that the dual objectives of prudence and efficiency in the national payment systems are achieved and sustained.

Saudi Arabia is and remains committed to cooperating with international financial institutions such as the Financial Action Task Force, the Financial Stability Forum and other relevant international bodies to prevent abuse of its financial system via terrorist financing and money laundering. Networking on these issues is strongly pursued, through various forms where Saudi Arabia is active. In particular, Saudi Arabia is committed to providing:

Over the past two decades much progress has been made through the introduction of laws, regulations, systems and procedures. Some of the specific actions taken by the Kingdom of Saudi Arabia in its combat against terrorist financing and money laundering are listed below.

A permanent committee composed of the Ministry of Interior, the Ministry of Foreign Affairs, SAMA and the Commission for Intelligence has been established with the following mandate:

The Kingdom supports and cooperates with all international efforts to combat terrorism. For example, Saudi Arabia has signed, under the auspices of the Arab League, a multi-lateral agreement to fight terrorism (in 1998). It has also signed various bilateral agreements with non-Arab countries to fight terrorism and has applied all the UN resolutions related to anti-terrorism. Saudi Arabia is also participating in and is cooperating with many international initiatives to combat terrorist financing regime.

Legislative Framework: The Kingdom ratified the 1988 United Nations Convention against "Illicit Traffic in Narcotics and Psychotropic Substances" (Vienna Convention) through decision number 19 dated February 10 1990. This was followed by a decision of the Saudi cabinet number 168 dated November 30 1998 approving and adopting the executive rules that include the procedures and measures for the implementation of most provisions of the 1988 UN Convention.

Subsequently, the Saudi cabinet also issued its executive decision number 15 dated May 3 1999 approving the implementation of the 40 recommendations issued by the FATF related to money laundering.

Money laundering has been deemed to be a criminal offence with specific punishments stipulated as a component of drug control regulations. Furthermore, the government has recently set up a committee of seven ministries and government agencies to deal with money-laundering issues.

International cooperation: Saudi officials of various government agencies regularly attend the FATF meetings held in various parts of the world. Also, Saudi Arabia has hosted many conferences in Riyadh, as shown below.

Saudi Arabia cooperates and coordinates with all relevant international agencies in exchanging information and expertise pertaining to money laundering. With respect to self-assessment against the 40 plus eight FATF recommendations, a committee has been established to ensure the Kingdom's compliance, and it is anticipated that a team from the FATF will visit the Kingdom in 2003 to carry out an evaluation.

With the issuance of a banking license to the Dubai based Emirates Bank International (EBI) in early 2002, the number of licensed banks in the Kingdom has increased to 12. EBI is expected to open its branch in the last quarter of 2002. More recently, the government has announced the approval of the applications from the National Bank of Kuwait and National Bank of Bahrain to open their branches in the Kingdom.

In the first half of 2002, the banking sector continued to show healthy growth. Total assets of the banking system expanded by 6.6% to SR487 billion, while customer deposits rose by 6.1% to SR349 billion. Loans to customers grew by a significant 15% due to substantial growth in corporate lending, particularly in the building and construction, commercial and miscellaneous sectors. In terms of quality of assets, non-performing loans decreased by 12% and were 8.8% of the total outstanding loans. The provisions for doubtful loans now provide a cover of 110%. Banks' investment portfolios increased by 12% to SR227 billion. The net profit of the banking system increased by 8.4% in the first half of 2002. This equates to a return on equity of 21.44% as against 21.4% in 2001 and return on assets of 2.29% as against 2.25% in 2001. Banks' profitability can be attributed to the widening of spread between their funding costs and their lending and investment income.

As a result of the significant increase in lending, loans to deposit ratio of the banking system has increased to 51.8% from 47.7% at the end of the first half of 2002 while the liquidity ratio (liquid assets/ deposits) declined to 46.2% from 51.9% at the end of first half of 2002. The Saudi banking system continues to be highly capitalized as total capital increased by 6.7% to SR46.6 billion. The Basel Capital Adequacy ratio is a healthy 18.7% against the international standard of 8%. Banks' capital leverage ratio is a sound 10.7%.

During the first six months in 2002, the number of employees in the banking system grew by 3% and the number of branches rose by 1.3% to 1201. The banking system continues to invest heavily in technology. The number of ATMs increased by 7.8% to 2768 and electronic funds transfer at point of sale terminals rose by 5% to 22,738. Mutual funds managed by the Saudi banks continued to show rapid growth with 13 new funds launched this year, an increase of 9%. Assets under management reached SR 52.175 billion, an increase of 4.2%. The prospects for the Saudi economy in the second half of 2002 remain steady, with the banking system continuing to show healthy results.

Organizational structure and staff

This article outlines the structure of the agency's staff and the importance of human resource development to the central bank

Structurally, SAMA is under the control of a board of directors which is responsible for its efficient administration and operations. The board consists of the governor (chairman of the board and CEO), vice-governor (vice-chairman of the board) and three members who are non-government officials. The governor and members of the board are appointed for four years by a royal decree, in accordance with the nomination by the minister of finance and national economy and the approval of the Council of Ministers. The removal of board members from office also takes place by a royal decree. Board meetings are held once a month and are called by the chairman or the vice-chairman, in the event of the absence of the former. The board of directors is responsible for the formulation of policies directed toward the "efficient administration and operation" of the agency, and has "such powers as are necessary and appropriate to this end". SAMA has no capital, but is allowed to cover its expenses by charging a fee to the government. The organizational chart (see Figure 6) shows various departments, their functions and reporting lines.

Flexibility in Selection

As a public sector organization, SAMA is responsible for carrying out relevant functions and strategies entrusted to it by the government. Therefore, employment procedures are governed by the rules and regulations of the Saudi Arabian civil service bureau. Such rules and regulations define the manner in which an employee progresses in terms of seniority and state salary scales, annual increments and promotion for public sector employees. Nonetheless, being an independent institution, SAMA has some flexibility in the selection and hiring of cadres that best fit its special needs and requirements. In addition, in order to attract and keep its highly qualified personnel, SAMA also has some flexibility to allow its staff additional allowances and monetary benefits. These allowances are generally given based on the special nature and sensitivity of the job, or in consideration for distinguished contribution or an outstanding level of

Currently, there are about 2,500 employees working for SAMA of which about 50% work at the head office in Riyadh and the remaining are in ten branches spread across the country. In a rapidly changing world, SAMA cannot remain rigid. The ample range of independence given to SAMA allows it to decide its own affairs. In this sense, human resources development (HRD) plays a crucial role in training and upgrading the skills of SAMA staff. The present status of SAMA may reflect the efforts that have been exerted over the past years to make real changes in its organization and structure through strategies and plans carefully drawn for staff development. To this end, HRD works on two tracks. One track is to upgrade and refine the capabilities and skills of the present staff while the other is to recruit the best possible cadres from university graduates with the intention of subjecting them, later on, to extensive professional training and educational programmes. The second track may also include hiring professionals from the immediate labor market. Since the effectiveness of an organization depends very much on the quality of its workforce, SAMA's employment strategy aims at building a competent and highly skilled staff, particularly in areas of economics, banking and technology. In order to attract outstanding candidates, SAMA uses different selection techniques such as advertising in newspapers, direct selection from recent university graduates and employing the services of professional head-hunting agencies.

Human resources. Human resources and development policies and activities are all consistently directed to create an ideal environment that assists SAMA's staff to carry out their duties effectively. Education and training strategies are two important cornerstones in SAMA's short- and long-term human resources development planning programmes. Identification of training needs is subject to continuous assessment and review. Strong business relationships are made with local, regional and international educational and training institutions. The objective of the training activity aims not only at improving the performance and enhancing the productivity of the employee but also at providing him with solid knowledge that renders him creative, self-dependent in carrying out his duties and self-confident. This policy has proved to be highly effective.

With its various training programmes in areas of banking, finance, computer applications, management and English language courses, SAMA's Institute of Banking (IOB) in Riyadh plays an important role in developing and improving the performance and productivity of the banking staff. Over the years, SAMA has managed to build a wide base of Saudi staff with expertise in various fields. Such competent national cadres are now successfully engaged in running businesses at the domestic banks and SAMA