Saudi Arabia’s National Transformation Plan (NTP) is as complex as it is ambitious. What is, in effect, the wholesale redesign of the country’s economy is leaving few private or public sector actors untouched.
A sustained lower oil price environment is underscoring the urgency of this reform plan, as the government grapples with twin challenges of reduced oil revenues and sluggish non-oil growth. The International Monetary Fund expects the economy to expand by just 0.1% this year as the impact of this environment begins to bite.
Performance down
Saudi Arabia’s banks have not been immune from these challenges. Data from The Banker’s Top 100 Arab Banks Ranking for 2017 clearly demonstrates year-on-year performance declines for the country's banking market as a whole. The 12 Saudi lenders featured in this year’s edition recorded an aggregate return on assets (ROA) of 1.87% and a return on capital (ROC) of 12.28% over the 2016 review period. This compares with an ROA of 2.02% and an ROC of 14.02% in the previous ranking.
“Lower government spending is eroding economic growth and slower growth is dampening credit demand and weakening borrowers' debt repayment capacity,” says Ashraf Madani, vice-president and senior analyst at rating agency Moody’s.
Aggregate asset growth for Saudi lenders over the ranking's review period was just 2%, less than half of the Middle East and north Africa (MENA) average of 4.9%. Saudi pre-tax profits, meanwhile, fell by 5.2%, compared with region-wide growth of 1.4%. The only metric on which Saudi banks outperformed the regional average was in Tier 1 capital growth. In Saudi Arabia this was 8.2% against a regional figure of 8.19%.
Indeed, the immediate outlook for some Saudi lenders is not ideal. “The slowing economy will lead to higher provisions across all banks. We expect that banks with larger corporate books will be hardest hit as their clients are exposed to reduced government spending on infrastructure and construction projects,” says Mr Madani.
Standout exception
But there are always exceptions to every rule. The performance of Al Rajhi Bank, Saudi Arabia’s second largest lender by total assets, is the highlight of the 2017 ranking on a national scale. By nearly every metric, Al Rajhi Bank has either outperformed domestic or regional market averages or has come close to doing so. Over the 2016 review period, its net profits grew by 13.9%. Of the 12 Saudi lenders featured in The Banker’s ranking, only National Commercial Bank, with 2.9% net profit growth, came anywhere near Al Rajhi.
Meanwhile, Al Rajhi Bank’s ROA was the best of any Saudi bank, at 2.39%. This compares favourably with the domestic market average of 1.89% and the MENA average of 1.67%. By ROC, Al Rajhi Bank hit 15.64%, beaten only by National Commercial Bank on 15.78%. But compared with the regional average of 14.39% and the Saudi average of 12.28%, this performance was impressive.
More notable still is that Al Rajhi Bank is the only Saudi lender to make the list of top 20 regional banks by growth in pre-tax profits with a ROC above 15%. This, beyond any other metric in The Banker’s Top 100 Arab Banks ranking, defines a bank’s ability to achieve sound growth.
To put this performance into context, two Saudi lenders made the list in the 2016 ranking but could not replicate this the following year. Even as domestic economic conditions have deteriorated, Al Rajhi Bank appears to have improved on its profitability as its peers have struggled.
Retail focus
Al Rajhi Bank’s market leading performance over the review period is partly attributable to its strong and growing retail franchise. As Saudi Arabia’s largest retail lender, it has been less exposed to the travails of corporate-focused banks in this lower oil price environment. Al Rajhi Bank’s dominance in the retail market is underscored by the fact that it has the largest customer base in Saudi Arabia, the largest branch network in the Middle East (900) and that four out of every 10 bank transactions in the country are conducted through its network.
Moving forward, Al Rajhi Bank is not resting on its laurels. “We will continue to align our focus with the NTP agenda,” says chief executive Steve Bertamini. “We plan to maintain our leadership position in retail in terms of financing, funding, remittance and distribution. Aligned with this, we are diversifying our retail business and have already gained market share in real estate on new acquisitions, from 33% to 46%.”
Indeed, the bank’s broader growth strategy is expected to sustain healthy loan growth over the coming year. In The Banker’s Top 100 Arab Banks ranking, the lender achieved the highest asset growth of the top five Saudi banks in the country ranking at 7.63%. Outside of the top five, this was surpassed only by Banque Saudi Fransi, at six in the country table, with 10.72% asset growth, and Alinma Bank, coming in eighth place, with 18% growth.
Further growth is expected to come from the bank’s push into small and medium-sized enterprise (SME) and corporate lending, as well as its continued expansion in the retail market. “SMEs and corporate banking have also been a priority over the past two years. For SMEs in particular, our 2020 objective is to build one of the top two SME banks leveraging synergies with our retail and corporate business. We are aiming to become the preferred partner for SMEs in the kingdom,” says Mr Bertamini.
Slowdown in credit
For the Saudi banking market as a whole, credit growth is slowing. Research from Moody’s, covering the performance of Saudi’s five largest banks in the first quarter of 2017, shows that lending hit SR878bn ($234.1bn), down from SR982bn in the same period in 2016.
“The overall contraction in lending was due to subdued economic activity, which has hit corporate loan demand in particular. There was also artificial growth in banks’ lending in the first half of 2016, mainly in the construction sector as contractors borrowed to cover government payment arrears, which were later cleared,” says Mr Madani.
Over the coming year, operating conditions in Saudi Arabia are expected to remain relatively muted for domestic lenders. According to Moody’s, profit growth is likely to stall, credit growth will be sluggish and provisioning costs could increase. Navigating these conditions will not be easy. Some of the country’s largest banks, including SABB, Banque Saudi Fransi, National Commercial Bank and Alawwal Bank, all registered flat or falling net profits in the second quarter of 2017. Al Rajhi Bank was again the exception, with a 6% growth in net profits for the second quarter. The bank saw its total profits climb by 8% in the first half of 2017.
Strong liquidity
Yet Saudi banks remain in good health despite the more challenging operating environment. In particular, capitalisation and liquidity levels are strong while non-performing loans, for the time being, are low. “Banks in Saudi Arabia are very resilient. We are well capitalised, have strong capital buffers and are in stable financial positions. These factors are really a testament to the steps and efforts made by the government and the Saudi Arabian Monetary Authority [the country's central bank], which have already led to a healthier market in 2017 and an improved liquidity position,” says Mr Bertamini.
And as he points out, local lenders are also adjusting their cost structures to meet the challenges of an economy in transition. “Saudi banks have increasingly focused on reducing their cost base through cost control and efficiency programmes. Also, cost-to-income ratios have already fallen more than 200 basis points in the second quarter of 2017, allowing Saudi banks to achieve one of the lowest cost-to-income ratios among regional peers,” he adds.
In common with other regional markets, Saudi lenders are contending with stronger economic headwinds. And although their aggregate performance has suffered as a result there is little doubt that the country’s banking market is, otherwise, in good health. If the NTP delivers meaningful reform, over the longer term there is every reason to believe that Saudi banks can resume their stellar growth trajectory.
