Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
Middle EastSeptember 1 2016

Saudi banks' growth hit by liquidity squeeze

Liquidity in the Saudi Arabian banking sector has tightened, but there is no cause for concern just yet, reports Kit Gillet. However, the central bank is introducing measures to ease the pressure and boost lending.
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
Saudi Arabia feels pinch embedded

With the global price of crude oil down markedly since 2014, Saudi Arabia, which is heavily reliant on oil revenues, has found itself forced to deal with a new and harsher economic reality, consisting of lower governmental income and an even more pressing need for economic diversification.

The country's banks have found themselves facing a challenging climate, as government deposits have been withdrawn to fund the budget deficit while private sector deposits have stuttered. Banks have seen their liquidity squeezed and this, along with other issues, has curtailed their ability to lend and hit their bottom lines.

Low oil prices have led to a tightening of liquidity across much of the Gulf Co-operation Council (GCC) region, affecting some countries more than others. Saudi Arabia, where government and government-related deposits account for about 22% of the total, has not been as badly hit as some, but still has to contend with an economy that has less money sloshing around.

“The United Arab Emirates is certainly under some stress, [with] tight liquidity there. Saudi Arabia is not as tight as the UAE or Qatar but is somewhere in the middle of the GCC,” says James Reeve, deputy chief economist at Saudi Arabian financial services firm Samba Financial Group.

“Liquidity is tight but it is by no means critical,” he adds. “The main issue is the government is not spending as much as it was, and because it is the main engine of the economy, that has ripple effects [across most sectors]."

Feeling the pressure

Still, with liquidity tight, banks in Saudi Arabia are feeling the pinch. According to ratings agency Fitch, the sector continued to grow in 2015, with assets up 3.6%, but this was down from an average of 11.4% annually between 2012 and 2014.

In August, Fitch rated the country's banking sector outlook as 'negative', together with the outlook for all 11 Saudi banks as well as the country’s sovereign rating. Fellow rating agency Moody’s downgraded the long-term deposit ratings of nine Saudi banks on May 16, while confirming the ratings of just two: Al Rajhi Bank and National Commercial Bank.

The central bank, the Saudi Arabia Monetary Authority (SAMA), published data in June showing the country's banking sector had experienced a 0.5% decline in total deposits in May, following a 0.7% drop in April.

Overall, Saudi banks experienced a 12-month decline of 3.4%, the largest year-on-year drop since August 1994, according to Moody’s (government deposits actually rose slightly, by 0.1%, in May, but that was not enough to offset the 0.9% drop in private sector deposits). For the 12 months of 2015, deposit growth slumped to just 1.9%, according to Fitch, down from 12.4% in 2014.

Loan growth

At the same time, Saudi Arabian banks’ loan books have continued to grow. On July 4, Moody’s reported that the Saudi banking sector’s loan growth had remained above 9% since January, presumably helped by the relaxation of the country’s loan-to-deposit (LTD) ratio.

Saudi banks have retained a high level of liquid assets. Yet while they had an average Basel III liquidity coverage ratio of 193% at the end of 2015, according to Moody’s, the ratio of liquid assets to total assets has declined strongly since December 2014, down from 22.3% to 17.1% as of March 2016.

This has increased the cost of funding, with a rise in the three-month Saudi Interbank Offered Rate to 2.23% on June 21, up from 0.77% one year earlier.

“No doubt there is a liquidity concern. We are seeing a deposit outflow and less money supply in the economy. Oil revenue is low, therefore the government revenue is down,” says Chiradeep Ghosh, research manager at Securities & Investment Company (SICO) in Bahrain. “Most Saudi banks are likely to have a slightly tougher time related to low liquidity in the near future.”

In a report released in March, Jadwa Investment, a leading Saudi investment management and advisory firm, estimated the availability of excess liquidity in the banking system at SR356bn ($95bn) as of January 2016, down from SR448bn in January 2015.

However, it added: “We view this excess liquidity as sufficient to finance part of the fiscal deficit in the medium term if the government continues with its current trajectory of bond issuance and reserve withdrawals.”

Lending boost

To help the country's banking sector, SAMA has pushed through measures aimed at improving banks’ capacity to lend money. These have had a positive effect, and many industry insiders believe there could be further action by the authorities in the near future.

In February, SAMA relaxed the country’s LTD ratio, from 85% to 90%, with the aim of freeing up liquidity, and gave banks more room to lend at a time when system-wide deposits have declined for the first time in years. Saudi banks are largely deposit funded, so the move allowed greater use of their available resources.

As might be expected, the banks welcomed the move, as it enabled them to increase their loan books and provided much-needed flexibility. Nevertheless, SAMA’s revised LTD ratio is still lower than that found in most of its neighbours, with the vast majority of GCC markets operating under an LTD ratio of 100% or more. Still, the move is unlikely to have a strong long-term impact.

“SAMA increasing the LTD ratio obviously helped the banks, but it is a short-term fix. Most of the banks are now already working at about 90%, so there is not much more room,” says SICO’s Mr Ghosh.

“SAMA could increase the ratio from 90% to 95%, but there is no reason to believe it will at the moment. If you look at the LTD ratio elsewhere in the GCC, all except Bahrain have a ratio that is more than 95%, so it wouldn’t necessarily be a bad idea for Saudi Arabia to raise the ratio to 95%.”

Liquidity move

SAMA has also tried to directly add money to the system. According to international press reports, on July 31 it acted to add liquidity to the sector by offering short-term loans to banks.

These loans were offered at a discounted rate, according to several sources who spoke anonymously to reporters from Bloomberg. Individual banks were offered loans for up to one year and worth as much as SR1.5bn, depending on the bank’s balance sheet. Overall, SAMA was said to have extended loans worth SR15bn.

Economists and bankers responded positively to the news – although the overall numbers were not huge, considering the Saudi banking sector has a total loan book of about $375bn – and Fitch Ratings said it “should ease short-term liquidity pressure”.

“The Qatari government did something similar in the post-financial crisis period in 2008/09, infusing liquidity into the banking system, buying rights issues of the banks, while the UAE government and its central bank subscribed to UAE banks’ perpetual bonds [Tier 1 capital] during that year. Both incidents had a positive effect,” says Mr Ghosh.

Other measures

Looking ahead, there are plenty of other steps that SAMA may take on the government’s behalf to further support the Saudi Arabian banking sector as it deals with tighter liquidity, including cutting the reserve ratio or increasing international borrowing.

"The obvious step would be to cut the reserve requirement ratio,” says Samba Financial Group’s Mr Reeve. “It is something it has done in the past and it's a relatively painless process. I’m slightly surprised that [SAMA] didn’t do that before making the loans, I thought that would be one of the first things it did.

“I suspect that [the cut] could be exercised if liquidity doesn’t improve. It could have a strong impact, depending on how much[SAMA] cuts it by," he adds, while declining to give specific numbers of what the new ratio could be.

Walid Alameddine, CEO of Middle East operations at Promontory Financial Group, says the LTD ratio is just one tool available to SAMA to increase liquidity in the market. “There are a host of other measures that can be taken, which would keep liquidity in the market available for years to come,” he says.

“The country remains very under-borrowed. The banks themselves are well capitalised, and have unutilised borrowing capacities of their own. Saudi banks can become more active in the international and regional debt or sukuk markets. Moreover, many of the Saudi public sector companies are also barely leveraged.”

According to Mr Alameddine, Saudi Arabia's financial system as a whole is well positioned to become more active in pursing new initiatives to increase and maintain healthy levels of liquidity, “which it has not had to do up until now, given the abundant liquidity available to it in the past decade”.

A question of profitability

Currently, Saudi banks are not in a bad state, though they are facing a difficult time in the near future when it comes to achieving anywhere near the kinds of profit growth they have become accustomed to.

"The banks are well capitalised, with adequate financial buffers, so the issue is not really one of solvency. It is more about how to make money against a backdrop of funding challenges created by weaker deposits and rising interest rates, alongside slower credit growth given a weaker economic outlook," says Daniel Kaye, the head of the Middle East at analyst Oxford Economics.

"The Saudi government is cutting spending significantly to reduce the fiscal deficit and, of course, that deprives banks of funds and adds to the financial squeeze," he says.

An expected sovereign bond issue later in 2016 should help to pump some much-needed liquidity into the system. Saudi Arabia is expected to raise $25bn internationally in 2016, with a $10bn loan already issued in April, leaving $15bn more to be raised.

"Anything that it raises would have an impact, assuming it is parked with SAMA or some of the other banks,” says Samba Financial Group’s Mr Reeve.

Putting this money into the system should also release a logjam of back payments the government owes to contractors and would presumably help deposit growth overall, he says, adding: “We expect the sovereign issue to go ahead, to be pretty keenly priced and to be quite helpful.”

Diversification hopes

There is also a hope that Saudi Arabia’s long-awaited National Transformation Program 2020 (NTP), published earlier this year, will help to stimulate growth as it pushes the country on a path towards greater economic and fiscal diversity and away from its overwhelming reliance on oil revenue.

In a report published in June, Moody’s said the approval of NTP was credit positive for the sovereign and banks, as it offered a credible path to achieving fiscal and economic diversification.

"Over the short term, we can expect that the plan to further cut subsidies and collect a number of new taxes, which typically have more immediate effects than structural reforms, can have a positive effect on government revenues and liquidity placed in the domestic banking system," says Olivier Panis, vice president and senior credit officer at Moody’s and co-author of the report. "This could ease the liquidity tightening observed since the beginning of last year."

The Moody’s report also expected to see several initiatives to push banks to accelerate diversifying loan portfolios away from the corporate sector and towards real estate and small and medium-sized enterprise lending.

Still confident

For the moment, the liquidity squeeze in Saudi Arabia has not been a major cause for concern for banks operating there, and industry insiders and analysts remain fairly confident about the situation.

"There haven’t yet been any signs of banks under severe stress, or major operations undertaken by SAMA beyond those you would sensibly expect during an economic downturn such as increasing the LTD ratio," says Oxford Economics’ Mr Kaye.

And while liquidity may be tight, it falls far short of a crisis.

“Liquidity is a regular consideration in banking management, and there is no reason for liquidity to be of special concern for Saudi banks in the foreseeable future,” says Promontory Financial Group’s Mr Alameddine.

Others agree, with Samba’s Mr Reeve saying: "Liquidity is tight but I don’t think it is anywhere near as tight as 2009 or 2010. It isn't yet a serious situation.”

Was this article helpful?

Thank you for your feedback!

Read more about:  Middle East , Saudi Arabia