Saudi banks are hoping their healthy liquidity and capital levels, plus swift acceleration of their digital capabilities, will help them ride out the pandemic.
Banks in Saudi Arabia came into 2020 on a strong footing. Following three years of choppy economic trends in the country, lenders began the new year with healthy capital bases, having registered good growth in both assets and profitability in 2019.
In a report on the sector published on March 15, KPMG said: “The Saudi banking industry has weathered the storm of the recent economic downturn relatively well. Banks continue to be well positioned to take advantage of the improving economic outlook and an evolving technological landscape.”
Quick change
Fast-forward a few weeks to the end of April, and the outlook for Saudi’s banks – in line with their international peers – has darkened considerably due to the global coronavirus pandemic. The slowdown in the local economy prompted by lockdown restrictions, combined with a collapse in the price of oil – which accounts for more than 40% of Saudi gross domestic product – and the slashing of interest rates by the central bank, the Saudi Arabian Monetary Authority (SAMA), all spell trouble for lenders.
“Policy rates have been cut by 125 basis points [bps] so far [this year], which means a significant compression of net interest margins,” says Rania Nashar, CEO of Samba Financial Group, the country’s fifth largest bank by assets. “Add to that the collapse in demand owing to the Covid-19 restrictions, and you have the makings of a very tough year for the banking sector.”
With credit growth, asset quality and profitability all set to take a hit in 2020, banks are expanding their digital presence in order to cut costs and improve efficiency, especially in the current locked-down environment, while SAMA is looking to license the country’s first digital-only banks.
Nearly a year on from the completion of Saudi’s first bank merger in more than two decades, the altered banking landscape may also create other consolidation opportunities once the crisis is over, depending on the impact on lenders’ finances.
Crisis response
SAMA unveiled a significant suite of measures in March to mitigate the impact of the coronavirus lockdown on the Saudi economy. The central bank slashed its repo rate to just 1% – its lowest rate in more than 25 years – in two stages, tracking the US Federal Reserve’s 125bps rate cuts the same month.
By March 20, the government had unveiled SR120bn-worth ($32bn) of stimulus measures to support the local economy. This includes SR50bn earmarked for small and medium-sized enterprises (SMEs), of which SR30bn has been allocated to banks and finance companies to cover delayed loan payments due from SMEs for six months. A further SR13.2bn has been allocated to SMEs via bank loans, to help them continue operations during the crisis. Local reports suggested that stimulus funds began reaching commercial banks by late-March.
In the meantime, SAMA has urged banks to support vulnerable sectors of the economy, including energy, retail, industry and tourism and hospitality, by extending working capital to help companies with their short-term liquidity requirements, and providing bridge loans at concessional rates for at least six months to corporate customers.
The central bank has urged banks to be flexible with retail customers that have lost their jobs as a result of the crisis, by offering relief on loan and mortgage repayments for at least six months, while also reviewing credit card interest rates.
Strong start...
Finance minister Mohammed Al-Jadaan told a virtual session of the International Monetary Fund in mid-April that Saudi Arabia was facing the crisis “from a position of strength”, and that Saudi banks are well positioned to face the current crisis, given their strong capital and ample liquidity levels.
Banks’ net profit before tax and zakat (religious tax) rose 4.5% during 2019, with assets rising by 12% on the back of strong loan growth, while customer deposits increased by 10.5%, according to KPMG. The strong growth in assets saw return on equity and return on assets fall by 1.2% and 0.2%, respectively.
Lenders’ cost-to-income ratio improved for the third year in a row, according to Moody’s, falling to 35.3% in 2019 from 35.9% the previous year.
Capital adequacy slipped 0.9%, but remains well above minimum regulatory standards, according to KPMG. The country’s five largest lenders – National Commercial Bank (NCB), Al Rajhi Bank, Riyad Bank, Saudi British Bank (SABB) and Samba Financial Group – which between them account for just over two-thirds of the sector’s asset base, each had a BIS capital adequacy ratio (core Tier 1) of more than 16% at the end of 2019, according to The Banker Database, with NCB boasting Tier 1 capital reserves of more than $18bn.
The top five banks also have healthy loan-to-deposit ratios of between 81.48% for Samba Financial Group and 90.95% for Riyad Bank, according to The Banker Database.
...but setbacks likely
Yet the difficulties facing Saudi banks in 2020 and beyond should not be underestimated, in line with the challenges faced by peers both regionally and internationally. Rating agencies Fitch and Moody’s have both revised their outlooks to ‘negative’ for the sector in Saudi and the remainder of the Gulf.
“Talking to banks about their varying priorities in the middle of the crisis, there’s definitely a current focus on credit protection rather than growth,” says Ovais Shahab, head of financial services at KPMG in Saudi Arabia.
While the stimulus measures by SAMA have helped to boost liquidity in the short term, Fitch cautioned in a mid-March note that lenders may see liquidity tighten should the government withdraw deposits from the banking sector to fund the fiscal deficit. “At the end of 2019, government entities’ deposits accounted for 23% of system-wide deposits,” said Fitch. “Asset quality deterioration could also be sharp and exacerbated by lower growth, while at the same time revenue would suffer from lower interest rates and subdued new business.”
Analysts from Al Rajhi Capital noted in March that banks had come into 2020 expecting an improvement in Saudi Arabia’s economy, with a resultant uptick in corporate business and large project funding. Such hopes have largely been dashed with the onset of the crisis; in mid-March the Ministry of Finance announced SR50bn in budget spending cuts. “We expect [these] spending cuts to lead to delays or cancellations of government construction projects, denting banks’ loan growth and asset quality,” said Moody’s in early April.
Loans and losses
Credit underwriting will be one of the key challenges facing banks in the coming year, says Mr Shahab, with some banks surveyed by KPMG in April stating that up to 20% of their loan books may be adversely affected during the crisis. “In terms of credit impact there will definitely be some losses, and there will be plenty of businesses, particularly in the SME sector, that we don’t expect to open again once the crisis lifts,” he says.
Samba’s Ms Nashar says there is likely to be very little in the way of private investment in 2020, though there may be some pick-up towards the end of the year, given the low rate environment. “Demands for working capital could also be strong [while] mortgage demand will remain a key driver of overall lending, though obviously this will not revive until the restrictions are lifted,” she says.
“There may also be some uplift in consumer loans as households borrow to plug holes in income, though we do not expect this to be a major dynamic as most Saudis continue to be employed by the public sector, and the Citizens’ Account will continue to support the most vulnerable.”
Moody’s had forecasted that strong growth in residential mortgages – a key driver of Saudi banks’ loan growth in recent years – would continue for the next 12 to 18 months, supported by a government initiative to increase home ownership among Saudis.
“Though measures to the tune of SR120bn have been announced to mitigate payments/dues/liquidity, the cost of risk could eventually spike,” Al Rajhi Capital said in a note issued in late March. “Based on a two-times increase in cost of risk, the [negative] impact on profit would be about 3% by 2022.” In its most pessimistic forecasting scenario, the investment bank forecasts banks’ profits could fall by more than one-third by 2023.
Yet Mr Shahab believes banks’ strong capitalisation and high profitability going into the crisis mean that lenders will be able to ride out the worst of the crisis. “Banks in Saudi Arabia have recently been reporting huge profits with very high margins, so you’d expect the impact of the crisis will not be too earth shattering for them,” he says.
Digital imperative
In the quest to defend margins and keep transactions moving, the imperative to increase digitisation has become ever more pressing for banks. To this end, in March SAMA urged banks in Saudi Arabia to waive all fees and other charges on digital banking for up to six months.
“The key question that banks have been asking us since the crisis started is how they can automate their processes even further,” says Mr Shahab. “It is something they’re particularly looking at: further digitising the home finance space, using solutions such as digital signatures for housing valuations and mortgage documentation.”
The coronavirus lockdown is bound to accelerate national take-up of digital banking services. “Although the current situation is throwing up huge challenges, there are opportunities,” says Ms Nashar. “If clients are obliged to interact digitally, then hopefully they will become more comfortable doing so. It is up to us as banks to make the experience as easy and positive as possible.”
Saudi Arabia is fertile ground for mobile banking in particular, with a high rate of smartphone use. Matthew Reed, principal analyst for the Middle East and Africa at consultants Omdia, says smartphones accounted for 80% of mobile connections in the country at the end of 2019.
Ms Nashar adds that, as of early April, 92% of Samba’s bank-wide transactions were carried out digitally, with over half stemming from its SambaMobile platform. More than half of bank accounts are opened digitally, with cashless payments conducted via digital wallets and near-field communication accounting for more than 36% of payments.
Indeed, digital banking is set to enter a new phase, as SAMA issued new licensing guidelines for digital-only banking in February. The central bank told United Arab Emirates-based Zawya in February that it was reviewing licence requests for two digital banks to operate in Saudi Arabia. If licensed, they would be among the first digital-only banks in the Gulf region. AUB in Kuwait is set to be transformed into a digital-only bank under the terms of its acquisition by National Bank of Kuwait.
Consolidation on the cards?
The prospect of new digital entrants raises the prospect once again of further consolidation in Saudi Arabia’s banking sector, which consists of 13 Saudi and 17 foreign institutions. Banking licences were awarded to Standard Chartered and Credit Suisse in 2019, while Bank of China was granted a licence in January 2020.
Consolidation among the country’s lenders has been subdued, compared with the frenzied merger and acquisition (M&A) activity in the wider Gulf region during the past four years. The country’s first bank acquisition in more than 20 years, which saw SABB acquire Alawwal Bank in June 2019, created the country’s fourth largest lender by assets, according to data for that year.
Yet the main M&A story of the past year was the was the breaking off of merger talks in December 2019 between NCB and Riyad Bank. The coming together of the two entities, which was first floated in December 2018, would have created a $180bn mega-bank with a 30% domestic market share, according to Moody’s. No reason was given for why the deal fell through.
The ending of talks came despite both institutions having a shareholder in common – in this case Saudi Arabia’s Public Investment Fund and pension fund General Organisation of Social Insurance. This was a key factor in the success of other mergers in the region, notably tie-ups between First National Bank and National Bank of Abu Dhabi, and the acquisition of Noor Bank by Dubai Islamic Bank.
“What I’m sensing now is more a sense of containment among banks, where they want to keep their house in order, invest in digital, and not lose market share,” says Mr Shahab. “There’s a possibility that when the curve goes down and things go back to normal, there may be [acquisition] opportunities if a bank has been hit and is available for sale.”
However, Ms Nashar of Samba believes that despite the prospect of new entrants in the market, the drive for M&A across the Gulf region does not apply to Saudi Arabia. “The need for further consolidation is not obvious [as the country] is underbanked,” she adds.
