JEDDAH, 13 April 2005 — The Saudi banking sector is one of the strongest in the Middle East and among emerging markets. In its latest report published on Monday, Standard & Poor’s Ratings Services attributed this to banks’ high profitability, strong liquidity, high capitalization and strict supervision.

In the report entitled “Bank Industry Risk Analysis: Kingdom of Saudi Arabia”, S&P credit analyst Emmanuel Volland said: “These strengths are partly offset by the risks of operating in an economy sensitive to oil-price fluctuations and government spending, the banks’ exposure to the potentially volatile real estate and capital markets, booming consumer loans that have not been tested by a severe economic downturn, and increasing competition.”

The strong financial performance of Saudi banks is supported by the low cost of funds and labor and increasing business volumes, especially in consumer loans. Overall, non-interest-bearing deposits represent close to 50 percent of total deposits and fund about one-third of total assets. The banking sector also benefits from the macroeconomic stability maintained in the Kingdom — in particular, a stable exchange rate and low inflation. Large excess liquidity of the banking sector is conservatively invested in low-risk assets (mainly international bonds and money markets).

The Saudi economy is driven by the oil and gas sector. Consequently, a prolonged decline in oil prices would have negative implications for the economy, and ultimately for banks’ asset quality. “In addition, we believe that Saudi banks bear some risks from their exposure, direct and indirect, to their booming equity and real estate markets,” added Volland. The asset price inflation of the past two years largely reflects a surge in funds flowing back to the country and structural economic improvements, but is partly an artificial bubble that could deflate. Although most banks are well equipped to absorb a major correction, the impact would be very significant if both markets were to crash (this worst-case scenario is not expected). On a positive note, record oil revenues, solid economic growth, low interest rates and inflation, and strong fiscal performance characterize the current economic environment.

S&P also said yesterday it raised its long-term counterparty credit and certificate of deposit ratings on Kuwait-based Gulf Investment Corporation (GIC) to ‘A-’ from ‘BBB+’. At the same time, the ‘A-2’ short-term counterparty credit rating was affirmed. The outlook is stable.

“The rating action reflects GIC’s improving financial performance and funding profile,” Volland said. “The focus on profitability and more commercial approach to business, helped by a buoyant economic environment in the Gulf region, translated into a significant increase in the bank’s financial performance,” he added. Profitability is still low, but has improved rapidly in the past two years, with an ROA of 1.94 percent and an ROE of 11.9 percent in 2004. GIC has a relatively weak funding structure, as it is a wholesale institution, but the bank is currently addressing this issue by issuing longer-term debt.

The ratings on GIC continue to be supported by the bank’s ownership structure, low risk profile, and adequate capitalization. Negative rating factors include the bank’s limited customer franchise and weak structural funding profile.

GIC is a wholesale bank involved in projects and equity participations, commercial banking, and global markets. It is owned equally by the six states of the Gulf Cooperation Council (GCC): Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates.

“The stable outlook reflects Standard & Poor’s expectation that GIC will keep its existing business profile and operate in its present business lines with the same ownership structure,” Volland said. The bank will face the key challenges of expanding its customer franchise, generating a high level of recurrent noninterest revenues, and keeping a strong balance sheet. The ratings could face downward pressure if the bank’s business profile deteriorates or if the bank’s financial leverage becomes excessive.