JEDDAH: Saudi banks, which have been hit hard by the global financial crisis, are well poised to weather the storm, but challenges still lie ahead for in the medium-term. The banks are still in a better position compared to the collapse of major banks and other financial institutions in the US and Europe.
The 2008 results show that aggregate net profits across the 11 locally incorporated banks declined by 14.2 percent to nearly SR26 billion. Nevertheless, core banking income increased by 12.6 percent to SR38.4 billion, driven by strong corporate loan growth through out most of the year.
Total assets have increased by 22 percent to SR1.26 trillion, 61 percent of which accounted for net loans and advances. As such, profitability ratios remained satisfactory, with return on average assets (ROAA) standing at 2.3 percent and return on average equity (ROAE) at 17.6 percent, according to the Jeddah-based National Commercial Bank’s (NCB’s) Saudi Economic Perspectives, July 2009, report released last week.
Saudi banks also enjoy high levels of capitalization, with the tier one capital adequacy ratio at 14.9 percent, above the 8 percent minimum recommended by Basel II guidelines.
“We expect a significant cooling off in lending to the private sector this year. The general macroeconomic slowdown scenario also favors such a situation as asset prices including banks’ collaterals have been witnessing a steep decline, which is a major deterrent for banks to lend,” Said Al-Shaikh, chief economist at NCB, said.
However, Saudi banks, the report said, will likely see decline in profits in 2009 on the back of: (1) lower net interest margins from falling benchmark rates and the maturing of fixed rate securities (depending on the asset mix), (2) lower interest income due to slower growth in loans, (3) lower banking fees on falling trading values in the stock market and (4) the expected increase in provisions for both investments and loans portfolios.
While Saudi Arabia was awash with liquidity during the first half of 2008, a number of factors contributed to a tight domestic situation later in the year. First, constrained by the Saudi riyal peg to the US dollar, SAMA (Saudi Arabian Monetary Agency) resorted to unconventional monetary tools in order to combat accelerating inflation in late 2007. Notably, SAMA increased the bank reserve requirements to reduce the supply of money available for lending and as a supplement SAMA increased issuance of treasury bills to absorb excess liquidity in the banking system. Second, there was a large outflow of speculative funds initially betting on exchange rate revaluations, given the sharp decline in oil prices and massive deleveraging in global financial markets. This had hurt bank deposits and led to a shortage in dollar-denominated funds. Third, the rapid growth in loans and the shortfall in the growth of deposits contributed to rising loan-to-deposit ratios, which in aggregate exceeded the 85 percent ceiling prescribed by SAMA. This constrained the capacity of the banking sector to extend loans. Finally, limited and more costly access to international capital markets added even further pressure on local bank markets. As early as June 2008, the average 3-month Saudi interbank offered rate (SIBOR) was around 150 bps larger than the benchmark reverse repo rate, reflecting higher local currency borrowing costs. The liquidity situation stretched further in the wake of the global financial crisis as the SIBOR peaked at 4.65 percent and the spread over the dollar LIBOR unusually widened to nearly 190 bps in September last year.
But thanks primarily to the efforts of SAMA, liquidity conditions have eased significantly. SAMA has taken a number of measures to provide liquidity to the local market, notably: (1) cutting the official repo and reverse repo rates by more than half to 2 percent and 0.25 percent since October last year, (2) easing the banking sector reserve requirement on demand deposits from 13 percent to 7 percent, (3) injecting SR6 billion and $2.5 billion in October into the banking system through deposits and (4) providing guarantees for deposits at commercial banks.
After peaking at 26.2 percent Y/Y in February 2008, broad money supply growth (M3) decelerated sharply to 13.9 percent in January and had only modestly increased to 16.4 percent Y/Y in June 2009. “We expect money supply growth to slow further in the year ahead. However, the pace of the slowdown is likely to be more subdued than we have observed over the past few months,” Al-Shaikh said.
He added “Monetary policy in Saudi Arabia is constrained under a fixed exchange rate system and free capital movement. This means that Saudi interest rates will continue to follow US rates. But in an unrelated move to the US Federal Reserve, SAMA decided to cut the reverse repo rate by 25 bps to 0.25 percent in June. By cutting the reverse repo rate, it seems that SAMA is trying to encourage banks to reduce deposits with the central bank and increase lending. Despite previous interest rate cuts, bank deposits with SAMA have more than doubled to SR118 billion by end-June from SR55.4 billion by end-October last year.”
The central bank will be watchful of the reverse repo rate in order to avoid any upward pressures on the exchange rate and keep the peg unchanged. “We therefore expect SAMA to maintain the reverse repo at a spread of no more than 50 bps from the fed funds in 2010,” Al-Shaikh said.
