This sizable issuance will offer a profitability boost to local IFIs as they will have an opportunity to invest their excess cash into this profit-yielding instrument. The prohibition of riba, or usury, in Shariah (moral guidelines of Islam, in this context analogous to ethical investment principles) prevents IFIs, which make up 20 percent of the system by assets from buying interest-bearing instruments commonly used by conventional banks for liquidity management purposes.
With limited tools available, IFIs tend to maintain higher levels of very low-yielding cash and Islamic interbank placements on their balance sheet than their conventional peers, thus partly sacrificing profitability to sustain their liquidity position.
A 2.5 percent yield on SR15 billion likely represents an additional SR300 million of profit for Saudi banks and, assuming that Saudi IFIs are the prominent buyers of this sukuk, Moody's estimates that the net profit and loss impact will be around 5 percent of 2011 net income. The sukuk's benchmark status will allow it to be repo-ed or quickly sold for cash, which also improves liquidity management for IFIs.
The GACA issuance also presents Saudi banks with a much-needed benchmark with which to price long-tenor issuances in local currency, another credit positive. In the context of sustained fiscal surpluses, the Saudi government has been aggressively reducing the amount of government debt outstanding over the past decade. Indeed, there has been little new bond or sukuk issuance in recent years, with data from the Bank of International Settlements showing an average remaining maturity of 3.1 years for government debt, down from 6.0 years over a decade ago.
This GACA issuance partly reverses this trend and helps build a much-needed local yield curve, which is important as Saudi banks, along with other Gulf Cooperation Council banks, possess severe asset liability mismatches on their balance sheets given the dearth of long-term market funding opportunities. As of the end of September 2011, 91 percent of the banks' non-equity funding was funded with short-term deposits and as such, a deeper bond market would support more term funding for Saudi banks and ultimately encourage the reduction of these persistent asset liability mismatches.
Finally, strong economic growth and high oil revenues, along with relatively limited domestic investment opportunities, are creating an excess of liquidity in the local banking system. At SR15 billion, the sukuk's size is approximately 12 percent of the total cash and cash equivalents of the Saudi banking system and 38 percent of cash and cash equivalents of IFIs in Saudi Arabia. In Moody's view, the GACA sukuk will therefore help absorb some of this excess, helping to moderate some of this inflationary credit growth.
