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Moody’s outlook for Saudi banking system remains stable

Despite structural challenges the rating agency notes that deposit levels have historically proven stable

Published: Updated:

The outlook for the Saudi Arabian banking system remains stable, unchanged since September 2009, said Moody’s Investors Service.

The outlook reflects the benign operating environment, Moody’s expectations of low problem loan levels, the banks’ strong loss-absorption capacity, and the benefits of low-cost deposit-based funding and ample liquidity buffers. Although Moody’s expects Saudi banks to maintain strong net income and internal capital generation, further improvements in Saudi banks’ profitability will be constrained by competitive pressures on lending margins and higher regulatory limits on fees and commissions.

The new report: “Banking System Outlook: Saudi Arabia,” said “over the 12-18 month outlook period, we expect continued high government spending, robust domestic consumption and increased private-sector business activity to drive economic growth.

Low government debt levels and sizeable reserves will continue to fuel expansionary fiscal policy, allowing the non-oil sector, to which most bank lending is extended, to grow by 5.2 percent in 2014 and around 5.0 percent in 2015.

Given this benign operating environment, we expect the problem loans-to-gross loans ratio to remain below 2 percent over the outlook horizon,” said Olivier Panis, a Moody’s vice president-senior analyst and author of the report.

“While current oil prices remain above the government’s fiscal breakeven oil price [estimated by the International Monetary Fund at $86.1 per barrel for 2014], the downside risk of further sustained price reductions – below the fiscal breakeven oil price – would nevertheless have a pronounced effect on oil income that can be recycled within the economy and the banking sector,” added Panis.

Moody’s expects Saudi banks to sustain their strong pre-provision profitability over the outlook period, with low-cost funding, a lean cost structure, low loan loss provisioning expenses (compared with the Gulf Cooperation Council (GCC) average) and growth in business activity.

These factors will offset the margin constraints caused by competitive pressures, the low interest-rate environment and stricter regulation on retail fees and commissions as Saudi Arabia implements new consumer financing regulation.

“We expect Saudi banks’ high profitability to continue to drive robust internal capital generation and substantial loss-absorption capacity. As the banks increase lending, we expect a slight decline in the Tier 1 capital ratio from 16 percent at end-June 2014, although capital buffers will remain strong compared to those of similarly rated global peers,” Panis further said.

In Moody’s view, the Saudi banking system will likely maintain a solid deposit base, reflecting the system’s strong funding dynamics, underpinned by a cash-rich government, a growing population and the banks’ well-established deposit franchises.

Despite structural challenges – evidenced by high deposit concentrations, primarily from the public-sector, and asset and liability maturity mismatches – the rating agency notes that deposit levels have historically proven stable, with a large proportion generated from government and state-related entities.

Consistent with the stable banking system outlook, the outlooks for the 11 Moody’s-rated Saudi banks are stable. The outlook for Saudi Arabia’s Aa3 sovereign rating is also stable.

Although current oil prices remain above the government’s fiscal breakeven oil price (estimated by the International Monetary Fund at $86.1 for 2014), the downside risk of further sustained price reductions – below the fiscal breakeven oil price – would have a pronounced effect on confidence and hence economic growth. Moreover, credit growth and asset quality could also be impacted negatively by tail risks stemming from the ongoing regional geopolitical tensions.

The banks’ financial performance and prospects are highly correlated to oil prices, which are reflected in the inverse correlation between oil prices and the level of NPLs in the banking system.

Although future contracts for Brent crude price oil reduced recently to below $90 per barrel for the rest of 2014, well below prices recorded in H1 2014, we consider that the average oil price will remain above the $86 fiscal breakeven oil price for Saudi Arabia and will translate into asset quality stability over the outlook horizon. — SG

This article was first published in the Saudi Gazette on Sunday, Nov. 2, 2014.