Saudi banking sector rock solid despite global economic crisis

The Saudi banking sector has proven to be rock solid: riding high on a strong local economy, while retaining limited exposure to the global economic crisis

Author: Ibrahim Al-Alwan
September 13, 2013

The banking sector is one of the most solid and profitable industries in Saudi Arabia. It represented almost 33 percent of the total listed companies’ profits in the first quarter of the year.

There are 23 licensed banks in the country: 20 of them are active and 12 – which have the major market share of the assets – are Saudi incorporated banks.

The Saudi banking sector weathered the turbulence of the global financial crisis – as well as the aftershocks that are still being felt – because of the tight and protective policy the Saudi Arabia Monetary Agency (SAMA, the Central Bank of the Kingdom of Saudi Arabia) implemented to protect it. The diversification of revenue drivers also helped profits remain stable and local exposure to creditors raised the credit quality.

The Saudi banking system’s structure of capital and liquidity limits its exposure to any shocks from the global economy

In 2012, approximately 32 percent of banking profits came from retail banking, 31 percent from corporate banking, 28 percent from the treasury and eight percent from investment banking. The aggregate profits of the Saudi banks grew by four percent in the first quarter of the current year compared to the same quarter last year: part of a sequence of slow growth in the sector that has followed the financial crisis.

The reason behind this is that interest rates have been heavily cut since 2006 – particularly at the start of 2009 – helping banks find high revenue sources and attract deposits. The declining trade volumes following the 2006 Saudi market crash also affected what – back then – constituted a large portion of bank revenues.

Strong defences
SAMA adopted Basel III on January 1, 2013. It came into effect with no objections from the banks due to the protective policies SAMA was already following. We believe the Saudi banking system’s structure of capital and liquidity limits its exposure to any shocks from the global economy – just as it did before the financial crisis.

SAMA has also been working on developing the final regulations for mortgages in Saudi Arabia. The Saudi market has been waiting for such regulations for a long time: they will form a secured loan structure for real estate lending to the public. The number of non-bank finance firms is predicted to rise in the coming years, but banks are expected to see a particular benefit from the surge in real estate financing as they will be willing to take greater risks.

Outside SAMA, the currency held by commercial banks has been more or less stable, while the currency outside banks has risen by 2.4 percent on a quarterly basis and 11.1 percent on a yearly basis. This reflects the rise in the broad money supply M3: 1.4 percent on a quarterly basis and 16.2 percent on a yearly basis.

SAMA has also been working on developing the final regulations for mortgages in Saudi Arabia

The growth in the broad money supply shows the strong performance of the Saudi economy. As of May, total deposits have risen around 17 percent year-on-year, and 1.3 percent month-on-month. The aggregate assets and liabilities of Saudi banks have risen by 13.5 percent year-on-year and 1.1 percent month-on-month.

The net foreign assets of Saudi banks rose by one percent year-on-year and almost 10 percent month-on-month, reaching around SAR139bn – proving the strength of the sector. Aggregate Saudi banking sector credits have grown 16 percent year-on-year and one percent month-on-month. This will be reflected in the sector’s yearly profits.

Winds from the West
The pegging of the Saudi riyal to the US dollar is likely to continue in the short to medium term. The three-month Saudi Arabia Interbank Offered Rate has dropped 3.3 percent since the start of the year. It was pushed down by the high level of liquidity in banks, coupled with a decrease in demand for that liquidity. That volatility will increase in line with regional turbulence or stress.

There are many factors that could affect the interest rates in Saudi Arabia in the next three years: the demand for credit is expected to rise steadily; the price of oil – the country’s main economic driver – is expected to be around $95-100 a barrel; and the slow recovery of the US economy will likely force the Fed to increase interest rates, pushing Saudi rates up 0.25 to 0.5 percent.

In the short run, we don’t believe Saudi banks will much benefit from the recovering world economy

In the short run, we don’t believe Saudi banks will much benefit from the recovering world economy. In the medium to long term, however, any increases in global interests rates – especially US government bonds – will likely boost profits – although excess liquidity in the banking sector will be an obstacle to raising Saudi rates at a similar speed. On the other hand, strong competition between banks in retail and corporate loans has put pressure on loan prices and therefore profit margins in the last few quarters.

Investment banking activities have seen profits decline in the first quarter of the year: trading volumes experienced a 46 percent year-on-year decline while assets under management rose by five percent as investors – and individual investors in particular – sought safer investments than equities. The pace of IPOs has also been slower than it was a few years ago.

The profits of investment banks dropped 38 percent year-on-year in the first quarter, while profit margins dropped to 70 percent from 80 percent in the same quarter last year. As you can see, the profits of the investment industry vary much more than those of the wider banking industry. This is due to the higher sensitivity of investment revenue drivers to geopolitical and global economic conditions. Overall, the profits of the investment banks represent almost six percent of the Saudi banking industry’s overall profits.