THE health and strength of the Saudi banking system will be tested in the coming months as the impact of lower oil prices works its way through the economy. While the banks have enjoyed steady growth in deposits and are very adequately capitalised, they will be facing any pressures from a positive position. Most bankers in Saudi Arabia dismiss a gloomy prognosis offered by Moody's Investors Service as too pessimistic and consider the sector to be well equipped to deal with any difficulties.

Figures released for the first half of 1998 by 10 local banks show that combined net profit has risen 12.8 per cent to SR 3,231 million ($860.1 million) from SR 2,864.9 million ($762.7 million) in the same period of 1997. Only Riyad Bank has still to report.

The rise in profits comes on the back of a leap of 15.5 per cent in interest income to SR 7,152.5 million ($1,904 million), and a 15.1 per cent rise in income from banking services to SR 754.6 million ($200.9 million). Investment securities income made a more moderate increase of 7.9 per cent to SR 3,212.3 million ($855.1 million).

The bottom line advancement comes despite heavier expenses. Interest expenses went up by 18.3 per cent to SR 5,025.7 million ($1,337.9 million) and staff costs rose 8.3 per cent to SR 1,551.2 million ($412.9 million). As might be expected in current conditions, provisions for loan losses rose by an average of 6.6 per cent to a combined SR 550.6 million ($146.6 million).

Al-Rajhi Banking & Investment Corporation was the most profitable bank, while Saudi American Bank was squeezed into third place by National Commercial Bank. Excluding United Saudi Bank, which was formed in September 1997 following the merger of United Saudi Commercial Bank and Saudi Cairo Bank, the greatest percentage increase in net profits was achieved by Saudi Investment Bank. Profits at the bank rose by 51 per cent to SR 121.3 million ($32.3 million) in the first half of 1998 compared with the same period of 1997. Arab National Bank (ANB), in which Jordan's Arab Bank retains a 40 per cent stake, continued to trail its rivals with a 12 per cent decline in net profits to SR 221.2 million ($58.9 million).

Combined assets in the sector, excluding Riyad Bank, grew by 10.6 per cent to SR 340,565.3 million ($90,659.7 million). This was funded by an 11 per cent increase in customer deposits to SR 233,624.5 million ($62,192 million) and a 10.7 per cent rise in shareholders' equity to SR 35,727 million ($9,510 million).

The balance sheets show a sharp rise in total loans and advances to SR 156,115.7 million ($41,558.8 million) from SR 135,333.9 million ($36,026.6 million) at the same time last year. Investment securities went up a marginal 2.5 per cent to SR 103,085.8 million ($27,442 million).

Despite the dominant market position of the larger banks, some of the smaller institutions posted impressive gains over the period. Saudi Investment Bank, for example, raised total assets by 21.5 per cent to SR 12,162.4 million ($3,237.7 million) while its loans and advances were ahead by 32 per cent to SR 6,115.6 million ($1,628 million). Bank al-Jazira, the smallest bank by far, lifted customer deposits by 36.7 per cent to SR 2,346.2 million ($624.6 million).

As might be expected at a time of growing strains in the economy after a period marked by an aggressive expansion in customer loans, loan loss provisions are now on the rise. The trend is particularly noticeable at NCB which allocated SR 137.3 million ($36.5 million) for possible losses, up 83.1 per cent from its loan loss provisions in the first half of 1997. At the other end of the spectrum, Saudi American Bank managed to reduce its bad loan provisions to SR 148 million ($39.3 million), half the amount it allocated at the same time last year.

The half-year 1998 figures tell a generally positive, if not outstanding, story. Reflecting global economic trends, many of the banks have directed their funds away from investment portfolios towards an expansion of loans and advances. Only in the months to come will the quality of the lending be tested as the economy slows down. As liquidity tightens in reaction to the slump in oil prices the banks will play a pivotal role in maintaining confidence and continuity but may face problems of their own. 'If they [oil prices] remain at such levels, banks could start experiencing asset quality problems later this year or in early 1999,' Moody's said in a report published on 20 August. Saudi bankers weighed in to rebuff the report and will be keen to prove the ratings agency wrong.

Lucy Boyd, MEEDMONEY