DESPITE the economic downturn that has begun this year, almost all Saudi commercial banks managed to boost their profits in the nine months to September. However, credit ratings agencies are warning that asset quality is at risk if oil prices remain low.

The consolidated net income statement of the Saudi banking sector - excluding Riyad Bank - shows a 10.65 per cent growth to SR 4,871.9 million in the first nine months of 1998 compared to the same period last year. Earnings for the sector were driven by a 15.58 per cent rise in interest income to SR 10,760.1 million, a 6.5 per cent growth in investment income to SR 4,822.2 million and a 14.6 per cent expansion in banking services to SR 1,305.6 million. Bottom line growth came despite a general rise in bank expenditure. Interest expense rose 16.7 per cent to SR 7,798.4 million and staff expenditure was up 7.9 per cent at SR 2,342.1 million.

Saudi Investment Bank (SAIB) enjoyed the highest profits rise at 52.4 per cent followed by Saudi Hollandi Bank at 22 per cent and Bank al-Jazira at 21.5 per cent. Arab National Bank (ANB) is the only bank to have reported a fall in income. Profits fell 22.9 per cent to SR 302 million. Although ANB boosted income from banking services and investment securities, special income fell by more than 2 per cent and general administrative expenses rose by 19 per cent.

Total assets of Saudi banks rose 8.2 per cent to SR 344,740 million. Loans and advances grew by 21.2 per cent to SR 168,450 million while investment securities dropped by 1.1 per cent to SR 99,720 million. Loans made up 48.9 per cent of total assets and investment securities 28.9 per cent. The growth in assets was largely financed through a 7.3 per cent increase in customer deposits to SR 235,680 million and a 7.2 per cent rise in shareholders' equity to SR 37,230 million.

With the exception of ANB and Saudi American Bank (Samba), all the banks boosted their deposits. The highest growth was achieved by Bank al-Jazira, which managed a 33.61 per cent rise to SR 2,304.2 million.

Loans and advances to customers were up 21.17 per cent in the period. SAIB's loan portfolio expanded the most at 29.1 per cent to SR 6,383.3 million, followed by Samba at 27.8 per cent to SR 18,567.4 million. Increased lending was coupled with a 10.42 per cent rise in loan loss provision (LLP). The most conservative bank in maintaining the quality of loans was National Commercial Bank (NCB), which increased its LLP by 77.05 per cent to SR 213.89 million. The bank sector's loans to deposits ratio edged higher to 71.5 per cent, compared to 63.3 per cent at the end of September last year.

'Banks are in a good position,' says Saud Saleh al-Saleh, SAIB's general manager. 'The general liquidity situation has not deteriorated too badly. Deposits are still growing slowly and demand for resources is growing.' Most analysts expect lending to increase further in the coming months as the low oil price begins to bite and credit lines are extended.

Al-Saleh's positive outlook is shared by Kevin Taecker, chief economist at Samba. 'The banks have come into the latest economic downturn in a strong position,' he says. 'Most of them had bitten the bullet of bad loans in 1996/97 and now have clean loan portfolios.'

Some analysts argue that it is their privileged status, rather than their performance, that has allowed the banks to buck the prevailing economic trend. 'The banks are enjoying a monopoly. They are working in the biggest cash economy in the region where the cost of operating is very cheap,' says one senior Riyadh-based banker. Analysts also say that local banks benefit from the high proportion of deposits placed with them which incur little or no interest. Under Islamic law the charging of interest (riba) is forbidden. 'Customers are not aware of the opportunities they are losing,' the banker adds.

The Saudi Arabian Monetary Authority (SAMA - central bank) has not issued any new banking licences in the past 10 years. GCC leaders agreed in principle last December to allow GCC banks to open branches in each of the six member states, but analysts say that the mechanism allowing cross-border branching is not yet in place. Permitting banks from outside the GCC to operate in the kingdom is not even on the agenda.

All the major banks are looking to expand their activities, especially into fee-based business. Credit cards are on offer, as are a range of new private insurance policies. The number of mutual funds - investing in a variety of instruments from real estate to venture capital - is also increasing. 'This is one area where Saudi banks can really do things,' says Al-Saleh.

Despite continuing growth in profits, US ratings agency Moody's Investor Services warns that the low oil price will have a negative effect on the credit quality of Saudi banks. In early November, it downgraded the Financial Strength Ratings (FSRs) of Samba, NCB and Saudi Hollandi Bank. The FSR rating for Samba was lowered from C+ to C-, while the positive outlook of D+ for NCB and Hollandi was lowered to stable. The positive outlook for Riyad Bank of D was unchanged, as was the stable outlook judgement for the seven other commercial banks. All the commercial banks are rated at the Baa3/Prime-3 country ceiling for foreign currency deposits.

Bleak outlook

Moody's said the downgrading was a consequence of the low oil price and the unlikely prospect of any short-term improvement in the situation. Although the government has managed to protect the economy from the full effects of the oil price slump, the agency argued that the financial situation will become more acute in the coming months.

If oil prices conform to expectations, it warns of further downgrades. 'During a recession, it will be difficult for any Saudi banks to maintain an FSR at the higher end of the rating spectrum...the banks most likely to be affected will be those which have paid least attention to intrinsic credit quality in expanding their loan portfolios,' Moody's said in a statement.

In addition to the consequences of the oil price slump, Moody's has also expressed concern about the legal loopholes that exist across the Gulf that make it difficult for banks to succeed in court action against defaulters. This strikes a chord with bankers in the kingdom. 'Banks are taking risks when they extend credit. Not only is there a question of the ability to repay loans, but also of the desire of people to pay their debts,' says the Riyadh banker. 'This is when legal issues come into play. Unfortunately, the legal situation is not always clear.'

Saudi bankers tend to dismiss Moody's as being overly pessimistic. Certainly, it seems to be more bearish than its rivals. In October, Standard & Poor's agreed with Moody's that the overall credit picture in Saudi Arabia was deteriorating because of the fall in the oil price, but added: 'Rated banks generally have high reported levels of capital and reserves to protect them against the volatility associated with dependence on hydrocarbons.'