Compared with their troubled Western counterparts struggling to meet Basel regulatory requirements, Saudi banks are swimming in liquidity.

The latest figures from Saudi Arabian Monetary Agency (Sama) show deposits at the central bank exceed regulatory requirements by a hefty SR80bn ($21.3bn), while all Saudi banks have a loan-to-deposit ratio of less than one.

The contrast to the situation in Europe and the US could hardly be starker. Recent studies suggest that if European banks were forced to implement the tougher Basel rules relating to their liquidity coverage ratio, it would expose a liquidity shortfall of $840bn for US banks and e1.15 trillion ($1.49 trillion) for European lenders.

The liquidity coverage ratio is the amount of cash and liquid assets banks have to hold as a buffer to ensure obligations can be met in the event of a severe short-term shock.

Credit growth

No such challenges face Saudi banks. Buffeted by rising oil revenues, major lenders’ liquidity levels have climbed consistently over the past few years. Between 2007 and 2013, Saudi banks added $145bn to their collective deposit base, which reached $336bn, or SR1,262bn, in February this year, according to the latest Sama figures – an increase of 12.1 per cent over the same period in 2012.

Sama says medium- and long-term credit is outpacing short-term credit growth. Despite dropping marginally on a monthly basis, medium-term credit grew by 41.6 per cent year-on-year in January, reaching $52.5bn, a level that has been doubled since March 2009, the central bank says.

There have also been signs, however, that the Saudi liquidity boom may be petering out after a period of steady month-on-month expansion. Bank deposits contracted in February by 0.3 per cent, raising the prospect of a looming fall in liquidity.

For Saudi banks struggling to generate strong profits from corporate lending activities in a low interest rate environment, the possibility of tighter liquidity conditions, leading to a firming up in loan pricing, would be a highly welcome development.

In an assessment of the Saudi banking system issued in October last year, the US’ Moody’s Investors Service said that as economic growth strengthens, banks are gradually deploying this excess liquidity towards new lending, This is indicated by the declining trend in deposits with Sama as a percentage of total assets. So far, however, few banks seem willing to consider the short-term, month-on-month decline as anything significant. Notions of a growing tightness in liquidity in the kingdom may be overstated, say analysts.

“Loan growth has picked up and is outstripping deposit growth, yes, but the loan-to-deposit ratio is still well below 90, so there is plenty of money in the system,” says James Reeve, deputy chief economist at Samba Financial Group.

Saudi banks themselves are maintaining a cautious stance. “Generally, liquidity levels remain high in the system,” says a spokesperson from Sabb. “The market has not witnessed any significant change in liquidity levels. In comparison to the fourth quarter of 2012, the cost of raising liquidity has come down and stabilised during the first quarter of this year.”

Easing demand

Loan-to-deposit ratios in Saudi Arabia are well below those in other Gulf states, such as the UAE and Qatar, where their respective ratios were both above one last year. One reason for the abundant liquidity in the kingdom is that banks are able to grow their deposit bases without much effort. “With inflation of 4 per cent and the existing deposit base growing by about 3 per cent a year – that gives you 7 per cent growth without really doing anything,” says a local banking analyst.

As economic growth strengthens, banks are gradually deploying this excess liquidity towards new lending

What would erode the strong liquidity position of banks would be a sharp surge in loan demand. Last year, loans at Saudi banks grew by 16.4 per cent, compared with a 10.4 per cent increase in 2011. The 16.4 per cent increase also seen in December represented the sharpest increase on a monthly basis since 2009. But while lending is expected to remain solid, some analysts expect loan growth to slow in the next two years.

“The Sibor [Saudi Interbank Offered Rate] appears to have levelled off recently,” says Reeve. “We think the decline in oil prices will begin to weigh on sentiment and loan demand may well ease as we move through the year.”

This comes despite the fact that low loan-to-deposit ratios leave substantial scope for Saudi banks to increase lending, without need to access wholesale markets or securitisation. Although there is ample leeway to increase lending, the consensus is there is unlikely to be any unleashing of large volumes of credit in the current environment – particularly with banks focusing on fee-earning possibilities in the retail segment.

According to Samba’s March 2013 Saudi economic outlook, credit growth is likely to slow in 2013-15, as Saudi lenders shift towards a more conservative stance.

Project finance

In the meantime, Saudi banks will be looking for ways to deploy their excess liquidity domestically, as a series of major projects reach the financing stage.

One side effect of the liquidity and capital pressures at international banks is that Saudi banks are now starting to replace them in the project finance space.

The pick-up in lending seen in Saudi Arabia last year was driven largely by a more prominent role played by local banks in replacing international financiers that are still in the process of deleveraging. According to Bank Audi, the share of local banks in total project finance deals in the kingdom increased from about 20 per cent to almost a third between June 2011 and June 2012.

With suggestions of $44bn of lending in the kingdom still held by European banks as of 2012 (equating to around 18 per cent of Saudi banks’ lending) this could provide a sizeable opportunity in the event of further deleveraging by Western lenders.

A series of major projects that were backlogged in 2012 are likely to be released in 2013, which would require more local bank credit. The key question is whether Saudi financial institutions will have the appetite to ramp up their project exposure, given the attraction of generating income more easily through retail lending. For example, income from increased opportunities for home financing that will result from the recent mortgage law reforms.

The decline in oil prices will begin to weigh on sentiment and loan demand may well ease … through the year

James Reeve, Samba Financial Group

One sign of renewed appetite for project activity emerged in March, with the completion of a $1.4bn loan for Saudi Aramco Mobil Refinery Company (Samref), a Clean Fuels Project based at Yanbu in the Western Province. Split between a $1bn term loan and a SR1.5bn revolving credit facility, the loan is the first major dollar-priced deal in Saudi Arabia involving regional banks in years.

Alongside Saudi lenders Riyad Bank, National Commercial Bank and Sabb, was Bahrain’s Gulf International Bank – the financial adviser on the deal – and other regional players including National Bank of Abu Dhabi, National Bank of Kuwait and Jordan-based Arab Bank.

The trend in the past couple of years has been for Saudi banks to beat off foreign competition by offering more competitive local currency lending terms. The Samref deal may suggest change is brewing, with more interest from both within the kingdom and other Gulf states to participate in dollar-funded projects.

Landmark deal

“Many Saudi banks have been allergic to dollars,” says a Riyadh-based project financier, but he questions whether it will trigger a welter of similar deals. “The Samref deal did pull in GCC banks, but then it has impeccable parentage with ExxonMobil [of the US] and Saudi Aramco as the main sponsors.”

Some major deals are in the pipeline that will truly test local and regional lenders’ capacity, headed by the $3.4bn Kemya elastomers project (again backed by ExxonMobil with Saudi Basic Industries Corporation (Sabic)), and Saudi Arabian Mining Company (Maaden), which is sounding out banks over a financing package for a $7bn phosphates scheme. 

Should the Samref loan emerge as a landmark deal that leads to more transactions involving local banks with appetite for dollar financings, there will be better prospects for eroding the excess liquidity on Saudi lenders’ balance sheets. This could eventually facilitate a situation where banks are able to lend at more aggressive rates that do more for the bottom line.