Key fact

The loan-to-deposit ratio across the Saudi banking system fell to a historic low of 74.8 per cent in April 2011

Source: Barclays Capital

Saudi banking executives met in late 2010 to discuss the state of their market and the intense competition to lend money that was making it unattractive to grant new loans.

An informal agreement was made that loan margins would not be allowed to fall further. By mid-2011, that agreement looks to have been largely forgotten.

Loan margins have continued to be under pressure since the start of the year and have now fallen so low that some banks are beginning to walk away from transactions rather than accept the low returns on offer. “Some deals just aren’t viable for several of the local banks at the moment,” says one local banking executive.

Low pricing for borrowers

The banks are now in a curious position; they are flush with cash, buy they are also struggling to find something to do with it. The dearth of lending opportunities means that when good opportunities arise, banks leap on them and the intense competition allows borrowers to get the lowest pricing possible. “Good-quality borrowers are definitely having a field day,” says Rajiv Shukla, head of global capital financing at HSBC in Saudi Arabia.

Loan-to-deposit ratio, 2011
  (Percentage)
Alinma Bank 180.1
Al-Rajhi Bank na
Arab National Bank 76.1
Bank al-Bilad 72
Bank al-Jazira 67
Banque Saudi Fransi 87.4
National Commercial Bank 52.1
Riyad Bank 82.1
Sabb 74.4
Samba 60.5
Saudi Hollandi Bank 83.3
Saudi Investment Bank 81.1
na=Not available. Source: MEED

No two deals are the same, but records of recent borrowings in Saudi Arabia show that banks outside the kingdom have been unable to match the lower pricing offered by local banks, lending in riyals.

Saudi banks are currently some of the most liquid in the region. The loan-to-deposit ratio across the banking sector fell to just 74.8 per cent in April – an historic low, according to analysts at UK investment bank Barclays Capital. Deposits rose by 16.5 per cent as the government spent SR53bn ($14.1bn) giving public sector employees a two-month bonus payout, a move matched by many private-sector firms.

At the same time, private-sector loan growth fell slightly in April to 6.4 per cent, from 6.5 per cent a month earlier. Most analysts and bankers expect credit growth for the year to be about 8 per cent.

Bankers also worry that state domestic borrowing is maturing, meaning more liquidity will be coming their way as those loans are paid off. Banking deposits at the Saudi Arabian Monetary Agency (Sama), the kingdom’s central bank, are also at the highest level since 2006, currently standing at SR154bn.

“Liquidity is still building up, and there is already more of it than we can put to work,” says one Riyadh-based banker. Idle money means less opportunity for profit growth.

The desperation to start putting all the liquidity in the Saudi banking system to work means banks are even trying to get projects that have been financed over the past few years to accelerate their drawdown schedule.

The challenge then is what the banks will do with the money they have. Although loan growth is picking up in recent years, there are increasing concerns the massive state spending plans, particularly the $150bn announced since the beginning of 2011, will reduce the role of the private sector in the economy, as well as the demand for bank finance.

Reduced demand for bank loans

“The government is not crowding out the private sector,” says Suliman al-Gwaiz, deputy chief executive officer at Riyad Bank. “It may look like that at the beginning, but the spending does eventually trickle down through the economy. However, is it reducing the demand for bank loans? Yes.”

The government is not crowding out the private sector … the spending does trickle down through the economy

Suliman al-Gwaiz, Riyad Bank

Instead of long-term project financing, which was a key part of the lending environment over the past few years, banks are shifting focus to funding contractors working on government projects that need start-up capital for projects or bid-bonds.

But even that demand has been diminished by the government increasing its start-up payments on contracts in order to get projects moving quickly.

The focus on government-led development is not the only factor weighing on loan growth. As a result of the financial crisis and several large corporate defaults and debt problems at company’s such as Saad Group and Ahmad Hamad al-Gosaibi & Brothers, credit risk officers have became much more reluctant to approve new loans.

There is also still only limited appetite among corporates to take on additional debt.

The expectation is, however, that pricing cannot go down much lower. Some borrowers, notably state-controlled firms such as Saudi Aramco and Saudi Basic Industries Corporation have been able to borrow at less than 50 basis points above the Saudi interbank offered rate.

“I don’t think there is much scope for margins to go down further now,” says Shukla. “But it will remain a very attractive market for a lot of borrowers, who will be able to raise finance at good margins and push out tenors on loans.”

Undercutting competition in the banking sector

Part of the reason margins have fallen so low over the past 18 months is the emergence of a handful of banks eager to put down huge commitments on loans at rates well below the competition. Jeddah-headquartered National Commercial Bank (NCB) is one of the main lenders to have forced pricing lower by offering deals as large as $500m at low interest rates.

Banks including Riyad Bank and Banque Saudi Fransi have been able to match the low pricing benchmark, but often just to ensure they maintain their market share and stay in the game.

NCB’s tactics have helped it expand its loan book 11 per cent in 2010, while the market as a whole grew by just 4.3 per cent. “Margins are being squeezed because competition is fierce,” says Al-Gwaiz.

The advantage Saudi banks have over regional peers is they are able to offer loans at very cheap rates because they have a large base of non-interest bearing deposits from Muslim customers, giving them what is essentially a free source of funds. That means that even with interest rates at historic lows, Saudi banks can still be more profitable than regional peers.

Banks are more confident in the economy now, which should help lending volumes increase

Paul Gamble, Jadwa Investments

General sentiment has improved as a result of the massive state spending packages announced by the government, which has helped to remove the fear in the banking sector that another economic shock is waiting around the corner. “Banks are more confident in the economy now, which should help lending volumes increase,” says Paul Gamble, head of research at the local Jadwa Investments. “The central bank is also eager for the banks to start picking up the pace of lending.”

But there is not much Sama can do to get the banks to lend if they do not want to.

Loan growth is expected to continue to pick up over the rest of the year, but will not be anywhere near the 30-40 per cent growth seen in 2006-08. Some banks could even become more cautious over the rest of the year as they worry about booking loans now that look even less profitable once interest rates start to rise.

Even if loan growth does reach 8 per cent during 2011, most bankers think it will not be enough to absorb the liquidity that is building up. “Even as loan growth picks up we probably won’t be able to book enough deals to make up for the fact that deposits are growing faster,” says a local corporate finance banker.

The same is true for the retail sector, which banks have been targeting aggressively for loan growth. “Even the retail side is not growing as fast as we would like, despite consumer confidence getting better all the time,” says one local bank head. The total value of point of sale transactions in April was SR9.11bn, 58 per cent higher than the same month last year. Consumers are also generally cash rich and in less need of loans.

High oil prices, generous state spending packages and an advancing economy will leave Saudi Arabia’s banks with a larger deposit base over the coming year. That will make the problem of what to do with the money even more acute as time goes on. One option would be to allow the banks to start putting their capital to work financing companies and projects in the rest of the region.

That would be a significant boost for the regional finance sector, where banks are nowhere near as liquid as their Saudi counterparts. So far, Sama has shown only limited appetite for allowing local lenders to start booking deals elsewhere, unless they do it though a non-Saudi branch, which does not fall under Sama’s jurisdiction. Instead, it wants the banks to keep their reserves for local deals and most executives say they do not see that changing.

Distorted market

The excess liquidity is already starting to distort the market. When companies ask banks for financing, the responses they get are often inflated because banks think that in the final deal they will only be allocated about half of the amount offered. So banks are offering companies loans that are sometimes double what they really want to lend, in the expectation they will be scaled back. That leads to deals that are massively oversubscribed, but not perhaps reflective of real demand.

The danger is that in their haste to put money to work, banks will make some loans they will later regret. The past few years have shown that despite being liquid and generally well regulated, the Saudi banks (and their international colleagues) can make huge mistakes during periods of exuberance. Credit growth will have to increase greatly before that starts to become a real concern, but it remains a risk.

Bankers are already saying the prominence of risk managers that emerged after the financial crisis has started to reverse. For now at least, most banks are just happy to being booking any deals.