Saudi banks have been hit hard by the global financial downturn, with sharply reduced profits across the board. But compared with the banking collapses in the US and Western Europe, they are well positioned to weather the current crisis.

There have been some write-offs – Samba Financial Group revealed SR500m ($133m) in impaired investments in its 2008 end-of-year report – but these are minimal compared with the multi-billion-dollar holes that have appeared in the balance sheets of the world’s largest banks. In February 2009, the UK’s RBS reported losses of £28bn ($40bn).

Although aggregate net profits for 2008 across the 12 Saudi commercial banks declined by 12.9 per cent to SR26.3bn, these figures were broadly in line with expectations that Saudi banks would be affected only moderately by the global meltdown. Saudi banks did not suffer losses in 2008. In fact, in absolute terms, they remained profitable, although the sector’s profits were lower than in 2007.

But they are not out of the water just yet. This year’s performances will be undermined by lower fee income, higher cost of funds due to lower liquidity levels, and slower loan growth. But the feeling among Saudi banking chiefs is that their advantage of scale, and the tight regulatory grip exercised by the Saudi Arabian Monetary Agency (Sama), the central bank, will put the sector on a firmer footing for the future.

“The economic circumstances in the kingdom are different,” says Robert Eid, managing director of Arab National Bank (ANB). “We have a government that is fully committed to fiscal expansion. The budget was positive and the spending has not stopped.”

However, the absence of international banks in the kingdom means Saudi banks are under-resourced to take on all of the financing needs of the Saudi corporate sector, where industrial projects costing $10bn are commonplace.

“This year is likely to be one of subdued corporate loan growth, as banks focus on building deposits and keeping well within the mandated loan-to-deposit ratio of 85 per cent,” says Howard Handy, chief economist at Samba Financial Group. “Strong growth potential lies on the consumer banking side, where the mortgage law is expected to be approved this year. Nevertheless, banks are likely to proceed cautiously.”

In December 2008, Fitch Ratings downgraded the ratings of eight Saudi banks, including National Commercial Bank (NCB), Samba and Sabb. Yet the agency says Saudi Arabia remains the region’s strongest banking sector, with an overall rating of B.

Despite having a highly concentrated banking sector, there is room for further growth as large tracts of the kingdom are yet to be penetrated. A population of more than 27 million and an under-developed home loans market means that when economic confidence returns, Saudi banks can look forward to significant growth opportunities through lending.Saudi banks have not suffered as a result of a property market collapse like other Gulf markets, in part because Riyadh is still drafting a new mortgage law for the kingdom. Until this happens, the number of home-owners will remain at the current level of one in five Saudis.

“The kingdom’s real estate market has not had the strong price appreciation seen in, say, Dubai, and therefore the probability of a substantial downward correction in property prices is limited,” says Constantinos Kypreos, senior Saudi banking analyst at ratings agency Moody’s Investors Service. “Hence the potential impact on Saudi banks would also be limited.”

Limited exposure

Because of this limited exposure to real estate, the kingdom’s banks still have strong profitability, liquidity, asset quality and capitalisation indicators. Liquidity is an issue, but this is a global symptom of the credit crunch.

Saudi banks are relatively liquid as they all comply with Sama’s prudent liquidity requirements, including a loan-to-deposit ratio limit of 85 per cent. In addition to these standard requirements, Saudi banks have been helped by a robust regulatory response to the financial crisis, with Sama rapidly cutting interest rates, tracking the US Federal Reserve policy.

In January, Sama reduced its benchmark repurchase rate, the rate it charges for lending to commercial banks, for the fourth time since October 2008, to just 2 per cent to encourage corporate lending. This is down from a mid-October peak of 5.5 per cent.

The commercial bank reserve requirement for current accounts was also lowered to 7 per cent, bringing it back to where it was before Sama began tightening the minimum capital requirements in 2007.

“Sama has been consistently proactive and prudent,” says Kypreos. “For example, a few years ago, when retail loans were growing aggressively, it put a cap on how much they should grow. Its prudence has served it well in this environment.”

This does not mean that the banks will be able to recover quickly from the slowdown of the past year. “This year will be affected by lower brokerage income, higher funding costs and potentially higher provision charges,” says Kypreos. “But overall, we expect Saudi banks to maintain strong profitability indicators.”

However, those banks that have protected their balance sheets are confident of emerging from the downturn in a stronger position. “We have a diversified asset base that minimises any losses,” says ANB’s Eid. “What is at play now is modest growth in consumer and corporate lending.”

But more still needs to be done to get banks lending. As a January 2009 report from NCB chief economist Said al-Sheikh highlights, a funding gap evolved throughout 2008, meaning the annual growth in private credit exceeded that of deposits.key Facts

NCB says the situation needs to be resolved if the 30 per cent annual credit growth of recent years is to be maintained.

Lending growth

NCB, where private credit and deposits grew by 20.62 per cent and 21.4 per cent respectively in 2007, says the pace of the corporate-driven private lending exceeded growth in deposits every month in 2008.

Although the authorities have been ready to deploy monetary and fiscal tools, more may be needed to keep the banking sector ticking over beyond 2009. One solution could be medium-term deposits by the government, whether through Sama or quasi-government agencies.Public debt held by the Public Pensions Agency (PPA) and the General Organisation for Social Insurance (Gosi), estimated to be about SR100bn, could trickle in through deposits.

With risk management to the fore, a resurgence in commercial bank lending growth to the levels seen in recent years is unlikely. Banks are more likely to maintain a cautious approach.

There has been some more positive news, with the launch at the end of 2008 of a 10-year maturity sukuk (Islamic bond) by Saudi Hollandi Bank (SHB) worth SR775m, and plans to issue another SR725m via Islamic bonds to boost its capital.

However, more such moves from other banks might help to unfreeze the debt financing markets. However, to entice foreign investors, sukuk issues will need to be priced more keenly than they were prior to the current financial crisis.

The SHB sukuk’s pricing, at 200 basis points above the Saudi interbank offered rate (Sibor), shows that the bank was willing to pitch more aggressively to investors, and may prove to be a guide to future bond pricing in the new environment.

If stability returns to the global economy by 2010, Saudi banks could begin to contemplate a return to the double-digit profitability of recent years. Bankers say there are opportunities for expanding business lines across the board, from the corporate side, with huge infrastructure spending requirements, to the still untapped retail side.

Given the global banking sector’s bitter experience of the past year, as a result of the collapse in the US sub-prime mortgage market, Sama will need to keep a close watch on the nascent mortgage sector. However, the Saudi authorities have taken a more active stance to encourage banks to keep on lending, even when their best instincts tell them not to.

The pay-off may be delayed, but the kingdom’s banks feel, with some justification, that they will be well placed to capitalise when the time is right.