The top five banks in Saudi Arabia could face a squeeze on profitability in 2018 as reduced government spending affects the economic growth negatively, in turn dampening credit demand and affecting borrowers’ ability to repay debt, according to ratings agency Moody’s Investors Service.

“As the Saudi government reins in spending, we expect lending to slow and problem loans to rise,” Ashraf Madani, a vice-president and senior analyst at Moody’s, said in a research note. The top-five financial institutions – National Commercial Bank, Al-Rajhi Bank, Samba Financial Group, Riyad Bank and Banque Saudi Fransi – can, however, use their “pricing power” to offset these pressures and keep profit steady over the coming 12-18 months, he added.

Saudi Arabia, which relies heavily on the sale of hydrocarbons for revenues, has been forced to rationalise spending after crude prices fell more than 50 per cent from the mid-2014 peak of $115 a barrel. The kingdom, the region’s biggest economy, has scaled back or shelved multibillion-dollar projects to narrow the fiscal deficit.

The banking sector is already seeing a rise in bad loans, especially in the cash-strapped contracting sector, where tens of thousands of jobs were lost last year. A number of banks have already taken provisions for their exposure to contractors, and other banks are trying to negotiate new terms for their outstanding debts with firms such as Saudi Binladin Group (SBG) and Saudi Oger.

Banks operating in the retail sector stand a better chance to defend their profits despite a slowdown, according to Moody’s.

Al-Rajhi is best-positioned to maintain its profitability over the coming quarters, reflecting its strong retail focus, with only limited, albeit expanding, corporate sector exposure. The lender also has a large Islamic franchise and a low cost retail deposit base, which is expected to assist with its profit drive. 

Rising interest rates will, in general, help the lenders offset the impact on profitability of higher provisions and lower fees and commissions, allowing them to reprice floating-rate corporate loans. This has been reflected in Riyad Bank’s increase in net interest income in the first quarter of 2017, despite negative growth in total earning assets, Madani said.

“Credit growth will be muted, with most banks already reporting flat or negative lending growth, with the exception of Al-Rajhi,” Madani said, adding that non-oil GDP, a key driver of banks’ business activity, will grow by just 2 per cent, keeping credit growth subdued at about 3 per cent.

Moody’s expects provisioning costs to rise and fee income to fall as the economy slows, with corporate-focused lenders Samba, Banque Saudi Fransi, Riyad Bank and to a lesser extent NCB being more vulnerable: the clientele of these banks are exposed to reduced government spending on infrastructure and construction projects.

All five banks, Madani said, have ample liquidity and strong capital buffers. They have -1 capital ratios above 15 per cent, far above the minimum regulatory ratio of 8.5 per cent, which translates into high loss-absorption capacity.

This article has been unlocked to allow non-subscribers to sample MEED’s content for FREE. MEED provides exclusive news, data and analysis about the Middle East every day. Subscribe to MEED to have full access to Middle East business intelligence. Click here