Lending volume will boost Saudi banks’ profits as higher funding costs loom, report says

April 5, 2014 9:23 am

Throughout the financial crisis,banks in Saudi Arabia fared better than most of their peers in developed markets, thanks to consistently strong profitability and a low risk profile,Standard & Poor’s Ratings Services noted in a report published today titled “Lending Volume Will Shore Up Saudi Banks’ Profitability As Higher Funding Costs Loom”.

Saudi banks have notably absorbed the impact of prolonged low interest rates since 2008 and the spike in the cost of risk without impairing capitalization. Such resilience underpins Standard & Poor’s expectation that the ratings on Saudi banks should remain high and relatively stable over the coming 24 months.

However, Saudi banks now face a budding threat to that strong profitability: a further compression in net interest margins as an increase in U.S. interest rates looms.Previously, the biggest threat to banks’ profits has been the higher cost of risk since 2008 and the global financial crisis. But with the cost of funds now near a low tide and the specter of the U.S. Federal Reserve beginning a move to higher interest rates, possibly in 2015, Saudi banks are likely to look for ways to squeeze higher profits from their balance sheet.

The structural mismatch between the short-term nature of Saudi banks’ funding-overwhelmingly customer deposits–and the longer tenors of their lending will likely translate into a temporary pincer effect that further compresses margins. Rising interest rates could give depositors incentives to move away from the non-remunerated deposits that helped banks buffer falling yields on lending since 2008? At the same time, we do not expect a significant change in the banks’ funding profiles.

In this context, we expect lending volume to be the strongest variable of Saudi banks’ profitability, especially because we believe the banks have little headroom left to further improve efficiency. Prospects remain sound in both the corporate and retail segment given the Kingdom’s need to address the demands of a young and fast growing population. But we forecast that lending growth won’t markedly exceed 10% yearly over 2014-2015. Government spending is likely to remain stable, and we expect the banking system and the regulators to focus on a steadier approach to growth to maintain current financial profiles. Generating fees will be a prime component of all banks’ strategies: Competition will therefore be fierce.

Under Standard & Poor’s policies, only a Rating Committee can determine aCredit Rating Action (including a Credit Rating change, affirmation or withdrawal, Rating Outlook change, or CreditWatch action). This commentary and its subject matter have not been the subject of Rating Committee action and should not be interpreted as a change to, or affirmation of, a Credit Ratingor Rating Outlook.

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