Saudi banks primed for leap in corporate lending

Reuters/Ahmed Yosri

• US Fed expected to cut rates
• Reductions will be gradual
• Banks’ net interest margins to drop

Saudi Arabia’s banks are financially well equipped to meet an expected surge in corporate borrowing once US interest rates start to fall, experts have said.

They are unlikely to face lending constraints despite the industry’s loan-to-deposit ratio again edging higher, they added.

In June 2022 Saudi Arabia’s central bank (Sama) placed about SAR50 billion ($13 billion) in deposits with commercial lenders to try to ease the worst liquidity squeeze since late 2008.

Liquidity, as measured by a bank’s loan-to-deposit ratio, has again tightened, rising to 97.8 percent as of June 30, up from 97.0 percent three months earlier, according to a report by consultants Alvarez & Marsal.

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Yet Sara Boutros, head of real estate and financials research at Cairo’s CI Capital, says this is unlikely to lead to banks suffering fresh liquidity problems.

“Executives at several banks were asked about this on their recent earnings calls and they said the pressures had eased,” Boutros says. “Yes, the loan-to-deposit ratio has increased but we’re not concerned.”

She cites recent movements in the three-month Saibor – the benchmark Saudi interbank lending rate. This fell to 6.21 percent in July from 6.27 percent in June, indicating liquidity constraints are not especially pronounced.

Saibor hit an all-time high of 6.32 percent in December 2023, according to Trading Economics.

US interest rates soared to a 23-year peak of 5.3 percent from near-zero in early 2022. The Federal Reserve is widely expected to start cutting rates when it meets on September 17-18.

Saudi interest rates follow those of the US due to the riyal’s dollar peg.

• Saudi’s top 10 banks post 3.8% rise in profits
• Liquidity strain set to push Saudi banks to seek more funds
• Saudi banks’ profits fall as interest margins are squeezed

“Our research shows Saudi banks’ loan growth is much more sensitive to interest rate changes than banks in the UAE, for example,” Boutros says.

“Even in the current high-interest rate environment, loan growth in Saudi Arabia has been strong due to corporate borrowing, so when rates fall we expect corporate loan growth to accelerate.

“That’s without taking into consideration Saudi’s increased financing needs for hosting Expo 2030 and the 2034 World Cup – those are more medium-term triggers for loan growth.”

The sector’s aggregate loan book was $709 billion on June 30, up 11 percent year on year, according to Alvarez & Marsal.

“Saudi consumers are more sensitive to interest rates, so retail loan growth has been weak,” Boutros says.

“A 25 or 50-basis point rate cut won’t do much to improve demand for retail loans – rates will need to fall by 100 basis points for there to be a noticeable impact.”

Time deposits

The ratio of time and saving deposits – money held in interest-bearing accounts – to total deposits, including current accounts which earn no interest, has soared since US rates started to rise. Consequently, banks’ funding costs have increased.

Excluding so-called “quasi money” from central bank data, time deposits represented 38.9 percent of total deposits in the second quarter of 2024. That is up from 37.5 percent in the previous quarter, AGBI calculations show.

“Rate reductions will be more gradual than the rate rises of 2022-23, so banks' funding costs are unlikely to significantly fall – especially because lenders won’t necessarily cut interest rates on term deposits because they need these to remain attractive,” Boutros says.

“Funding will be available – so there won’t be a liquidity squeeze – but it will be relatively more expensive.”

As such, banks’ net interest margins will drop although lenders can offset this decline by increasing their loan volumes, Boutros says.

Net interest margins fell to 2.94 percent in the second quarter, the third successive quarter-on-quarter decline since hitting a high of 3.06 percent in three months to September 30, 2023.

Lower interest rates will “in theory cause margin compression, but the timing and extent of it will differ for each bank depending on their respective asset and liability profile”, Asad Ahmed, Alvarez & Marsal’s regional managing director, says.

A bank’s assets include loans and its liabilities include customers’ deposits.

“Net interest margins have peaked, but they won’t be under excessive pressure,” Boutros says.

Saudi Arabia’s banking stock index has fallen 10 percent from January’s 14-month high.

“The sell-off was mostly related to oil prices,” Boutros says. “Bank valuations have fallen. Many are now priced at attractive levels for investors.”