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Gulf banks face margin squeeze as funding costs rise

Gulf bank rates Alamy/Fabio Mazzarella
In the UAE customer deposits totalled $803 billion on March 31, up 5.6 percent on three months earlier
  • Fed rate cuts may be delayed
  • Funding costs hit 4.5% in first quarter
  • Quarterly revenue down 2%

Gulf banks are likely to offer more attractive rates on savings accounts to woo depositors, putting more pressure on lenders’ already tight net interest margins, a report suggests.

The move towards higher interest rates for savers is predicted to become more pronounced as expectations of imminent rate cuts by the US Federal Reserve fade.

Benchmark interest rates in the six-member GCC follow those of the Fed because the region’s various currencies are mostly pegged to the dollar.

Kuwait is the exception, its dinar tracking a basket of major currencies, though the dollar is believed to have a large weighting in that basket, meaning the Kuwaiti dinar is still also influenced strongly by Fed rates.

Across the Gulf’s 57 listed banks, aggregate net interest margins have been stable at 3.2 percent over the 12 months to March 31, a report by Kuwait’s Kamco Invest found. However, that could soon change, the report said.

“We expect net interest margins to come under pressure, as the cost of funding in the local markets remains high as banks make efforts to attract depositors,” Kamco wrote.

Historically, Gulf banks, especially Saudi lenders, have benefitted from cheap funding costs because many customers prefer to put their savings in non-interest-bearing accounts for religious reasons.

In addition, nearly 15 years of ultra-low interest rates, in response to the global financial crisis and then the Covid-19 pandemic, meant savers could earn scant returns on interest-bearing accounts anyway.

However, the rapid rise in US interest rates to a two-decade peak of around 5.3 percent, from near-zero in February 2022, has spurred customers to switch cash to accounts that pay interest.

Higher savings rates also encourage customers to retain cash rather than invest in riskier assets such as equities.

Meanwhile, higher US inflation has caused Fed officials to suggest this week that long-mooted rate cuts may be delayed.

Funding costs

Gulf banks’ funding costs rose to 4.5 percent in the first quarter of 2024, Kamco estimates, describing this level as one of the highest on record and up from 2.5 percent the year before.

Gulf banks’ combined deposits were $2.45 trillion on March 31, up 2.8 percent versus three months earlier in the biggest quarterly increase over the past year.

In the UAE customer deposits totalled $803 billion on March 31, up 5.6 percent on three months earlier. Over the same period, deposits in Saudi Arabia rose 2.4 percent to $767.5 billion.

Aggregate net loans were over $1.9 trillion, up 2.3 percent quarter on quarter.

Higher funding costs caused Gulf banks’ net interest income to fall 0.4 percent to more than $21 billion in the first quarter of 2024 compared to three months earlier. This was also the first quarter-on-quarter decline in the past 12 months, Kamco estimates, although quarterly net interest income was still up 7.7 percent year on year.

Total quarterly bank revenue fell compared to the preceding three months for the first time since early 2021, slipping 2 percent to $31.4 billion from $32.0 billion in the final quarter of 2023.

Deposits up

Gulf banks’ combined loan-to-deposit ratio fell to 78.7 percent in the first quarter, the lowest level in at least a year and down from 79.1 percent at the end of 2023, Kamco reported.

This reflects “a steep increase in customer deposits during the quarter as against a relatively smaller increase in loans”, Kamco wrote.

UAE banks’ loan-to-deposit ratio fell 1.6 percentage points to 66.5 percent, although Saudi Arabia’s grew 0.9 percentage points to 88.3 percent, the highest among the six GCC countries.

Saudi Arabia’s rising loan-to-deposit ratio reflects strong borrowing demand from government and corporations as the kingdom proceeds with wide-ranging economic diversification projects.

Higher-for-longer interest rates have yet to cause loan defaults to rise, with loan loss provisions falling to a five-year low of $2.3 billion as of March 31, down from $3.5 billion on December 31.

Usually, increased interest rates cause more loan losses as some borrowers fail to meet costlier repayment instalments.

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