Rate cuts will put pressure on Gulf banks’ margins

Faisal Al Nasser/Reuters

• Impact of interest rate reductions
• Q3 earnings unaffected
• Lower rates may increase loans

September’s benchmark interest rate reductions came too late to affect Gulf banks’ third-quarter earnings to a meaningful extent, although the longer-term impact on lenders’ net interest margins will be negative.

In mid-September the Federal Reserve cut the benchmark US interest rate by 50 basis points to 5 percent, its first reduction since late 2018.

The US benchmark rate had soared from near-zero in February 2022 as policymakers sought to tame inflation.

Gulf countries’ interest rates follow those of the US because of their respective dollar pegs. The Kuwaiti dinar is pegged to a basket of currencies whose exact constituents are not public, although the dollar is believed to have the biggest weighting by far.

Longer term, rate cuts will cause Gulf banks’ margins to fall, and so are broadly negative for banks’ profitability, although lower rates should boost consumer demand for loans, and ease pressure on borrowers with variable rate loans who are struggling to make repayments.

• IMF proves Saudi banks have reasons for optimism
• Gulf stocks steady despite regional geopolitical issues
• Fed loosening cycle may not be such a big fillip to Gulf

A bank’s net interest margin is the spread between the interest rate a bank pays on customers’ deposits and what it levies on borrowings.

“Several Gulf banks benefit in the short term when rates fall because their cost of funding – the interest they pay on deposits – declines more rapidly than they reprice their lending,” said Rahul Bajaj, director of Mena equity research at Citi in Dubai. “That sizzles out in the medium term.

“It depends on each bank and how they’re positioned in terms of different repricing buckets: 0-3 months, 0-2 months versus 0-12 months and so on. Medium to long term falling interest rates are generally negative for Gulf banks, with a few exceptions like Al Rajhi Bank and Saudi National Bank.”

Saudi Arabia has so-called sustainable lending criteria to guard against residents falling into unmanageable debt – the higher the interest rate, the less a person can borrow, so lower rates will raise borrowing limits at an individual level.