Opinion Banking & Finance IMF proves Saudi banks have reasons for optimism Over the long term the kingdom’s banks will benefit from the scale of spending on Vision 2030 projects By Andrew Cunningham October 23, 2024, 1:19 PM Ayman Zaid/Alamy via Reuters Connect Al Rajhi Bank is the second largest in the kingdom and has 70% of its deposits in non-interest-bearing accounts Saudi Arabia’s banks have performed well this year, as evidenced by a big vote of confidence from the International Monetary Fund (IMF) in its annual Article IV report on the kingdom’s economy. Falling interest rates and the widening of the Iran-Israel conflict could make the final months of this year more challenging, but for the moment liquidity in the financial system remains strong. Government expenditure on local projects is robust. As a result, despite huge political uncertainty in the Middle East, the medium-term outlook for Saudi banks is positive. All 10 Saudi commercial banks reported higher net profits in the first half of this year, compared to the first half of 2023, and all reported operating profits – before loan loss provisions – that were higher or, in a couple of cases, almost unchanged, from a year before. All had increased their lending over the first six months of this year. The IMF’s annual Article IV report on Saudi Arabia, published on September 4, described the banking sector as “dynamic and competitive” and “resilient to severe macroeconomic shocks”. The IMF did send a warning shot about the dangers of rapid credit growth, due either to the greater availability of new products such as mortgages, or to government project spending as part of the Vision 2030 plan. Figures from Sama, the Saudi central bank, show that real estate lending grew by 6 percent in the first half of this year. Credit card lending by banks rose by 11 percent and bank loans to SMEs by 12 percent. Specifically, the Fund said that Sama might have to consider macroeconomic tools, such as tightening limits on loan-to-deposit ratios or imposing higher capital buffers, if current rates of growth persist. The energy of the Saudi economy is evident, as are the social changes that will drive productivity But, for now, banks’ balance sheets have capacity to keep lending and their income statements can easily cope with an increase in delinquencies. Provisioning against loan impairments has not been making much of a dent in the banks’ net profits. Government spending is the key determinant of liquidity in the Saudi economy and that liquidity, in turn, drives the health of the banking sector. Here again, the picture is generally positive. The Ministry of Finance’s pre-budget statement for 2025, issued on September 30, shows full year revenues and expenditures closely aligned with the budget numbers announced at the beginning of this year. Spending next year is set to rise by 4 percent compared to 2024. Oil prices have been remarkably stable over the past two years, only rarely straying outside a $70-$90 per barrel band. As for oil production, the kingdom voluntarily cut its output by one million barrels a day in July last year, as part of wider efforts by the Opec+ group to support prices. The group is planning to start unwinding those cuts in December this year. The arrival of lower interest rates could possibly spoil this rosy picture. On September 18 the US Federal Reserve cut its benchmark rate for the first time in four years. The cut of 0.5 percent was unusually steep, and more than analysts had been expecting. With the Saudi riyal pegged to the US dollar, Sama cut its own benchmark rates by 0.5 percent the following day. Federal Reserve Chairman Jay Powell has indicated that more cuts in US interest rates are likely to follow before the end of this year. Falling interest rates matter especially to Saudi banks because such a large proportion of their deposits bear no interest at all. When rates fall, banks have to cut the interest rates they receive on loans to customers, but this loss of revenue can be offset by reducing interest paid to depositors – unless the rate being paid to depositors is already at zero. Al Rajhi Bank, the second largest in the kingdom, has 70 percent of its deposits in non-interest-bearing accounts. The figure for Saudi National Bank, the largest bank, is probably about the same. So, lower interest rates are unquestionably a threat to current levels of profitability, but one must remember that Saudi banks were able to remain healthy during seven years of extraordinarily low interest rates that followed the global financial crisis of 2008-09. Saudi banks primed for leap in corporate lending Saudi banks’ profits fall as interest margins are squeezed Five Saudi banks to finance cultural development fund As for the impact of the military conflict in the region, the fear is that foreign direct investment will be put on hold until hostilities end. Saudi Arabia is certainly keen to attract foreign investment as a way of diversifying its economy, but with the Public Investment Fund holding a portfolio of around a trillion dollars, the kingdom’s fiscal health hardly depends on it. The energy of the Saudi economy is evident for all to see, as are the social changes that will drive greater productivity. I saw this for myself during a brief visit to the kingdom’s capital Riyadh last week. The grandiose ambitions of Vision 2030 will not all be fulfilled. Costs aside, Saudi Arabia does not have the administrative capacity to implement such a huge number of diverse, far-reaching projects. But a significant portion of the vision will come to pass. (The IMF Article IV report has a useful annex tracking progress to date.) Over the long term, Saudi banks, already strong, will benefit from the scale and variety of spending on Vision 2030 projects, and in time from the social changes that the vision promotes. Andrew Cunningham writes and consults on risk and governance in Middle East and sharia-compliant banking systems