Saudi banks urged to shun conservatism to optimize and benefit the long term health of the Saudi economy and its banking sector.
Alkhabeer Capital, a leading asset management and investment firm based in Saudi Arabia, and authorized by the Capital Market Authority, has released its latest Saudi Banking Sector Outlook for 2014.
Overview – a stable banking sector
In recent years, falling cost of funds had broadly aided Saudi banks to register steady improvement in NIM’s (Net Interest Margins). With interest costs at record lows and credit growth set to ease, there is little maneuvering banks can do to sustain current NIM’s.
In addition, SAMA’s recent move to impose restrictions on fee charged on retail transactions and prohibiting offering of “step up” loans is likely to impact income of banks largely dealing in the retail segment.
Despite above concerns, the overall liquidity situation of banks remains sanguine and banks in the Kingdom are well capitalized to absorb systemic shocks. Fitch Ratings recently affirmed its credit ratings on eleven Saudi Arabian banks and upgraded its outlook on three banks, further reflecting the stability in the Saudi banking sector.
Limited impact of Basel III – return on Equity for Saudi banks well above European and US peer group
Meanwhile, the implementation of Basel III is unlikely to put any stress on the Saudi financial system, as banks in the Kingdom have maintained a high capital adequacy ratio since the financial crisis in 2008. Gross Non Performing Loans as a percent of total loans have witnessed a decline in the third quarter of 2013 as compared to the end of 2012. Additionally, rising coverage ratios among major banks highlight that they remain well poised to mitigate challenges arising due to prospects of a possible rise in impairments.
With the advent of strong non-oil growth witnessed in recent years, Saudi banks have continued to show resilience and have outperformed their western peers in terms of profitability and efficient utilization of their resources. The RoE (Return on Equity) for Saudi banks stands at over 10% compared to single digit returns at the larger European and US banks.
Conservative approach to lending has constrained growth
Although banks have high appetite for lending, their approach has been conservative. At the end of 2013, the loan-to-deposit ratio for Saudi banks stood at 80%, which is below the SAMA’s prescribed level of 85% and compared to 74% for US and 103% for European banks. Although the loan-to-deposit ratio can be looked upon favorably as a means of cushioning the banks from the impact of a global downturn, it has constrained the industry’s growth potential in terms of lending.
Banking sector needs to embrace innovation and change
A key area where the banking sector needs to focus for sustainable growth is product innovation. This encompasses both broadening of existing offerings as well as the use of new products and services. At a time when awareness about Sharia-compliant products has heightened, banks need to expand their portfolio and include a range of services and products that address the needs of the population. Banks need to leverage new generation technologies to deploy these additional products and services as packaged solutions, allowing fast and flawless delivery. This would not only bring significant value to the banks’ customers but also help banks in managing costs and expected growth in their scale of operation.
Meanwhile, the unfolding events since the financial crisis of 2008 have highlighted concerns over transparency and processes followed while lending. Clearer laws need to be drafted to plug loopholes in the system, which currently seem to enable large exposure of bank’s capital to few influential business houses.
Urgent need to strengthen non-oil sectors
The Saudi economy continues to be vulnerable to a possible decline in oil prices. Increasing US shale oil output and expectations of increased oil supply from Iran, Libya and Iraq, would not only put stress on oil prices but pressurize Saudi Arabia’s market share as well. There is a need in the Kingdom to appreciate supply related changes taking place in the oil market and the longer term implications this has for the nation’s fiscal and the economy. Any impact on the Kingdom’s fiscal could lead to a scale back in large public sector projects, which have been a key driver of growth for the non-oil sector. Such a development would impact growth and asset quality in the banking sector adversely. There is thus an urgent need to develop and strengthen the non-oil sectors in the economy so that this part of the economy can stand on its own feet and not be subject to vagaries of price fluctuations in the oil market.
Conclusion – banking sector must shun conservatism to achieve long term growth
The banking sector needs to shun its conservatism and start lending to the SME and the housing sectors, while the government and regulators need to play their part as facilitators to drive this change. Unless these issues are addressed seriously, the long term health of the Saudi economy and its banking sector will not be optimized.