Economic slowdown and squeeze in liquidity is impacting the sector’s operational efficiencies
The headquarters of Saudi Arabia’s central bank in Riyadh. The bank has warned banks against conducting derivatives trades that could pressure the riyal.
Dubai: Persistent decline in oil prices since mid-2014 is posing a new wave of challenges for Saudi Arabia’s banking sector which enjoyed, abundant liquidity during the years of oil boom between 2003 and 2013.
During this period, the Kingdom was able to build up reserves of around 100 per cent of the 2014 GDP despite spending billions of dollars in education, health care and infrastructure, which helped to double its economy, increase the household income by 75 per cent and create more than 1.7 million jobs.
The biggest beneficiary of this economic boom was the country’s banking sector which benefited from strong investment-led credit growth, a growing population, and a recovery in non-core income. This period also helped the banking sector in improving their balance sheets and funding requirements in the form of deposits from the public sector, and significant growth in earnings to shore up capital ratios.
Although, the banking sector witnessed shock waves resulting from the 2009 financial crisis, record oil prices during that period ensured that the government had enough ammunition to pump up liquidity within the system to weather the storm.
The current situation is different from the global financial crisis because lower oil prices is putting strain on government revenues, while spending continues to meet the long term objective of the government. The country that once enjoyed petrodollar driven surpluses until 2014 is now facing the challenges to tackle its rising deficits since 2015. The government has been funding the deficit by drawing down banking sector deposits and by borrowing from local banks, both of which is impacting the liquidity of the system.
Rising liquidity crunch
The money supply has remained under pressure as growth turned negative during the first two quarters of 2016. The rising liquidity crunch in the system is evident from the three-month Saudi Interbank Offered Rate (SAIBOR), which has increased from 0.774 per cent in the second quarter of 2015 to 2.073 per cent in the same quarter of 2016, a level which was last seen in April 2009.
Given that broader banking indicators are worsening and credit risk is rising, the government decided to take appropriate measures to mitigate this risk. First, the government decided to tap the international bond market by issuing US dollar denominated debt. Secondly, the Saudi Arabia Monetary Authority (SAMA) has raised the loan to deposit (LDR) ceiling to 90 per cent from 85 per cent in February 2016. Additionally, SAMA has also provided banks with short term loans totalling about $ 4 billion (Dh14.7 billion) to ease out the liquidity pressure and to ensure cash reserves for banks.
Slowing deposit mobilisation and a slowdown in economic activity is dampening the operating environment within the sector. Banks are also witnessing steep increases in funding costs due to the liquidity squeeze across the sector. Banks in the Kingdom continue to rely on customer deposits as their main source of funding, hence inability to mobilise deposits can impact the growth of the overall sector. Total deposits declined by 2.5 per cent to reach 1,661.58 billion Saudi riyals in the first half of 2016 compared to 1,703.40 billion riyals in the first half of last year.
Profitability for the sector grew by 0.7 per cent to reach 23.32 billion riyals in the first half of 2016 compared to 23.14 billion riyals in the first half of 2015, which can be attributed to a slowdown in core income, subdued non-core income and rises in operating expenses. Core income during the first half of 2016 remained under pressure as banks witnessed a steep rise in interest expense, while interest income grew by 18.3 per cent during that period. Non-interest income of the sector witnessed a decline of 7.1 per cent year on year driven by subdued capital market activity, which led to a significant decline in brokerage income and a slowdown in loan origination impacted fees and commission income from corporate and retail segments.
The banking sector is going through a challenging period as the economic slowdown and squeeze in liquidity is impacting the sector’s operational efficiencies. However, SAMA has taken appropriate measures to tackle the issue and improve liquidity by easing regulatory reserve requirements. Further, the government’s plan to raise debt from international bond markets will also reduce the government’s reliance on domestic funds, which will provide stability within the sector.
Shailesh Dash is the founder and CEO of Al Masah Capital