The Saudi banking sector is one of the strongest in the Middle East and among emerging markets, Standard & Poor’s Ratings Services has noted in a recent report.

 

“Sector strength is based on the banks’ high profitability, strong liquidity, high capitalisation, and strict supervision,” says Standard & Poor’s credit analyst Emmanuel Volland. “These strengths are partly offset by the risks of operating in an economy sensitive to oil-price fluctuations and government spending, the banks’ exposure to the potentially volatile real estate and capital markets, booming consumer loans that have not been tested by a severe economic downturn, and increasing competition.”

 

The strong financial performance of Saudi banks is supported by the low cost of funds and labour and increasing business volumes, especially in consumer loans. Overall, non-interest-bearing deposits represent close to 50% of total deposits and fund about one-third of total assets. The banking sector also benefits from the macroeconomic stability maintained in the kingdom – in particular, a stable exchange rate and low inflation. Large excess liquidity of the banking sector is conservatively invested in low-risk assets (mainly international bonds and money markets).

 

The Saudi economy is driven by the oil and gas sector. Consequently, a prolonged decline in oil prices would have negative implications for the economy, and ultimately for banks’ asset quality.

 

“In addition, we believe that Saudi banks bear some risks from their exposure, direct and indirect, to their booming equity and real estate markets,” adds Volland. The asset price inflation of the past two years largely reflects a surge in funds flowing back to the country and structural economic improvements, but is partly an artificial bubble that could deflate. Although most banks are well equipped to absorb a major correction, the impact would be very significant if both markets were to crash (this worst-case scenario is not expected). On a positive note, record oil revenues, solid economic growth, low interest rates and inflation, and strong fiscal performance characterise the current economic environment.