Dubai: The world’s leading credit rating agencies and banking sector analysts expect a further deterioration in the operating conditions of Saudi banks, leading to lower profits, a squeeze on funding and weakening asset quality across the sector.

According to Moody’s, the planned moderation in public spending in Saudi Arabia will be credit negative for banks as it will slow credit growth, tighten funding and weaken asset quality.

However, the robust liquidity and profitability of Saudi lenders and their capital buffers will enable them to moderate these pressures, the rating agency said.

Following a recent period of robust growth in public expenditure, Saudi Arabia is now planning to moderate the pace of spending growth due to the persistent drop in oil revenues. Moody’s anticipates that government spending growth will slow to 2 per cent in 2014 and 4 per cent in 2017 — down from an average of 14 per cent between 2010 and 2014.

“We expect that this slowdown in government spending will be credit negative for Saudi banks as it will dampen credit growth and moderate deposit flows to the banks,” said Olivier Panis, a vice president and senior credit officer at Moody’s.

Standard & Poor’s Ratings Services said last week that economic risks had increased for lenders based in Saudi Arabia. The rating agency expects that a sharp drop in oil prices and the resulting negative swing in Saudi Arabia’s fiscal balance will weaken operating conditions in the kingdom’s banking sector.

“We expect lower business volumes, [a] higher cost of risk, weaker profitability and [a] slower growth in deposits for Saudi banks. In addition, we view the trends for both economic and industry risks for Saudi banks as negative, versus stable previously,” S&P said in a research update.

The rating agency has taken negative rating actions on the eight Saudi banks it rates such as Al Rajhi Bank, Arab National Bank, Banque Saudi Fransi, Riyad Bank, Samba Financial Group, The National Commercial Bank, The Saudi British Bank and The Saudi Investment Bank.

The revised view of the Saudi banking industry and rating actions on the banks follow S&P’s recent downgrade of the Kingdom of Saudi Arabia’s sovereign rating on October 30, 2015.

Fitch Ratings has revised the outlooks on the long-term issuer default ratings (IDRs) of Saudi British Bank (SABB), Banque Saudi Fransi (BSF) and Arab National Bank (ANB) to Negative from Stable and upgraded the Viability Rating (VR) of Alinma Bank (Alinma). Fitch has affirmed all other ratings as part of its 2015 peer review of the Saudi Arabian banking sector.

According to Fitch’s assessment, all banks in Saudi benefit from a favourable operating environment, high barriers to entry, a strict and hands-on regulator, sound liquidity and capital ratios and pre-impairment operating profit levels that enable them to absorb high impairment charges, if necessary.

However, the rating agency expects the operating environment to weaken over the next two years as lower oil prices impact government spending, slowing loan growth and impacting growth in earnings and profitability, and over time impacting asset quality — all of which could result in lower capital ratios.

“The impact of lower oil prices will likely reduce some of the liquidity in the system, although this is not expected to be significant, either through an outflow of government-linked deposits or an increase in the cost of government or other deposits,” said Redmond Ramsdale, director (all banks) at Fitch, in a recent note.