Saudi government to compete with private sector for bank funding

Dubai: The International Monetary Fund (IMF) said that the Saudi Arabia’s plan to meet large fiscal deficits through debt financing will help slow the erosion of government deposits in the banking system, and build a yield curve to support the development of domestic debt capital markets.

But the IMF along with banking analysts expect the government borrowing programme could result in a sharp change in the asset mix of banks with banks increasingly favouring government issues.

Attractive yield and higher security associated with government instruments are expected to price out private sector borrowers — at least to some extent — resulting in higher borrowing costs for private borrowers.

“We expect corporate bank loan pricing in Saudi Arabia to increase as the sovereign issuance absorbs the excess liquidity in the banking system,” said Trevor Cullinan, an analyst at Standard & Poor’s.

Although private sector lending had grown significantly over the past decade, the yield compression in the post financial crisis years has resulted in declining appetite for private sector lending.

Since the financial crisis of 2009, global and local interest rates have declined sharply to historically low levels. Net interest margins (NIMs) for Saudi banks have visibly shrunk in the past few years in line with declining lending prices and low interest rates, to 2.9 per cent last year from 3.9 per cent in 2009.

Owing to increased competition, corporate pricing has softened significantly in the past few years resulting in visible margin erosion for the banks. As a result, the NIM of rated Saudi banks contracted 100 basis points on aggregate between 2008 and 2014. “We now expect a reversal in this trend because the banks will be able to generate returns on zero-risk-weighted government securities,” said Timucin Engin, an analyst with S&P.

The rating agency expects deposit growth to visibly slowdown in the coming quarters due to low oil prices and we expect banks’ significant liquidity buffers to gradually tighten. Saudi banks are expected to reduce their balance sheet allocation to other exposures to be able to accommodate the sovereign issuance.

S & P expects the banks to visibly reduce their liquid asset exposures over the next few quarters. The average yield on the recent 10-year Saudi issuance is 265 bps or 49 bps over US treasuries, while Saudi banks generate less than 15 bps blended yield on their interbank placements as a result of the historically low interest rates. This means the banks should see a visible increase in asset duration. “We expect to see the banks’ appetite for private sector lending gradually decline. Since 2003, private sector lending has grown from a base of 42 per cent of system assets to 60 per cent, as banks placed the liquidity from maturing government securities into other yield-generating assets. This shift was supported by the acceleration in the government’s capital spending, which fuelled growth in the private sector across various economic segments,” said Engin.