Dubai: The $17.5 billion (Dh64.2 billion) sovereign bond issue by the Kingdom of Saudi Arabia last month and the Saudi Arabian Monetary Agency’s (central bank) liquidity injection into the banking system has contributed to easier liquidity condition in the domestic banking system.

Last week the three-month Saudi Interbank Offered Rate (SAIBOR) fell to 2.19 per cent from 2.39 per cent three weeks earlier to reach its lowest level since June 2016 and reverse the upward trend of the past 12 months.

Rating agency Moody’s said the SAIBOR’s decline is credit positive because it indicates that liquidity pressures among Saudi banks are easing after the past two years of deposit outflows and increased funding costs as a result of falling oil prices and associated government revenues.

“We expect that the decline in three-month SAIBOR, a gauge of domestic funding conditions and a benchmark for lending rates, will reduce banks’ funding costs,” said Jonathan Parrod, Associate Analyst at Moody’s.

Over the past year, the benchmark rate surged to 2.4 per cent in October, its highest level since January 2009, from 0.9 per cent a year earlier, amid a tightening liquidity environment. As a result, the average cost of funding for local banks more than doubled to 0.85 per cent for the first nine months of 2016 from 0.4 per cent in the first half of 2015. However, net interest margins and bottom-line profitability have not been affected, with banks’ return on assets unchanged at 2 per cent as of third-quarter 2016.

The interbank interest rate decline, including a steep 2.9-basis-point drop in the first week of November, follows Saudi Arabia’s $17.5 billion international sovereign bond issuance on 19 October.

“While the monetary survey data for October is not yet available, it seems likely that at least a portion of the bond proceeds have been transferred to the domestic banking system, with both government and private sector deposits likely to have increased over the last few weeks,” said Khatija Haque, Head of Mena Research at Emirates NBD.

Delayed payments

The government’s recent decision to clear pending payments to contractors also is helping to ease liquidity. According to press reports around 40 billion riyals of outstanding payments had been made by November 20 and another 100 billion riyals of delayed payments is expected to be made by year-end. As a result of the likely increase in bank deposits, the 3-month interbank rate has declined for the last two weeks, even as US dollar rates have continued to rise. The narrowing spread reflects the easier liquidity conditions in the Kingdom.

Earlier this year, the central bank deployed various monetary instruments to alleviate banks’ liquidity challenges. Those moves included increasing the maximum allowable loan-to-deposit ratio to 90 per cent from 85 per cent, successive deposit injections totalling 32 billion riyals, and introducing seven-day, 28-day and 90-day repurchase agreements with the SAMA.

Since the fall in oil prices, Saudi banks’ deposit growth has been subdued owing to government spending cuts and slowing economic growth, as shown by a 2 per cent year-on-year decline in total banking deposits as of September 2016, versus a 12 per cent compound annual growth rate during 2011-14. At the same time, total banking credit grew rapidly, rising 7 per cent in September 2016 from a year earlier. Both trends resulted in a significant rise in banks’ net loan-to-deposit ratio to 86 per cent as of September 2016 from 77 per cent as of year-end 2014.


Factbox: Credit growth to moderate

Analysts expect Saudi banks’ credit growth to moderate and pressures on SAIBOR to ease further owing to a number of factors. One factor is lower volumes of domestic government bond issuances following the success of the external bond issuance, which will limit competition for available liquidity in the banking system. Another factor is traditionally lower loan growth in the second half of the year because of seasonal factors, and the potential slowdown to 3 per cent to 5 per cent growth next year. Easing cash flow pressures in the private sector will also help as the government settles outstanding bills with contractors.

Slowing deposit growth due to low oil prices has brought the loan-to-deposit ratio of Saudi banks near the regulatory ceiling of 90 per cent. SAMA has clarified that there was no plan to change the ceiling, especially since new funds were expected to enter banks. Analysts expect banks’ operating environment to remain challenged by low non-oil GDP growth of 0.8 per cent this year and 2 per cent in 2017, versus the 2010-15 average of 6.2 per cent. Higher oil prices are expected to alleviate some of the liquidity strains in the domestic banking system, as the government’s budget deficit and borrowing requirement is forecast to be much lower than in 2016. These developments should provide a boost to the system liquidity. This, in turn, will support banks’ funding and profitability in 2017.