Slowing deposits to hurt credit quality of Saudi banks

The full year results of Saudi banks showed a sharp decline in deposit growth to 1 per cent last year compared to 12 per cent in 2014. In the context of sharp decline in oil prices lower deposit growth is credit negative for Saudi banks according to credit rating agency Moody's. Oil price declined by more than 75 per cent since June 2014 and a 14 per cent reduction in the 2016.

"Lower deposit growth will limit banks' capacity to lend and refinance existing borrowers and increase borrowing costs, which will reduce asset quality and drive increased provisioning costs for banks," said Olivier Panis, Senior Credit Officer at Moody's. During 2010-14, a time of high oil prices, Saudi banks had abundant low-cost liquidity.

As a result, banks increased their lending at a compound annual growth rate of 13 per cent. Access to non-interest bearing deposits also improved to 51 per cent of total assets from 42 per cent, leading to a decline in banks' cost of funding to 0.5 per cent in 2014 from 2.1 per cent in 2008, which supported domestic banks' return on assets of 2 per cent as of June 2015.

Moody's project the Brent price will average $33 per barrel in 2016 and $38 in 2017. The persistently low oil price is leading the Saudi government to report material fiscal deficits of 15 per cent in 2015 and a projected 12.7 per cent in 2016.

"Deficits will result in less government spending, a key engine of the Saudi economic growth, which in turn will contribute to a softening of Saudi Arabia's non-oil real GDP growth, which we forecast will fall to 2.8 per cent in 2016 from a 5.7 per cent average during 2010-15. Consequently, we expect lower profits and savings from the private sector to flow into the banking system," said Panis.

Data shows between June and November 2015, private-sector deposits fell by 3 per cent.

The deficits are also driving the government to draw on its reserves and deposits, and increase debt issuances, which were mostly subscribed by autonomous government-related entities in2015. These two factors explain the reduction in public-sector deposits placed with banks. Time and savings deposits from these sources fell by 13.6 per cent year-to-date as of November 2015.

Moody's expect banks' muted deposit growth to moderate lending growth, with overall loan growth in 2016 falling to 5 per cent, the lowest since 2010, from 8 per cent in 2015.

The deposit-growth slowdown is also increasing banks' cost of funding, which reached a floor in 2014. While the noninterest-bearing deposits are expected to remain the main source of funding, their proportion is seen gradually decreasing in favour of more expensive term deposits and long-term borrowing. Combined with the possibility of rising interest rates in line with US rates banks will pass on the increased cost to the borrowers. This will help stabilise banks' profitability, but increase customers' borrowing costs.

Moody's expect a surge in cost of borrowing borrowings to result in increase in the ratio of nonperforming loans to gross loans increasing over the next 12 months to 2.5 per cent from 1.4 per cent as of June 2015 and provisioning costs to gradually increase.