Banks in Saudi Arabia will continue to post strong net profits in 2024 thanks to a robust credit volume supported by overall net interest income, Moody’s said in a new report.

While the fee-related income remains strong, net interest margins will likely narrow this year after remaining broadly flat during 2023 as their funding costs rise amid tight sector liquidity.

“Historically, Saudi banks have largely been funded by low-cost deposits. The recent shift towards interest-bearing term deposits consequently pressures their net interest margins,” the report said.

Saudi banks’ net interest margins narrowed on average since interest rate hikes began in 2022, falling to 2.9% sector-wide in 2023 from 3.0% in the first half of 2022.

Although banks have implemented various initiatives to reduce deposit costs, these will partially soften the impact.

With the growth in low-cost demand deposits unable to keep pace with loan demand, the banks are increasingly resorting to alternative funding to finance their lending, such as repo borrowings, Tier 1 and Tier 2 capital, and other debt instruments (senior unsecured and subordinated debt).

With interest rates likely to stay steady this year, Moody’s said lending yields are set to flatline, providing limited repricing opportunities for most of 2024.

A reversal in interest rates will ease pricing pressure on deposits, but banks’ deposit mix has shifted considerably over the years.

Interest-bearing deposits are growing faster than non-interest bearing deposits as customers seek higher returns on their savings.

The share of non-interest bearing deposits fell to 54% in Q1 2024 from 65% in Q4 2021, the report said.

(Editing by Seban Scaria