|14 April, 2020

Implications of COVID-19 on the financial services sector in Saudi

Dr. Mattar is a Managing Partner at MMK Capital, an alternative investments firm regulated by the DFSA at the DIFC. He has extensive experience in asset management and investment banking focusing on the GCC region. He previously served as the Managing Director of Evolvence Group heading its private equity unit focusing mainly on the education and the retail sectors. He also served as the CEO of CAPM Investment part of Finance House Group. Dr. Mattar started his career as an economist and covering the various GCC countries and their key industries, he was the Head of Research and Chief Economist of SHUAA Capital and the Director of Financial Markets Division at the DIFC. Dr. Mattar holds a Doctorate in Risk Management from the Sloan School of Management at MIT, a Master of Science in Construction Finance from MIT, and a Bachelor of Engineering from the American University of Beirut.

Website: http://www.mmkcap.com/

The economic impact of this perfect storm would outlast the outbreak itself

The dual shocks of the global shutdown due to COVID-19 and the collapse in oil prices will take a heavy toll on Saudi Arabia and the Gulf economies.

The recent OPEC+ record production cut by 9.7 million barrels per day, with nations outside of the group, mainly the US and other G-20 countries willing to support, will put an end to the devastating price war.

However, this agreement won’t be enough to offset the recent build up in oil inventories and the continued demand destruction from national lockdowns. The deal will prevent extreme downside but won’t be enough to help the oil market recover and push prices much higher.

Saudi Arabia is proactively fighting the spread of COVID-19 and its authorities are implementing both monetary as well as fiscal policy responses. SAMA, through the banks, is aiming to assist small and medium-size enterprises.

In parallel the government, mainly through the Ministry of Finance, has unveiled stimulus packages to support companies that were affected by the pandemic such as covering 60 percent of private sector wage costs for a period of three months.

Given that the pandemic is still unfolding with many uncertainties around its duration and intensity, the economic consequences of the containment measures, and the alleviating effects of the stimulus packages, any exact economic forecast at this stage is most likely to miss. Broadly speaking headline GDP will turn negative, however domestic demand which is a better indicator will see a sharp contraction, with both consumption and investment expected to decline.

The economic impact of this perfect storm would outlast the outbreak itself, affecting government spending, its structural reform program (the Vision 2030 program would most like be recalibrated), and the long-awaited recovery of the private sector will reverse into contraction.

In light of this gloomy economic backdrop, banks’ profitability will come under pressure. Cost of risk will increase with larger-than-expected deterioration in loan losses, net interest income will contract following the SAMA’s interest rate cuts mirroring those of the United States Federal Reserve, and none interest income would come under pressure as loan growth slowdown (in addition to the regulator’s effort to reduce fees on impacted banks’ clientele).

The above-mentioned headwinds should in theory support consolidation. However, consolidation has taken place in some cases (Saudi British Bank and Saudi Hollandi Bank) and in others, discussions didn’t materialize (Riyad Bank and NCB). However, some major hurdles exist for any further consolidation such as the lack of significant common shareholding structure within the banks. As for regional banks with growth aspirations in the Saudi market, it remains uncertain whether they would be able to acquire majority stakes in existing Saudi banks given the ownership rules in the kingdom.

Therefore, despite such deteriorating operating environment, I don’t believe there is much room for further banks consolidation in the kingdom given the current landscape

However, within financial services, I believe the insurance sector is ripe for some major consolidation accelerated by the current economic downturn. Despite some minor profits in the very short-term from lower expected claims in health but mainly auto due to the lockdown, the sector is expected to face some major headwinds that would add to its existing structural challenges.

The anticipated economic contraction and later on the slow recovery would generally result in lower insurance spending. The expat exodus which was slowing down in last 12 months might reaccelerate. The private sector anticipated rebound would reverse with closures and severe losses anticipated in small and medium size enterprises, despite the government stimulus plans. All of these would result in lower mandatory insurance policies.

Furthermore, the COVID-19 outbreak has dealt a heavy blow to both general tourism and religious tourism to the Kingdom, reducing drastically the anticipated premiums from the mandatory health insurance the regulator was imposing for tourists as well as the pilgrims visiting the country.

In addition to a drop in premiums, most insurance companies would suffer losses incurred on their investment portfolios as both regional as well as global markets meltdown. This negative outlook would surely push for further consolidation the insurance sector, a sector that was already ripe for such consolidation pre-COVID-19 pandemic. The Kingdom has 33 insurance companies, most of these firms are small, undercapitalized and barely profitable (10 were loss making last year). The sector’s bulk of profits is being earned by two companies and the top five players command around two-third of the premiums with the largest two player gaining further market share.

* Any opinions expressed in this article are the author’s own

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© Opinion 2020

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