Saudi banking outlook: Profits likely to face pressure; mortgage the way forward

A squeeze on net interest margins, slow pick up in loan growth and poor asset quality metrics are key negatives for the Saudi banking sector

Image used for illustrative purpose. A trader monitors stocks at a Saudi Bank in Dammam October 26,2008.

Image used for illustrative purpose. A trader monitors stocks at a Saudi Bank in Dammam October 26,2008.


The banking index on Saudi Arabia’s Tadawul stock exchange has fallen from just under 9,000 in mid-August to 7,248 on Monday as the euphoria over inclusion in the MSCI Emerging Markets index fades and investors take a hard look at the fundamentals underlying the valuations.  

While most Saudi banks are expected to continue to be profitable through to the end of the year, net profit growth is likely to be tempered by weaker lending to the private sector and a squeeze on interest margins.

“There are only three ways in which banks can increase profitability in the near-term: by increasing the loan book, increasing margins, or lowering provisions, which are already very low,” Chiradeep Ghosh, a banking analyst at Bahrain-based SICO Bank, told Zawya.


In September, the Saudi Arabian Monetary Agency (SAMA), the kingdom’s central bank, cut its repo rate by 25 basis points to 2.5 per cent after the US Federal Reserve cut its target range by the same margin. This is expected to squeeze lenders’ profit margins.

Saudi lenders traditionally have a large percentage of zero-interest deposits, which means their net interest margin (NIM), the difference between a bank’s income from loans and mortgages and what it pays out on liabilities such as savings accounts and deposits, is set to see some compression. NIM is a key component of Saudi banks’ profitability.

Ashraf Madani, Vice President and Senior Analyst at Moody’s Investors Service, said, “We expect profitability for the system to be pressured by lower rates; however, it will remain strong.” 

He added that as interest income constitutes around 75 per cent of banks’ gross income, lower rates will pressure NIMs once banks start to reprice their loans lower. Additionally, some 60–65 per cent of the deposits in the system are demand deposits (earning little or no interest), and lower interest rates will reduce revenue generated from these deposits for banks.

“We expect return on assets to be slightly below 2 per cent for 2019, down from 2.1 per cent in 2018,” he told Zawya. 

However, in a recent report, analysts at Al Rajhi Capital said that the NIM outlook for Saudi banks is only marginally lower, as interest margins have proved remarkably resilient in the past “due to the sticky nature and tenure of loans,” particularly for retail banks.

“This NIM resilience may lead to resilient earnings,” the report noted, adding, however, that large corporate banks, where the competition is much higher, could see a decline in NIM.   


Growth in Saudi banks’ loan book is unlikely in the near term as there is no pick-up in corporate lending, and any increase in retail lending is capped by the stable population, Ghosh said.

According to SAMA, Saudi bank lending to the private sector has picked up slightly from a dip in June, coming in at 1.43 billion Saudi riyals in August, up by 2.8 per cent year-on-year.

Although government expenditure rose by 5 per cent year-on-year in Q2 2019 to 294 billion Saudi riyals, in line with the Saudi government’s stand that said it will continue with its expansionary fiscal policy, this may not be enough to boost corporate lending. According to global ratings agency Fitch, loan growth in 2019 is likely to be “at most mid-single digits” as demand for credit is being weakened by low confidence levels and geopolitical risk in addition to fiscal tightening.

The agency downgraded the kingdom’s credit rating to A from A+ last week, citing a deterioration of the kingdom’s fiscal position as well as rising geopolitical and military tensions in the region following an attack on Saudi Arabia’s oil facilities.

According to Madani, lower interest rates are generally positive for credit growth. “Having said that, we expect credit growth in Saudi [Arabia] going forward will be more linked to government’s spending and the growth in the non-oil economy than it is to lower interest rates. Our expectation for credit is to grow by 4–5 per cent in 2019 and 2020 based on the increased government spending and the growth in the non-oil economy.”


While there are signs that the Saudi banking sector’s asset quality is improving, banks saw their non-performing loans (NPLs) rise in Q2 2019. Data from Al Rajhi Capital showed that the NPL ratio rose to 1.90 per cent from 1.85 per cent in Q1. “Cost of risk also increased significantly to 105 basis points from 58 basis points in Q1 as the provisions increased during the quarter,” the investment bank said in a recent report.  

According to Fitch, asset-quality metrics will remain under pressure through 2019, particularly in contracting and retail/wholesale trade, until the effects of higher government spending on the private sector are visible.

However, Madani said there are signs of stability in asset quality following several years of deterioration. “We expect the NPL ratio to range between 2 and 2.25 per cent for the next 12 months. Loan loss provisions are high, at 140–150 per cent of non-performing loans.” 

MORTGAGE: THE WAY FORWARD                      

The consensus among analysts is that the way forward for Saudi banks until corporate lending picks up again is to focus on mortgage financing amidst plans within the kingdom to increase local home ownership rates to 70 per cent by 2030.

Fahad Alshathri, SAMA's Deputy Governor for Supervision, said at a conference in Dubai last month that the kingdom’s mortgage market is expected to double in size over the next five years. Alshathri said mortgage loans from commercial banks grew by 168 per cent while housing loan deals by finance companies rose by 79 per cent.

According to Madani, mortgages have been a key driver for loan growth over the past two to three years, and he expects it to remain the same for the next 12–18 months, driven by a variety of government initiatives to increase home ownership.

“These include higher maximum loan to values, reduction in risk weight for banks, supply of lower-cost homes in addition to subsidies, [and] guarantees and support on down payments for low-income Saudis,” he said.

(Writing by Brinda Darasha, editing by Seban Scaria

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© ZAWYA 2019

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