Saudi Arabia moderates a rise in consumer lending against falling bank deposits

A robust recovery from the Covid-19 pandemic and a positive economic outlook should help the Saudi banking sector overcome a relative lack of liquidity as consumer lending growth outpaces deposits.

Amid a high inflationary global environment, rising commodity costs and interest rate hikes worldwide, Saudi Arabia has become an increasingly attractive destination for international investors as a safe haven in the post-pandemic context. Strengthened by increased oil-related revenue and a strong domestic market, the country has positioned itself as the second-largest recipient of foreign direct investment (FDI) in the region, with inflows in 2021 tripling to $19bn, according to figures from the UN Conference on Trade and Development.

This attractiveness has been further cemented by 9.6% year-on-year (y-o-y) real GDP growth in the first quarter of 2022, which marks a 10-year high, and a forecast by the IMF that the country will post one of the world’s highest GDP growth rates in 2022, at 7.6%. Steady expansion fuelled by rising oil prices, which has added to government revenue, would ordinarily help to inject liquidity into the economy. However, this period of development has also led to a rapidly growing credit expansion, one that has outpaced the volume of deposits in domestic banks.

Profit Expansion

In addition to the positive macroeconomic outlook for Saudi Arabia, bank profitability has also been on the rise. The top-10 banks in the country witnessed a y-o-y growth in net profits of 22.8% in the first quarter of 2022, or around $4bn, and a drop of expected credit loss change of 11.5% while their total assets expanded by 3.8% compared to the fourth quarter of 2021.

This growth has taken place on the back of a 40.2% increase in profit at the end of 2021 compared to the previous year, consolidating an upwards trajectory in the banking sector. Indeed, it was able to not only recover to its pre-pandemic performance but boosted consumer confidence. A principal factor for improved profitability in the banking sector was rising net income, which increased by 15.5% in 2021, largely driven by a 3.5% rise in operating income and a 28.9% decrease in lower impairment losses, the latter of which was facilitated by lower provisions.

As a result of aggregate operating income outpacing operating expenses, the sector’s cost-to-income ratio declined slightly, by 0.2 percentage points to 35.2% in 2021. Likewise, the capital adequacy ratio of the top-10 banks decreased from 20.3% in 2020 to 19.9% in 2021 as the cost of risk decreased. These factors strengthened Saudi banks’ financial positions and profitability metrics across all measures.

As a result of recovering consumer confidence, aggregate loans and advances at Saudi’s top-10 banks grew at an accelerated rate of 14.2% in 2021, compared to 12.8% the previous year. This promising trend was a consequence of the strong performance of the mortgage segment, with retail mortgage totals jumping by 47.8% in 2021, amounting to roughly $110bn.

As seen in other markets around the world in the time leading up to the pandemic, Saudi Arabia had been experiencing a low-interest rate environment over a prolonged period. This deepened in early 2020, when the Saudi Central Bank (SAMA) cut repurchase agreement (repo) rates by 125 basis points in March 2020 to 1%, the lowest rate since 2007. Due to 15-year low rates, the net interest margin (NIM) declined by 18 basis points to 2.9% in 2021. However, despite the lower NIM, banks’ increased profitability signalled improved efficiency across the sector, as well as a concerted focus on retail lending vis-à-vis corporate lending, which often generated better asset yields.

Inflation Curbs 

Despite rising oil prices causing increased shipping costs and double-digit spikes in consumer goods prices, inflation in Saudi Arabia has been largely contained, in contrast with the rest of the world. More specifically, global inflation is projected to reach 6.7% in 2022, a figure that is twice the average of 2.9% experienced over the 2010-20 period. By contrast, however, inflation in Saudi Arabia is expected to be less than half this figure in 2022, at 2.8%, according to an August 2022 report published by the IMF.

Public Finances & Deposits 

Healthy public finances, along with the robust supervision framework created by SAMA, is expected to support a resilient financial services sector that is less sensitive to external shocks, although high oil prices and strong liquidity limit the impact of interest rates on the wider Saudi economy. More stringent financial services regulations and monitoring are particularly important as mortgage lending has risen significantly and risk management becomes increasingly paramount to help banks meet cash flow obligations.

Likewise, fiscal discipline has become a key aspect of Saudi budget planning as the country seeks to limit exposure to boom-and-bust oil cycles that have dominated much of its recent economic performance. For the first time in nine years, in 2021 Saudi’s budget experienced a surplus of $15bn. While the government plans to allocate part of these funds towards social welfare programmes to shield citizens from rising costs due to inflation, social spending will be restrained compared to previous growth cycles. Instead, the surplus will be used to support the Public Investment Fund (PIF), the country’s sovereign wealth fund, which has announced plans to invest SR1trn ($266.7bn) domestically by 2025 in order to broaden the role of private enterprise.

However, rapidly increasing consumer spending coupled with higher revenue from oil prices has not translated into similarly high-deposit growth in the banking sector. In fact, in contrast to double-digit lending growth, the deposit growth ratio declined from 9.2% in 2020 to 7.2% in 2021, leading to an increase in the loan-to-deposit ratio from 86% to 91.5%, its highest level in at least 15 years.

Lower deposits in a context of double-digit growth in consumer lending and an expansion in the mortgage segment have placed pressure on the banking sector to generate sufficient liquidity to support the ongoing economic recovery. Similarly, despite a $15.5bn budget surplus in the first quarter of 2022 generated by a 58% year-on-year (y-o-y) jump in oil revenue – which increased total government revenue by 36% y-o-y, or around SR278bn ($74.1bn) – spending has risen by 4% over this period, to around SR220.5bn ($58.8bn).

Additionally, government capital expenditure fell 1% y-o-y in the first quarter of 2021 as Saudi Arabia sought to rely more on its sovereign wealth fund for domestic investment. Therefore, despite higher levels of oil income, the country kept spending restrained to its 2022 budget plans announced on December 2021, effectively withholding oil revenue from injecting liquidity into the local market.

Liquidity Solutions 

To effectively reverse the ongoing liquidity gap in the Saudi banking system driven by strong credit growth and a tight fiscal policy, SAMA extended over SR100bn ($26.7bn) to local banks in June 2022 to inject liquidity and sustain lending activity. The funds are expected to allow commercial banks to continue extending lending facilities to the private sector and to restructure existing loans without additional charges. At the same time, these efforts aim to prevent layoffs in the private sector and expand e-banking services.

The intervention by SAMA preceded the US Federal Reserve’s interest-rate hike in June 2022 and consisted of money provided to banks at a discount to the three-month Saudi interbank offered rate, or SAIBOR. Likewise, in June 2022 SAMA extended the tenor on its repo facility to a maximum of 13 weeks from four to further ease the funding costs of local banks. These collective efforts aim to support growth in consumer lending and the funding of large-scale government initiatives such as The Red Sea Project, Qiddiya entertainment city and NEOM.

As a sign of ongoing momentum in Saudi Arabia’s mortgage market, in August 2022 the Saudi Real Estate Refinance Company, which is wholly owned by the PIF, signed an agreement with Riyad Bank to acquire an SR500m ($133.3m) real estate financing portfolio. This made the entity the second-largest mortgage refinancing firm in the country. The transaction aims to provide long-term liquidity in the real estate finance market as it delivers service providers with liquidity management solutions to deliver affordable financing to potential clients in the country. Likewise, the transaction contributed to the Iskan Programme, which falls under Vision 2030 and aims to increase homeownership of Saudis to 70% by 2030.

Also in August 2022, JP Morgan Payments launched a cross-border liquidity solution to help Saudi companies increase their visibility and connect their balances to offshore liquidity structures. The product aims to drive digital transformation and increase working capital by reducing idle balances, utilising internal cash more efficiently and improving deficit balances.