Saudi Arabia eases liquidity constraints by adjusting internal and external financing

The year 2017 has seen a welcome recuperation in the liquidity position of the banking sector. In October 2017 the Saudi Arabia Interbank Offered Rate (SAIBOR) stood at 1.79%, a considerable improvement on the 2.39% that was reached in the same month of 2016. The interbank rate has been below 2% since February 2017, suggesting the liquidity situation could be contained for the first time since the rate began to climb in late 2015. The upward march was the result of the drop in oil prices in the second half of 2014, and reduced oil revenues meant that the government was compelled to draw on deposits held with local banks to meet spending commitments. This trend was compounded by a contraction in private sector deposits, as a result of government spending cuts and slowing economic activity.

According to data published by the Saudi Arabian Monetary Authority (SAMA), demand deposits in the Kingdom dropped by SR50.5bn ($13.5bn) in October 2015, with deposits by businesses and individuals falling by SR23.2bn ($6.2bn) and those from government entities declining by SR27.3bn ($7.3bn). In November 2015 the SAIBOR rose at the fastest pace in seven years as lenders reacted to a shrinking deposit base. The liquidity squeeze had officially begun, and during the course of the following year a range of measures were implemented to successfully combat it.

Precautionary Steps

With mid- and long-range economic forecasts seeing no significant changes in macroeconomic circumstances, SAMA decided it was time to respond to the new liquidity scenario in January 2016. The regulator addressed the issue directly, choosing the most obvious regulatory lever to boost liquidity in the system: the loan-to-deposit ratio (LDR) requirement. This had stood at 85% for years, a conservative level which had helped to establish Saudi Arabia’s banking sector as one of the most stable in the region. By the beginning of 2016 the aggregate LDR for the sector stood at around 81%, which, while low when compared to the 89% average for Gulf banks and 93% for the rest of the world, was inching closer to the regulator’s limit. SAMA therefore decided to raise the LDR limit to 90%, granting more capacity to banks with regards to credit extension. During 2016 the aggregate LDR of commercial banks rose to a level nearly equal to the previous limit, reaching a high point of 84.79% in August 2016. The new 90% limit was never threatened, and by June 2017 the sector’s LDR had declined to 80.88%. Some individual banks did, however, exhibit LDRs in excess of 85% in 2016, according to Albilad Capital’s Saudi Banking Sector 2016 report, but none of them reached the new cap.

SAMA made other interventions throughout 2016 to ensure the liquidity squeeze did not escalate into a crunch. In June it injected approximately SR15bn ($4bn) into the banking system in the form of short-term loans and deposits – equivalent to approximately 1% of total banking deposits, according to Bank of America Merrill Lynch. It followed this action in September 2016 by giving banks around SR20bn ($5.3bn) in time deposits on behalf of government entities. SAMA also introduced seven-day and 28-day repurchase agreements, granting banks more flexibility in liquidity management, adding a 90-day repurchase facility the following month.

Lastly, in October 2016 the regulator moved to limit the weekly subscription to Treasury bills (T-bills) for domestic banks to SR3bn ($799.8m) from the previous level of SR9bn ($2.4bn). This restriction, which still remained in place during the third quarter of 2017, addresses the problem of scarce liquidity being directed to lucrative T-bills to the detriment of the proper function of banks in an economy.

Wider Operations

The regular issuance of T-bills is, however, an important component of government funding. The regulator has been able to limit banks’ consumption of them thanks in part to the government’s success in varying its sources of funding, which in turn has helped ease liquidity pressures. Key to this diversification, Saudi Arabia began to accept bids for its first international bond sale on October 16, 2016. The Kingdom had not previously issued a dollar-denominated bond, and investors showed considerable interest in the opportunity to place capital in Saudi debt, with investor orders reaching $67bn. This enabled the government to borrow more than it had originally planned, moving the sale from a $15bn offering to a new total of $17.5bn. The healthy order book also meant that the government sold its debt at a more favourable price: the five-year, 10-year and 30-year bonds were sold at yields of 2.375%, 3.25% and 4.5%, respectively – all lower rates than originally forecast. The rates were also significantly less than the average 5.2% yield of bonds tracked on JP Morgan’s emerging market bond index, a reflection of Saudi Arabia’s status as a G20 economy with an “A” rating from the three major credit rating agencies.

In April 2017 the country diversified its funding base further, with issuance of its first dollar-denominated sukuk (Islamic bond). Investor orders exceeded $33bn, allowing Saudi Arabia to sell two $4.5bn tranches with tenors of five and 10 years at below-benchmark rates. The Kingdom’s successful tapping of global markets is significant from a system liquidity perspective, in that it allows the government to draw down less of its deposits held with domestic banks. It also takes pressure off the local sovereign debt issuance programme, which drains further liquidity from the system.

New Environment

The liquidity situation was also notably improved in 2017 by the government’s move to clear a backlog of payments to contractors. Payment delays during 2016 were a side effect of the state’s reassessment of its liabilities as it formulated its midterm economic strategy. With the National Transformation Programme (NTP) 2020 in place, there has been a concerted effort to address the issue.

In November 2016 the government made a payment of SR40bn ($10.7bn) to private contractors, covering around 25% of the funds due from various government agencies. At that time the Council for Economic and Development Affairs pledged to follow a transparent procedure to pay down the remaining amount owned to contractors. In January 2017 this undertaking was reinforced by Mohammed Al Jadaan, the minister of finance, when he committed his department to henceforth make all private sector payments within a 60-day timeframe. The clearing of the backlog will have a positive effect on private sector deposits, as both contractors and a growing number of sub-contractors that work with the state re-establish regular cash flows. Delayed payments were less of a concern in 2017, and the sizeable tranches of funding released in late 2016 and 2017 provided a welcome boost to system liquidity.

Looking ahead, the government’s accommodation of private sector concerns bodes well for the midterm liquidity scenario. Similarly, Saudi Arabia’s proven ability to tap international markets for relatively cheap funding means that it has another important channel by which it can ease pressure on domestic liquidity. As a large economy with little external debt, the Kingdom has ample capacity to continue with its nascent international debt programme. The prospectus for its 2016 global issuance indicated that international bonds would play a larger part in the future funding mix, with as much as $120bn of debt offerings in the pipeline.

Proactive steps by SAMA in the second half of 2016 demonstrated the government’s willingness to support the banking sector, and provided comfort for banks at a time when the technical indicators were becoming a cause for concern. For many in the banking industry, however, the more interesting liquidity question applies to the longer term: in the absence of any significant increase in oil prices, Saudi Arabia’s funding requirements remain considerable and, while its plentiful reserves and low levels of external debt mean that the Kingdom has a number of options in meeting its spending requirements, system liquidity is likely to remain an issue of interest for the foreseeable future.