Saudi Arabia's banks to benefit from expected rise in interest rates, says S&P

An increase in 100 basis points in benchmark interest rates will boost lenders' earnings by 13%

The credit growth of Saudi banks is expected to be about 12 per cent this year. Waseem Obaidi / The National

Banks in Saudi Arabia will benefit from expected interest rate rises this year, as they record an increase in profit and register a potential shift from demand deposits to savings accounts, S&P Global Ratings has said.

For every increase in the benchmark interest rate of 100 basis points, lenders in the kingdom are expected to record a rise in net profit of 13 per cent and return on equity of 1.5 percentage points, S&P Global Ratings credit analyst Puneet Tuli said in a report on Monday.

“Higher rates will help banks promote savings products, in line with Vision 2030,” the ratings agency said.

“Higher profits will continue to support the strong credit profiles of rated Saudi banks.”

The Saudi Central Bank typically mirrors US Federal Reserve rate actions because of the Saudi riyal peg to the US dollar.

The Fed is expected to raise interest rates six times this year (including one that already took place in March), and five more times in 2023 and 2024, which is a steeper increase than the base case assumptions of many of the kingdom's banks. The rate rises are aimed at reining in inflation, which hit a 40-year high in the world's largest economy this year.

The Saudi Central Bank raised its repo rate by a quarter of a percentage point to 1.25 per cent and the reverse repo rate by 0.25 per cent to 0.75 per cent on March 16 after the first Fed increase.

The expected interest rate increases “will be earnings-accretive for Saudi banks because of the structure of their balance sheets”, Mr Tuli said.

“Second-round effects of the increase in interest rates could come from a higher cost of funding and slower-than-expected credit growth.”

Currently, a large portion of corporate loans (about 55 per cent of total loan books) extended by banks in the country are linked to a Saudi riyal benchmark rate, the report said.

Saudi Arabia's corporate sector, traditionally funded at floating rates, should be able to face a gradual increase in interest rates as companies have “reasonable financial profiles”, it said.

Meanwhile, most deposits (65 per cent) are demand deposits with zero or very little funding costs, with this ratio remaining stable over the past few years.

Rising interest rates may lead to a shift in customer funding from demand deposits to time and savings accounts, even though that did not happen over the previous cycle of Fed tightening in 2016-2019, S&P said.

“This is because Vision 2030 and the Financial Sector Development Programme, in particular, target an increase in savings products, including [the] creation of government-backed savings products offered through a separate, newly created entity,” it said.

After strong expansion in 2020 and 2021, Saudi Arabian banks' credit growth is expected stay strong at about 12 per cent in 2022, S&P Global Ratings said.

“At some point, higher rates will gradually cool off lending growth. Specifically, we believe that mortgage growth will start to moderate, even in nominal terms, in 2022 as the market becomes more saturated,” it said.

“Strong capitalisation of the banking sector will be further supported by an expected slowdown in lending growth, which will protect creditworthiness over the next 12 to 24 months.”

Lenders in Saudi Arabia have continued to perform well this year as they largely remain insulated from the Russia-Ukraine conflict.

“Rated Saudi banks have little direct exposure to Russian or Ukrainian counterparties. We do not expect to see any significant direct effects of the conflict on their asset quality indicators,” S&P said in an earlier report.

“The banking sector [in the kingdom] is in an overall net external asset position, with limited reliance on external funding due to a large domestic deposit base, and historically small overseas operations … we expect 2022 to provide stability, supported by increasing lending books and an improving economic environment.”