How Saudi banks can be resilient and grow

As the global banking sector comes under increasing stress, financial institutions in Saudi Arabia must take proactive measures as they evaluate their vulnerabilities and mitigate risk. Saudi banks should secure deposits, diversify their income streams, improve their profitability, and reduce their asset-liability mismatch to strengthen their position, and be ready for growth.

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Faster inflation has prompted many global central banks to reverse years of loose monetary policies, leading to significant strains on the global banking sector. Several banks in the U.S and E.U. have either failed or needed to be rescued (e.g., Silicon Valley Bank or Credit Suisse). The stress on the banking sector shows no sign of abating. J.P. Morgan purchased First Republic Bank at the beginning of May after customers withdrew approximately $100 billion in deposits.

Although the Saudi economy is performing well, its financial institutions are not immune to global financial problems. The Saudi Central Bank must follow the U.S. Federal Reserve’s approach to monetary tightening because the Saudi riyal is pegged to the U.S. dollar.

Similarly, while Saudi banks face no immediate risk from their investment portfolios due to unrealized losses, as was the case for some U.S. banks, they still have three issues:

The average loan-to-deposit ratio now exceeds 100% in the overall Saudi banking market. That is because deposits have grown slower than loans. The result is increasing competition for deposits among Saudi banks. That need for more deposits will only intensify given that banks need to extend finance for planned investments under Saudi Vision 2030, the national development plan.
Profit margins are being squeezed. There is a continuous rise in the share of interest-bearing accounts as part of the competition for deposits. That makes life difficult for banks that have a significant portion of their loan portfolio on fixed rates. These banks have to pay out more on deposits while being stuck with the same level of income from their loans.
There is a growing “duration mismatch” between assets and liabilities which could strain liquidity. On the asset side, over 90% of Saudi banks’ funding is short-term. On the liability side, too much is long-term. There has been a surge in long maturity real estate loans on Saudi banks’ balance sheets in recent years. The mismatch is particularly worrisome given the high loan-to-deposit ratio and the competition for deposits.

The first measure is to secure funding by ensuring the “stickiness” of deposits and diversifying funding sources. “Stickiness” refers to the loyalty of depositors and the stability of deposits, so that the deposits remain with a bank over an extended period of time. To achieve this, Saudi banks must offer customer-specific and superior value propositions to their private and public sector customers. That way they can retain existing deposits and attract additional ones. Furthermore, they can explore additional funding sources to enhance financial stability and resilience, such as increased interbank lending.

The fourth measure is to reduce the asset-liability duration mismatch. Banks can reduced the weight of long-term lending in the loan portfolio by securitizing through the Saudi Real Estate Refinance Company. Or they can develop a direct placement market for these loans. Another option is to attract longer duration funding, such as increasing the percentage of time deposits, money that customers must leave with the bank for a specified duration.

Despite the problems in global banking, Saudi banks are in a strong position, they have robust capitalization and operate in a buoyant macroeconomic environment. They can position themselves for continued success by taking proactive measures which will allow them to fund the growth and transformation of the Saudi economy.

This article originally appeared in Arabian Business, June 2023.

How Saudi banks can be resilient

As the global banking sector comes under increasing stress, financial institutions in Saudi Arabia must take proactive measures as they evaluate their vulnerabilities and mitigate risk.