The world economy is in a precarious position. Interest rates rising in tandem with sky-high inflation, uncertainty from new and ongoing global political conflicts, and a Chinese economy still reeling from the impact of COVID-19, have made for headwinds strong enough for some countries to declare that they face the possibility of a protracted and arduous recession.
However, the economic climate in the Gulf Cooperation Council (GCC) countries seems noticeably brighter. Elevated energy prices, abatement of COVID-related measures, and an increase in tourism resulting from major global events have precipitated what by all accounts would be classified as an economic boom. High energy prices are benefitting hydrocarbon economies and the International Monetary Fund estimates that energy exporters in the Middle East and Central Asia will net a windfall of $320 billion more than it had earlier forecast – approximately $1.4 trillion over the next five years if current global economic conditions persist. Much of this will flow to exporters in the GCC, which number among the top energy-exporting nations in the world.
Additionally, the Kingdom of Saudi Arabia (KSA) is accelerating the transformation of its economy in line with its ambitious Vision 2030 initiative. As part of the plan, the Kingdom is proceeding full steam ahead with the development of a raft of mega-projects, modernization initiatives, as well as reforms and development plans that will diversify its economy and open the country up to the world in a way that it has not attempted before. These developments are being mirrored in the performance of the banking sector in Saudi Arabia, which is experiencing a period of much-welcomed profitability.
Inflation around the world resulted from an unprecedented period of monetary expansion pursued by central banks to combat the economic slowdown resulting from the COVID-19 pandemic, followed by a surge in consumer spending once economies reopened.
The United States (US), Germany, and the United Kingdom recorded average inflation rates of 8.1%, 8.1%, and 9.1% respectively in 2022 as geo-political events created more disruptions to global supply chains. In the US, the world’s bell-weather economy, the Fed Funds Rate rose seven times in 2022; by 25 Basis Points (bps) in March, 50bps in May, 75bps each in June, July, September, and November, and 50bps in December. Despite a substantial increase in the Fed Funds Rate from 0.08% in March to 4.33% in December, inflation remains stubbornly high and is leading many analysts to expect further rate hikes in 2023.
The burden of inflation is affecting economies globally, but in the case of the GCC, has not been as problematic. This situation holds particularly true in KSA. From historically low levels in 2020 and 2021, the Saudi Arabian Monetary Authority (SAMA) raised policy rates in line with the US Federal Reserve, inevitably, as the Saudi Riyal is pegged to the US dollar. In tandem, SAMA also raised repo rates seven times over the year, from 1% in March to 5% in December. However, with less impact from current geo-political events and high oil prices, inflation in the country has so far largely been controlled.
Net Interest Margin (NIM), which reflects the difference between income from interest charged to creditors versus interest paid to depositors, moves in tandem with changes in the interest rate environment. Between 2015 and 2019, the three-month (3M) Saudi Arabian Interbank Offered Rate (SAIBOR) yearly average rose by 175 basis points (bps), and NIM over the period increased by 81bps, implying a NIM beta of 46%. From 2019-2021, 3M SAIBOR declined 182bps owing to pressures stemming from the global pandemic, NIM over the period also receded by 46bps, resulting in a NIM beta of 25%.
However, following multiple rate hikes in line with the US FED, SAMA’s last rate hike in December 2022 raised the 3M SAIBOR by ~200bps, taking 2022 NIM higher than the peak levels of 2019. With FED expected to maintain the tight monetary policy in 2023 to combat inflation, and SAMA likely to follow, interest rates are expected to remain high, portending favorably for the KSA banking sector.
Between 2011 and 2022, the trajectory of the Saudi banking sector’s loan and deposit volumes has closely mirrored the movement in oil prices, reflecting a changing economy. Overall, loan volumes grew at 9.6% CAGR while deposits grew at 6.8%, resulting in a Loan-To-Deposit ratio (LDR) growth from 77% to 101%.
From 2011-2014, high oil prices led to strong increases in lending volumes (roughly 13.9% CAGR) and deposit volumes (12.3% CAGR), with both retail and corporate loan products registering significant growth. Between 2015 and 2018, as oil prices declined to historic lows, loan volumes grew at only 2.3% CAGR while deposit growth remained flat. Between 2018 and 2022, as oil prices rose steadily, loan and deposit volumes also rebounded to 12.1% CAGR and 8.1% CAGR respectively.
Following a tough economic climate resulting from the collapse of oil prices from historic highs in 2014, the 2016-2022 period saw a steady return to growth. Profit after taxes and payments for the Saudi banking sector grew at 7.9% CAGR driven by strong revenue growth – recorded at 9.1% CAGR – and operating costs and loan loss provisions grew at 8.2% and 7.5% CAGR respectively, slower than revenue growth rates. Profit after taxes and payments suffered a decline in 2020 as banks increased loan loss provisions due to credit risks posed by the pandemic. However, revenue growth rebounded swiftly in 2021 as loan loss provisions also declined, leading to a sharp rise in profits.
Weighing on profits was the cost of taxes and payments. In KSA, banks are subject to an annual Islamic Shariah-based ‘zakat’ payment and corporate taxes. In 2018, the General Authority of Zakat and Tax (GAZT) began collecting additional zakat payments from banks that had been waived in previous years. This led to a sharp rise in the collective zakat and tax costs levied on banks in the country.
Throughout the 2016-2022 period, the retail segment registered the highest revenue increase, with loans (mortgages, credit cards, and corporate loans), payments, and investment products being the biggest drivers of growth. Non-Performing Loans (NPL), which increased in 2020 due to pandemic risks, have declined over the last two years given the rapid economic recovery. Similarly, profitability ratios were impacted in 2020 due to higher provisions but recovered to pre-pandemic levels by Q1 2022.
The prescriptions outlined in Saudi Arabia’s wide-ranging Vision 2030 development plan are poised to enable the banking sector to experience dramatic growth over the decade, especially as the global pandemic recedes further into the rearview. Banking assets in the country surpassed SAR3,515 billion in Q2 2022, three years ahead of time, indicating that strong growth is already underway and will only continue.
The Saudi banking sector’s overall loan volumes are forecast to grow at 8.5% CAGR from 2022-2027, with retail loans (11.3% CAGR) mainly driven by mortgage, outpacing corporate (6.2% CAGR) and public sector (6.2% CAGR) volumes.
With the growth in volumes forecast earlier, and margins also expected to rise, banking revenues are expected to grow at 8.6% CAGR in the 2022-2027 period, driven by strong growth from public sector clients (13.9% CAGR) and retail clients (9.5% CAGR). Revenues from corporate clients are projected to grow at a 6% CAGR.
Markus Massi
Given the forecasts presented in the previous section, the following four avenues emerge as viable options for Saudi banks to consider when pursuing strategies to strengthen their position:
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