Saudi banks are well positioned to withstand any shocks from the euro zone debt crisis. In fact, the overall Saudi financial system is well insulated from such shocks.
This stable outlook for the Saudi banking system is further supported by Moody's Investors Service's new report published Monday. The report says that the outlook for the Saudi banking system remains stable based on the country's benign operating environment, the expected decline in problem loan levels, as well as Saudi banks' supportive capital, profitability and liquidity attributes.
Christos Theofilou, analyst at Moody's, told Arab News: "We expect stable economic conditions, amid high government activity and spending, to support business opportunities and credit conditions for Saudi Arabian banks. Because of Saudi Arabia's reliance on other economies and the direct and indirect impact (through domestic confidence) of a drop in oil prices, developments in other parts of the world will continue to be a key uncertainty."
However, he said: "Saudi Arabia's economy and banking system are resilient to short-term oil price fluctuations during our outlook period."
Theofilou said: "Saudi banks' bottom line is profitability to remain strong and slightly higher than in 2010. Lower provisioning requirements should lead to higher overall profitability, counterbalancing the downward pressure on pre-provision income from the low interest rate environment and a moderate growth in private-sector business."
Moody's believes that the performance of the Saudi Arabian banking system will be supported by the expansion of nonoil private sector GDP (gross domestic product), which will rise by 4.8 percent in 2011 and 5.2 percent in 2012. The banks' performance will also benefit from continued high levels of government spending and resilience to oil price fluctuations over the outlook period as a result of low government debt levels and a large accumulation of reserves.
Khan H. Zahid, vice president and chief economist at Riyad Capital, said Saudi banks are well positioned to withstand any shocks from the euro zone debt crisis. "We expect the crisis to get worse before it gets better, but Saudi banks are not only well-capitalized, as Moody's notes, but also have minimal exposure to toxic euro zone debt. It is notable that even during the great financial crisis of 2007-2008, Saudi banks withstood the shocks well."
He added, the main channel of contagion from the euro zone debt crisis to Saudi banks will be indirect … through oil prices. "If the world enters a recession and oil prices fall, that will have a negative effect on the Saudi economy, and that may have some negative effect on banks. On the other hand, the associated fall in the euro against the dollar (and riyal) will mitigate some of the effect, as that will make Saudi imports from the euro zone countries cheaper," Zahid said.
Disagreeing on growth forecasts, Zahid said: "Moody's maybe underestimating the strength of the Saudi economy and the banking system. Their forecast (4.8 percent) for Saudi economic growth in 2011 is well below consensus. We forecast economic growth to be 7.3 percent this year, and the IMF forecasts Saudi growth to be 6.9 percent."
Paul Gamble, head of research at Jadwa Investment, was optimistic about the performance of the banks. He said: "The Kingdom's banks should remain healthy in 2012. The ongoing gradual increase in lending is a clear sign that they are comfortable with the outlook for the economy and with their own financial positions. After unusually high levels of provisioning for bad debts in recent years, banks' balance sheets are on a much stronger footing and profits are growing robustly."
He added that the continuation of high levels of government spending means the domestic lending environment should be sound despite the stresses in the euro zone. "Local banks do not have notable exposure to the sovereign debt of troubled euro zone countries. Nor are they greatly affected by the increase in wholesale funding costs, as deposits largely finance them. Furthermore, banks have large capital buffers to absorb negative impacts from events elsewhere in the world," Gamble said.
Commenting on Moody's report, Jarmo T. Kotilaine, chief economist at the National Commercial Bank, said: "It is clear that the Saudi banks have been very successful in addressing the pressure points created by the global financial crisis and their success has left them among the strongest financial institutions globally in terms of their capitalization and risk profiles. This now creates a very favorable backdrop for the banks to support the ongoing revival in private sector economic activity in the Kingdom."
He said the speed and effectiveness with which Saudi banks can rise to the occasion will have critical implications for near- to medium-term economic development where a steady transition from government spending to private consumption and investment as the key growth drivers is clearly desirable and necessary. Success in this regard would also help address some of the concentration risks and other challenges identified by the Moody's report. "Saudi Arabian banks have the advantage of approaching these opportunities with a track record of stability and a robust regulatory environment," Kotilaine added.
According to Moody's, asset quality to improve slightly, with declining problem loans (to 2.5-3.0 percent of gross loans over the outlook period, down from 3.5 percent at the end of 2010) and strengthening provisioning coverage.
The report said, Saudi banks continue to be profitable, supported by the prevalence of non-interest-bearing deposits, allowing the banks to absorb substantial losses without eroding capital. Net loans to customer deposits for the rated Saudi banks declined to around 74 percent at the end of September 2011 from around 83 percent at the end of 2008 because of muted loan growth and high domestic liquidity.
The outlook on Moody's Aa3 sovereign rating for Saudi Arabia is also stable.