Saudi banks' funding profiles are changing. At the heart of the shift has been a rapid expansion in lending, notably driven by new mortgages and underpinned by a state-backed push to increase home ownership. That trend, coupled with the ongoing financing needs of the Vision 2030 economic initiative and relatively sluggish deposits growth, is likely to incentivize banks to seek alternative sources of funding, including external funding, with potential implications for banking sector credit quality.
What's Happening
Saudi banks' lending growth has outpaced deposits for years, pushing the country's loan-to-deposit ratio beyond 100% in 2022, up from 86% at the end of 2019 (see chart). S&P Global Ratings expects that trend will persist, notably with corporate lending contributing more meaningfully to growth over the next few years. We consider Saudi banks are likely to turn to alternative funding strategies to fund that expansion, and see three possible options:
Change the balance sheet structure: Banks could liquidate a portion of their investment books, equal to about 15.7% of their total assets, or SAR622 billion ($166 billion), at year-end 2023. A potential downside to this strategy is that banks will have to crystallize unrealized losses (Saudi banks' total revaluation reserves were negative SAR7.4 billion at year-end 2023). The strategy could also reduce balance sheet liquidity as the money raised would be redeployed in less liquid assets.
Issue residential mortgage backed sukuk (MBS), either directly or indirectly: This has been on the cards for a long time. Saudi authorities, in 2017, created the Saudi Real Estate Refinance Company (SRC) to buy mortgages from the banking system and refinance them through capital market issuances. By year-end 2023, the SRC had bought about SAR26.7 billion, or about 5% of banks' total mortgage-lending. Banks' enthusiasm for further sales could be tempered by higher interest rates (which could result in the crystallization of some unrealized losses if mortgages are sold) and the currently good profitability of mortgage books. We also understand that some investors are skeptical of Saudi banks' capacity to foreclose on mortgages following default. That may weigh on investors' willingness to buy MBS and is likely a reason why SRC sukuk issuances have benefited from a government guarantee. However, according to Saudi banks, regulatory reforms have made foreclosure not only possible but fairly common.
Issue external debt: Saudi banks have already tapped international capital markets and we expect that will continue for the next three to five years. Overall, we think that the Saudi banking system could shift from a net external-asset position of SAR42.9 billion, or 1.6% of lending, at year-end 2023, to a net external-debt position within a few years.
Why It Matters
We have seen a significant increase in the maturity mismatch between lending and deposits on Saudi banks' balance sheets. Mortgages represented 23.5% of Saudi bank's total lending at year-end 2023, up from 12.8% at year-end 2019. We consider, however, that the risk created by the maturity mismatch is mitigated by the relative stability of Saudi deposits. At the same time, banks have seen the profit-margin benefits of higher interest rates diminish as a portion of deposits that previously paid no interest have migrated to interest baring instruments.
What Comes Next
We expect Saudi banks' foreign liabilities will continue to increase, from about $19.2 billion at the end of 2023, to meet the funding requirements of strong lending growth and amid lower deposit expansion. Our forecasts for Saudi banks already take into account that expected increase and while greater-than-expected recourse to external debt could weaken our view of systemwide funding it would not necessarily effect our view on banks' creditworthiness.
Related Research
- Saudi Retail Sukuk: Another Step Toward A Deeper Financial Ecosystem, Feb. 5, 2024
- Credit FAQ: How Will Saudi Banks Fare In 2024?, Feb. 5, 2024
- Bulletin: SAMA Support For Saudi Banks Eases Near-Term Liquidity Needs, June 29, 2022
This report does not constitute a rating action.
| Primary Credit Analyst: | Mohamed Damak, Dubai + 97143727153; mohamed.damak@spglobal.com |
| Secondary Contact: | Zeina Nasreddine, Dubai + 971 4 372 7150; zeina.nasreddine@spglobal.com |
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