DUBAI, July 4: Last Tuesday, the Saudi Arabia Monetary Authority, the country’s central bank, published data showing that Saudi banks had recorded a 0.5 percent decline in total deposits in May, after decreasing by 0.7 percent in April. These two consecutive months of declines contributed to a six-month decline of 0.9 percent and a 12-month drop of 3.4 percent, which is the largest 12-month decline in deposits since August 1994.
The declines are credit negative for Saudi banks because they add to the liquidity pressure that banks are already experiencing as a result of the drop in oil prices and associated government revenues, even though loan growth has remained above 9 percent since January. Tightening liquidity is negatively affecting banks’ loan-to-deposit ratios and liquid asset levels and will negatively affect banks’ cost of funding and profitability, with knock-on effects increasing nonperforming loan ratios.
The drop in deposits has further widened the gap with loan growth. Although government deposits have stabilized, rising 0.1 percent in May (but still down 4.5 percent year to date), private-sector deposits decreased 0.9 percent in May and are down 0.1 percent year to date. This points to a contraction in the private sector’s available cash and profits.
Saudi banks’ tightening liquidity is leading to a gradual deterioration of the banking system’s loan-to-deposit ratio, as indicated by the ratio of total claims (including loans and investments) to total deposits rising to 107 percent in May after having increased to more than 100 percent in February for the first time since February 2009. Although banks’ level of liquid assets remains high (Saudi banks’ average Basel III liquidity coverage ratio was 193 percent at the end of 2015), the ratio of liquid assets to total assets has declined materially over the past 18 months, reaching 17.1 percent as of March 2016 from 22.3 percent as of December 2014.
Tightening liquidity is increasing banks’ cost of funding, as reflected by a rise in the three-month Saudi Interbank Offered Rate (SAIBOR) to a high of 2.23 percent on 21 June from 0.77 percent a year earlier. Although banks’ profitability has so far remained stable, with a return on assets of 2.1 percent as of first-quarter 2016, we expect that sustained loan growth will fuel higher competition for deposits and higher recourse to market funding, which will increase funding costs. The central bank earlier this year attempted to ease this cost pressure by increasing the maximum loan-to-deposit guidance to 90 percent from 85 percent, which is credit negative for banks.
Without an easing of liquidity pressures, which three consecutive drops in the SAIBOR between 21 and 28 June might indicate, we expect that the decline in deposits will lead banks to become more selective in their lending and customers’ borrowing costs to rise. Additionally, the decline in deposits from the private sector suggests that sector is experiencing contracting cash flow and profits, which increases the risk of a rise in banks’ nonperforming loan ratio (which was 1.2 percent of gross loans as of March 2016 and has remained stable since the oil prices began dropping in July 2014) and provisioning costs.