SAMA's hike in key interest rates 'credit positive' for banks: Moody's

Saudi Arabian Monetary Authority's (SAMA), the Kingdom's central bank, increase in two key interest rates are "credit positive" for the banking system and will benefit banks’ margins in the next 12 months, Moody's Investor Service said in a new report.

"The increases are credit positive for Saudi banks because they will prevent Saudi investors’ and depositors’ capital outflows and positively reflect the Saudi banking system’s stable liquidity conditions," the ratings agency noted.

Last week, SAMA increased its repo rate, the reference for its financing to banks, to 2.25 percent, and raised its reverse repo rate, the reference for banks’ lending and their deposits placed with central bank, to 1.75 percent after US Federal Reserve recent hike.

According to the report, the improving liquidity and funding conditions in the Kingdom since 2017 have driven the Saudi Arabian Interbank Offered Rates (SAIBOR) spread against US dollar London Interbank Offered Rate (LIBOR) to its lowest level since 2009, which reached negative spreads in recent weeks.

"Last Thursday, the three-month Saudi rate was 13 basis points below its US dollar equivalent (it was more than 100 basis points higher than at the end of 2016), a negative spread that, if it persists and widens, risks triggering an increase in capital outflows as Saudi investors and depositors seek higher returns," the report said.

SAMA’s decision also reflects a funding situation that has improved since 2015 and 2016, when plunging oil prices and large sovereign debt domestic issuances reduced funding available to banks and negatively affected their funding costs.

Since 2017, liquidity conditions have improved for Saudi banks, though credit contracted by 1 percent last year and public-sector deposits increased 12 percent, underpinned by improving oil prices and increasing international sovereign bond issuances.

Banks’ liquid assets rose 11 percent last year to SAR 457 billion, while the ratio of reserves (including cash in the vault and balances with SAMA) to total deposits climbed to 14.8 percent at year-end 2017, the highest since year-end 2012. The increases occurred despite a 3 percent decline in private-sector deposit growth last year after a 4 percent increase in 2016.

Moody's, however, warned that further rate hikes risk hampering Saudi Arabia’s economic recovery, which it expects will be modest this year with real GDP growth of 1.3 percent against a contraction of 0.7 percent in 2016.

"Rising borrowing costs will weigh on consumption and investment decisions, lower debt repayment capacity and result in higher asset risks for banks," the report said.

Earlier this month, Moody’s said that a gradual pickup in credit growth and the positive effect of higher interest rates are likely to support Saudi banks’ profitability this year and offset continued provisioning efforts.