Saudi Islamic banks to benefit most from repo rate hikes: Fitch

Saudi Arabia's Islamic banks, which continue to outperform conventional banks, will be the biggest beneficiaries from rising interest rates this year, Fitch Ratings said in a new report.

"The offsetting impact of higher funding costs will be less for Islamic banks than conventional banks and will also get a boost because they have a higher proportion of non-profit bearing deposits," it added.

Saudi Arabian Monetary Authority, the Kingdom's central bank, raised the official repo rate from 2 percent at end-2017 to 2.25 percent in March and 2.5 percent in June.

"We expect the banking sector earnings to increase in 2018, although financing growth is likely to remain muted," the report said, adding, the capital buffers of Saudi banks will "remain strong and sufficient to absorb a potential mild deterioration in asset quality."

Meanwhile, Islamic banks continued to outperform conventional banks, helped by lower funding costs and a higher proportion of retail financing. Islamic banks, like conventional banks, have benefitted from improved liquidity conditions, Fitch said.

Last year, the Ministry of Finance established a Saudi riyal-denominated sukuk program, which has been issuing regularly. The report termed it is as a "positive development to help Islamic banks manage their liquidity."

Saudi Arabia has the largest Islamic banks' financing base (78 percent) of any country that allows commercial banks to operate alongside Islamic banks.  

The Kingdom's banks are predominantly deposit funded, with deposits representing about 90 percent of funding at Islamic banks and about 94 percent at conventional banks at end-2017.  

According to Fitch, Islamic banks are well capitalized, with an average core capital ratio of 18.6 percent at end-2017, which is 70 basis points above conventional peers due to lower risk weightings on retail banking assets and lower off-balance-sheet activities.

Capital ratios have increased in recent years due to lower financing growth and improved profitability, the report added.