Liquidity pressures among Saudi banks are easing after the past two years of deposit outflows and increased funding costs as a result of falling oil prices and associated government revenues, Moody's Investors Service said in its latest sector comment. Easing cash flow pressures in the private sector will also help as the government settles outstanding bills with contractors issuance to flow into local banks either directly, through public-sector deposits, or indirectly in the form of corporate deposits. Moody's expects Saudi banks' credit growth to moderate and pressures on SAIBOR to ease further owing to a number of factors: Lower volumes of domestic government bond issuances, following the success of the external bond issuance, which will limit competition for available liquidity in the banking system. Traditionally lower loan growth in the second half of the year because of seasonal factors (loan growth contracted 1% quarter on quarter during third-quarter 2016), and Moody's expectation of a further slowdown to 3%-5% growth next year. Moody's expect banks' credit growth to moderate and pressures on SAIBOR to ease further owing to a number of factors. One factor is lower volumes of domestic government bond issuances following the success of the external bond issuance, which will limit competition for available liquidity in the banking system. Another factor is traditionally lower loan growth in the second half of the year because of seasonal factors (loan growth contracted 1% quarter on quarter during third-quarter 2016), and our expectation of a further slowdown to 3%-5% growth next year. Easing cash flow pressures in the private sector will also help as the government settles outstanding bills with contractors. Although Moody's expect banks' operating environment to remain challenge On Monday, the three-month Saudi Interbank Offered Rate (SAIBOR) fell to 2.19% from 2.39% three weeks earlier to reach its lowest level since June 2016 and reverse the upward trend of the past 12 months. The SAIBOR's decline is credit positive because it indicates that liquidity pressures among Saudi banks are easing after the past two years of deposit outflows and increased funding costs as a result of falling oil prices and associated government revenues. We expect that the decline in three-month SAIBOR, a gauge of domestic funding conditions and a benchmark for lending rates, will reduce banks' funding costs. Over the past year, the benchmark rate surged to 2.4% in October, its highest level since January 2009, from 0.9% a year earlier, amid a tightening liquidity environment. As a result, the average cost of funding for local banks more than doubled to 0.85% for the first nine months of 2016 from 0.4% in the first half of 2015. However, net interest margins and bottom-line profitability have not been affected, with banks' return on assets unchanged at 2.0% as of third-quarter 2016. The SAIBOR decline, including a steep 2.9-basis-point drop on 2 November, follows Saudi Arabia's $17.5 billion international sovereign bond issuance on 19 October. We expect some of the proceeds from that issuance to flow into local banks either directly, through public-sector deposits, or indirectly in the form of corporate deposits. The government recently announced that it aims in the coming months to clear delayed payments to Saudi contractors that have accumulated since 2015. Earlier this year, the central bank deployed various monetary instruments to alleviate banks' liquidity challenges. Those moves included increasing the maximum allowable loan-to-deposit ratio to 90% from 85%, successive deposit injections totaling SR32 billion, and introducing seven-day, 28-day and 90-day repurchase agreements with the Saudi Arabian Monetary Agency. Since the fall in oil prices, Saudi banks' deposit growth has been subdued owing to government spending cuts and slowing economic growth, as shown by a 2% year-on-year decline in total banking deposits as of September 2016, versus a 12% compound annual growth rate during 2011-14 (see exhibit). At the same time, total banking credit grew rapidly, rising 7% in September 2016 from a year earlier. Both trends resulted in a significant rise in banks' net loan-to-deposit ratio to 86% as of September 2016 from 77% as of year-end 2014. — SG
