Saudi banks are likely to require further central bank liquidity injections after interbank spreads rose sharply in October and as lending growth continues to outpace deposit growth, Fitch Ratings said in a new report.

Sector loans increased by 12.5% in nine-month 2022, compared with 8% for deposits, loans/deposits ratio (LDR) for Saudi banks collectively to rise to 102.2%, its highest level in at least 15 years, according to Fitch’s calculations.

“Without liquidity support, lending growth could be muted in Q4 2022 and our 2023 loan growth forecast of 12% lowered, while banks’ cost of funding will continue to increase.”

Three-month SAIBOR-Libor spreads increased to more than 140 basis points (bp) in October from 36 basis points (bp) in September, close to their levels in May of 150bp before the liquidity injection. This compares with a historical average of about 50bp.

SAMA’s support helped bring SAIBOR-Libor spreads down sharply to about 2bp by end-August before they widened again as the US Federal Reserve continued raising rates and lending growth remained strong.

Last month’s increase in 3M SAIBOR-Libor spreads of more than 100bp indicates that liquidity conditions are tightening again. “With markets pricing in further US Fed rate rises by end-1H23, we expect three- and six-month SAIBOR to exceed 6%, which would probably lead to further SAMA intervention to ease liquidity conditions.”

The sector’s regulatory LDR of 81.9% is below the 90% limit, but is its highest since end-Q3 2017. In September 2016, SAMA injected more than SAR20 billion of liquidity into banks after three-month SAIBOR-Libor spreads had exceeded 150bp in June. However, this was amid weak lending growth (1% on average in 2016 and 2017).

Without liquidity support, lending growth could decelerate in 2023, despite strong credit demand with corporate and retail loans up 13.5% and 11.4%, respectively, in the first nine months of 2022. Corporate credit demand is underpinned by large infrastructure projects under the Saudi Vision 2030 framework to diversify the economy.

Government initiatives to reach 70% home ownership by 2030 should support further growth in retail mortgages (31% YoY in H1 2022; 22% of total loans).

Banks could also use medium- to long-term funding to finance growth through subordinated debt, additional Tier 1 (AT1) securities or senior unsecured issuance. However, this would weigh on banks’ cost of funding and would not meet high financing demand from borrowers. Saudi banks have issued SAR15.6 billion of AT1s this year and Al Rajhi Bank is looking to issue AT1 with an initial amount of SAR4 billion this month. Some banks have established EMTN (Euro Medium Term Note) programmes to issue US dollar senior unsecured notes and have securitised mortgages with the Saudi Real Estate Refinance Company.

“Tightening liquidity and the continuing increase in LDRs, our core funding and liquidity metric, is credit negative, especially for banks with higher Viability Ratings,” said Fitch.

Increased long-term issuance could be credit positive for banks’ funding and liquidity profiles, particularly if the duration gap between asset and liabilities narrows, and net stable funding ratios improve. However, duration gaps have widened significantly as the volume of mortgages more than doubled since 2019 and challenging global market conditions may constrain market access to some extent.

Earnings and profitability could come under pressure should domestic liquidity remain tight. “However, this is not our base case for most banks as profitability will remain underpinned by higher net interest margins (especially for corporate-focused banks) and non-interest revenues as assets grow, and by lower loan impairment charges as economic conditions remain solid.”

The sector’s profit before tax increased 28% YoY in nine-month 2022, with balance sheet growth and lower impairment charges offsetting higher cost of funding.