Saudi banks weather stock market crash but stellar financial performances will be difficult to replicate, says S&P

The banking system in the Kingdom of Saudi Arabia is the largest in the Gulf and among the most profitable worldwide, although foreign competition is rising, Standard & Poor's Ratings Services noted in a new report, "Bank Industry Risk Analysis: A Bright Future For Saudi Banks, Despite Stock Market Collapse". Asset quality has improved rapidly since 2002 due to the very strong economic environment and conservative provisioning policies, but may deteriorate in the future on the back of a real-estate or oil price correction.

"The profitability of Saudi banks is among the strongest worldwide, owing to high levels of nonremunerated deposits, good cost control, and a focus on profitable consumer banking activities. In addition, commercial banks tend to be deposit rich and highly liquid," said Standard & Poor's credit analyst Anouar Hassoune.

Overall, the Saudi banking system is a net placer of funds in the international capital markets. Fuelled by interrelated skyrocketing oil prices and government spending, high economic growth over the past years has boosted system assets, particularly on the retail-banking side. That and large nonrecurring gains from IPOs and brokerage transactions have delivered stellar financial performances for the whole banking sector, which will be difficult to replicate in the future. Finally, the capitalization of Saudi banks is solid.

Banks demonstrated their ability to weather the effects of the crash in local equity prices in 2006, which plummeted by more than 50%. Standard & Poor's considers a tumble in real estate prices--although unexpected--would have more severe consequences. On the banking market, foreign competition is mounting, although new entrants are forced by pure market forces to compete on expertise in niche segments, rather than business differentiation. Domestic banks have indeed strengthened their capacity to react and diversify their activities into new engines of growth such as Islamic and investment banking.

Given its size, the Saudi banking system remains protected with 21 commercial institutions--11 locally incorporated entities and 10 foreign banks. Sector strength is based on the banks' strong financial performance, ample liquidity, high capitalization, and strict supervision by the authorities. These strengths are partly offset by the risks of operating in an economy sensitive to oil-price fluctuations and government spending, banks' exposure to the potentially volatile real estate and stock markets, booming credit expansion--although slowed down by the recent stock market crash--and nascent foreign competition in niche segments.

"Our assessment of the Saudi banking system takes into account the highly supportive approach of the country's authorities, which nevertheless, leaves the industry vulnerable to moral hazard," said Standard & Poor's credit analyst Paul-Henri Pruvost.

Financial disclosure has improved considerably in recent years and with the application of the second pillar of the Basel II framework, additional analytical information is expected to become available. Standard & Poor's considers SAMA, the banking supervisory authority in Saudi Arabia, as one of the best regulators among emerging markets, steering the banking system through some potentially difficult times.

"SAMA's approach to banking supervision is a blend of American-style procedures and methods, and the Bank of England's model, which relies more on prudential returns and informal meetings with regulated institutions," Mr Hassoune added.