Assuring liquidity: New market tools are positioning lenders to expand credit

When the price of crude oil began its decline in mid-2014, banking regulators across the GCC examined the liquidity in their respective banking sectors. The centrality of hydrocarbons activity in regional economies means that large alterations to spot prices and futures have the potential to significantly affect the liquidity, and therefore the lending ability, of banks.

Robust oil revenues over recent years allowed governments from Riyadh to Muscat to drive economic growth through large infrastructure projects, but the flipside of this approach is that when hydrocarbons revenues fall the project pipeline tends to slow, and the chain of contractors and suppliers – from multinationals and domestic giants to the myriad small businesses that provide goods and services to them – see a drop in business. For the banks that secure their annual margins by lending to the corporate sector, the consequence is a reduction in net profit.


Should the decline in oil price be sufficiently large, or the duration of the subdued price be sufficiently long, the downward pressure on lending activity is given further impetus by tightening liquidity. The mechanics of such a trend are straightforward: slowing project pipelines mean smaller deposits in banks from institutions and individuals, which in turn means banks are liable to find themselves hitting the loan-to-deposit ratio (LDR) limits set by regulators, which in the GCC region tend to be on the more conservative side.

This effect is amplified when governments, attempting to meet the fiscal shortfall caused by falling oil revenues, draw down on their deposits with domestic banks. In an oil price environment such as the one seen since mid-2014, the ability of banks to extend credit to customers and thereby perform their function as agents of economic growth is an important government concern.

First Signs

Thanks to years of prudent regulation, Saudi Arabia’s banks are generally well capitalised and highly liquid. Nevertheless, the domestic system is not immune to the effects of a depressed oil price, and by the second half of 2015 signs of a potential liquidity issue were visible in the market. In November the interbank rate – the rate of interest charged on short-term loans between banks – rose at the fastest pace in seven years as lenders reacted to a slowdown in deposit growth over the previous month, caused in large part by the government delaying payments to contractors and drawing down on its own deposits as it set about tackling its fiscal deficit.

According to SAMA, deposits in the Kingdom dropped by SR50.5bn ($13.5bn) in October 2015, with the deposits of businesses and individuals falling by SR23.2bn ($6.2bn) and those of government entities by SR27.3bn ($7.3bn). Murad Ansari, analyst at EFG-Hermes Holding, highlighted the significance of the development: “The drop in deposits in October 2015, in absolute amounts, is probably the biggest since the 1990s,” he told Bloomberg.

Playing Percentages

With mid- and long-range economic forecasts anticipating no significant change in macroeconomic circumstances, in January 2016 SAMA addressed the issue directly, choosing the most significant regulatory lever available to boost liquidity in the system: the LDR requirement. This had stood at 85% for years, a conservative level which had helped to establish the Kingdom’s banking sector as one of the most stable in the region.

By the beginning of 2016 the aggregate LDR for the sector stood at 81% which, while low compared to the 89% average for Gulf banks and 93% for the rest of the world, was approaching SAMA’s limit. Therefore the regulator decided to raise the LDR limit to 90%, meaning that the Kingdom’s banks are better positioned to expand credit without resorting to either to a price war to attract the necessary deposits or expensive long-term borrowing. An August 2016 report by Jadwa Investment stated that, “Total bank deposits rose in June 2016 following two consecutive monthly declines… Private sector deposits saw a large monthly addition of SR21.8bn ($5.8bn), while government and other deposits fell. The LDR rose to 90%, which leads us to believe that SAMA will further ease the limit.”


A regulatory change of this nature does not come without costs. The previous 85% LDR limit was one of the strengths of the Kingdom’s banking system, and any change to it is bound to lead some observers to reassess aspects of the sector. Ratings agency Moody’s, for example, has described the move as “credit negative” in that it relaxes an important safeguard of the more prudential framework that has historically enjoyed its approval.

However, the regulator’s long-standing conservative approach means it has ample room for manoeuvre when it comes to deploying market management tools such as the LDR or capital adequacy ratio. Moreover, despite the market dynamics which impelled the regulator to adjust the LDR, Saudi Arabia’s banking sector is in a comfortable position as far as near-term liquidity is concerned, as demonstrated by the recently introduced metrics of Basel III – the set of banking rules and standards that are being implemented by regulators across the globe.

Liquidity Coverage Ratio

In January 2015 SAMA introduced a central component of Basel’s framework, the liquidity coverage ratio (LCR). Designed to boost banks’ short-term resilience to liquidity shocks, the LCR requires banks to hold a stock of high-quality liquid assets, such as cash or assets that can be easily sold in private markets with little loss of value, which must at least equal the value of the likely net cash outflows which the bank might experience during a 30-day period of stress.

With Saudi Arabian banks now reporting liquidity levels in line with Basel standards, Moody’s estimated in early 2016 that the local sector had an LCR of 200% – a high level by international standards.

This underlying strength is reflected in the Saudi Arabia Interbank Offered Rate (SAIBOR) in 2016. The modest upward trend in the three-month SAIBOR, which drew attention when it began in November 2015, had reached 1.91% by March 2016, according to data services consultancy Trading Economics. However, while this represents a significant rise on the SAIBOR low point of 0.6% in early 2010, it is only a modest uptick within the larger context: when the banking sector was experiencing a liquidity challenge in 2008 as a result of the global credit crunch, the three-month SAIBOR went as high as 5.24%. In this context, the more recent interbank rate rise is not seen as a major concern for the regulator.

Financial statements issued by Saudi banks in early 2016 appeared to support the idea that the liquidity issue has not yet seriously troubled them. Aggregate net loans and advances for the first quarter of 2016 rose year-on-year from SR1.3bn ($346.6m) to SR1.4bn ($373.2m), a gain of approximately 9.4%.