RIYADH: Saudi banks will see an expanded customer base and increased revenues thanks to government-backed economic diversification efforts that promote innovation and productivity, according to a new report.
Saudi Arabia and Oman were the two Gulf countries with the lowest volatility of non-oil sector expansion from 2020 to 2023, according to Moody's analysis of banks in the Gulf Cooperation Council and Commonwealth of Independent States.
The kingdom also ranked in the top three for combined non-oil growth over the period, along with the UAE and Qatar.
Vladlen Kuznetsov, assistant vice president at Moody's Ratings, said: “Oil-dependent economies in the Persian Gulf, Iraq, Kazakhstan and Azerbaijan are expanding as governments provide financing for diversification initiatives.”
He added: “Barring external shocks, growth in non-oil sectors could exceed 3 percent or 4 percent in the coming years, accelerating from an average of around 1 percent or 2 percent in 2016-2021. In most cases, it will outpace the growth of the oil sectors.”
Moody's noted that Saudi Arabia's 2030 vision aims to reduce dependence on oil through real estate and tourism development through projects such as NEOM. Banks, although small relative to the economy, increasingly finance non-oil businesses and have high-quality loans.
Slower growth in deposits may push them to unsustainable financing in the market. However, the government's strong creditworthiness and continued diversification are expected to improve bank support during economic stress.
The kingdom has actively used the debt market to finance its ambitious projects, leading the GCC bond market in the first half of 2024.
The Kingdom raised $37 billion through 44 issues during the period, according to a report by Kuwait-based Markaz. Despite these significant funding needs, Saudi Arabia's banks maintain healthy balance sheets, with S&P Global Ratings assigning investment-grade ratings and stable outlooks to most major lenders.
The economies of the countries of the Persian Gulf, Iraq and parts of the CIS are still heavily dependent on oil and gas. However, climate challenges are driving a shift to new sectors, supporting the government's diversification efforts.
Public funding favors major infrastructure projects and offers subsidies to small and medium-sized enterprises in non-oil sectors.
The governments of the Gulf states, including Saudi Arabia, Kuwait and Oman, as well as Qatar, the UAE and Bahrain, are working to reduce their dependence on hydrocarbons through ambitious diversification initiatives – along with CIS countries including Kazakhstan and Azerbaijan.
According to Moody's, these projects aim to mitigate economic vulnerability to oil price fluctuations and increase resilience to the global carbon transition, benefiting local banks. However, the full impact of these diversification efforts may take years to realize.
Advantages and problems of diversification
In oil-dependent countries, domestic banks often focus on narrower non-oil sectors such as real estate, construction, trade and services, and some manufacturing, Moody's said.
The major oil and gas companies in these countries, being financially sound, typically borrow from global banks rather than domestic ones, which limits lending opportunities for local banks.
Thus, the credit portfolios of domestic banks are dominated by a few large organizations, and their deposit base is also concentrated.
Most large-scale diversification projects are financed by governments and state-owned enterprises, not local banks, in contrast to more developed economies where such efforts are often financed by banks, the report added.
In the GCC countries, the presence of wealthy governments and state-owned firms further reduces the demand for domestic bank loans.
The report notes that as economies diversify, banks will benefit from several factors. They will expand their franchises and improve financial inclusion, as the non-oil sectors tend to be more stable than the oil sectors, leading to more stable economic growth and increased public welfare.
This increase in welfare increases the creditworthiness of retail borrowers and offers banks more lending opportunities. New companies will emerge, profits will rise as innovation is introduced, and household incomes will rise.
More lending options will help banks better manage risk and stabilize credit cycles in volatile sectors such as retail and construction. With reduced economic instability, it will be easier and cheaper for banks to obtain long-term financing.
Increased monetary and economic stability will attract long-term deposits and foreign investment, improve sources of funding for banks and support their growth.
Stable public finances will also improve their ability to help banks in difficult times, although these benefits may take years to fully materialize.
The benefits of economic diversification vary by bank and economy due to factors such as legal frameworks, the rule of law and corruption, according to Moody's.
Larger banks, especially in developed countries, can leverage diversification more effectively because of their financial strength, supporting growth in sectors such as manufacturing and construction.
Banks in Qatar, the UAE and Kuwait already play a significant role in financing economic development. However, the impact on the quality of bank loans, financing and government support will depend on their current conditions.
For example, banks in Saudi Arabia with low levels of non-performing loans may experience less of an impact compared to banks with more non-performing loans, such as in Kazakhstan.
Banks in the CIS and Iraq, where the banking sectors are smaller relative to the economy, have the greatest potential for growth.
Overall, banks in Kazakhstan, Azerbaijan and Qatar, as well as Oman, the UAE and Saudi Arabia, are well positioned to benefit from diversification, according to Moody's. They either experience strong economic momentum or have the ability to address key credit issues such as franchise growth, credit quality, financing and government support.
The role of the government
According to Moody's, diversification is highly dependent on government initiatives and may be hindered by adverse changes in commodity prices or geopolitical turmoil.
Countries such as Saudi Arabia, the UAE and Kuwait, as well as Qatar, Azerbaijan and Kazakhstan, have significant resources for infrastructure and sector subsidies, although not all are investing heavily.
Saudi Arabia's public budget expenditures in 2023 totaled $344 billion, an 11 percent increase over the previous fiscal year. In a December 2023 announcement, the Treasury Department projected spending for 2024 to be $333 billion.
That translates to 27.5 percent of public debt to GDP, according to the IMF's April World Economic Outlook.
This compares with the UAE's 2024 budget spending of $17.44 billion and Kuwait's projected public spending of $80 billion, according to announcements by the respective finance ministries.
According to the IMF, Kuwait's debt to GDP is projected at 7.1 percent, while the UAE's is at 30.3 percent
Saudi Arabia boasts one of the highest reserve coverage ratios among Fitch-rated sovereigns, equivalent to 16.5 months of current foreign payments.
This budget will focus on accelerating the implementation of critical programs needed to achieve the goals of Saudi Vision 2030, according to the ministry.
He also emphasized the importance of strengthening partnerships with the private sector to promote economic diversification and expand employment opportunities for the Saudi workforce.
