RIYADH: Saudi banks will see their customer base expand thanks to government-backed economic diversification efforts that are boosting innovation and productivity, according to a new report.
Saudi Arabia and Oman were the GCC countries with the least volatility in non-oil sector expansion from 2020 to 2023, according to Moody's analysis of banks from the Gulf Cooperation Council and the Commonwealth of Independent States.
The kingdom also ranked in the top three for total non-oil growth during the period, along with the United Arab Emirates and Qatar.
Moody's Ratings Assistant Vice President Vladlen Kuznetsov said: “Oil-dependent economies in the Gulf, Iraq, Kazakhstan and Azerbaijan continue to expand as governments provide funding for diversification initiatives.”
He added: “Barring external shocks, growth in non-oil sectors is expected to exceed 3 percent or 4 percent in the coming years, accelerating from an average of about 1 percent or 2 percent in 2016-2021. This will outpace the growth of oil fields in most cases. ”
Saudi Arabia's Vision 2030, noted by Moody's, aims to reduce oil dependence by boosting real estate and tourism with projects like NEOM. Banks, although small relative to the economy, are increasingly investing in non-oil enterprises and have high quality loans.
Slow deposit growth may push them towards volatile market funds. However, stronger government creditworthiness and continued diversification are expected to improve support for banks during times of financial 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.
According to a report by Kuwait-based Markaz, the kingdom raised $37 billion through 44 issuances during the period. Despite these substantial funding requirements, Saudi banks maintain healthy balance sheets, with S&P Global Ratings providing investment-grade ratings and a stable outlook to most major lenders.
The economies of the Gulf States, Iraq, and parts of the CIS are heavily dependent on oil and gas. However, climate concerns are shifting to new sectors supported by the government's diversification efforts.
State financing is fueling large infrastructure projects and subsidizing small and medium enterprises in non-oil sectors.
GCC governments 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 reduce financial vulnerability to oil price fluctuations and increase resilience to the global carbon transition, which will benefit local banks. However, it may take years to realize the full impact of these diversification efforts.
Benefits and challenges of diversification
In oil-dependent economies, domestic banks often focus on narrow non-oil sectors such as real estate, construction, trade, and services, as well as some manufacturing, according to Moody's.
Large oil and gas companies in these economies, being financially strong, typically borrow from global banks rather than domestic ones, limiting lending opportunities for local banks.
Consequently, domestic banks' loan portfolios are dominated by a few large institutions, and their deposit bases are similarly concentrated.
Most large-scale diversification projects are financed by governments and state-owned enterprises rather than local banks, in contrast to more developed economies where such efforts are often bank-financed, the report added.
In GCC countries, the presence of wealthy governments and state-owned firms reduces the demand for domestic bank loans.
The report notes that banks will benefit from a number of factors as these economies diversify. They will expand their franchises and improve financial inclusion, as non-oil sectors are more stable than oil sectors, leading to sustainable economic growth and an increase in public wealth.
This asset growth increases the creditworthiness of retail borrowers and provides more lending opportunities to banks. New companies will emerge, profits will increase as companies innovate, and household incomes will increase.
More credit options will help banks better manage risks and stabilize the credit cycle in volatile sectors like retail and construction. With less financial volatility, banks will find it easier and cheaper to get long-term funding.
Increased monetary and financial stability will attract long-term deposits and foreign investment, improve banks' funding sources and support their growth.
Stable government finances will also increase the ability to support banks in tough times, although these benefits may take years to fully materialize.
According to Moody's, the benefits of financial diversification vary across banks and economies due to factors such as legal frameworks, rule of law, and corruption.
Large banks, especially in developed economies, can leverage diversification more effectively because of their financial strength, supporting growth in sectors such as manufacturing and manufacturing.
Banks in Qatar, the UAE and Kuwait are already key to investing in economic development. However, the impact on banks' credit quality, funding and government support will depend on their current conditions.
For example, banks in Saudi Arabia with low problem loans may see less impact than those in Kazakhstan with high problem loans.
Banks in the CIS and Iraq, where the banking sectors are small relative to the economy, have the most potential for growth.
Overall, banks in Kazakhstan, Azerbaijan and Qatar as well as Oman, UAE and Saudi Arabia are positioned to benefit from diversification, according to Moody's. They either experience strong economic momentum or have opportunities to address key credit challenges such as franchise growth, credit quality, funding and government support.
The role of government
According to Moody's, diversification is highly dependent on government initiatives and could be hampered by adverse commodity price changes or geopolitical shocks.
Countries such as Saudi Arabia, the UAE, and Kuwait, as well as Qatar, Azerbaijan, and Kazakhstan, have substantial resources for infrastructure and regional subsidies, although not all invest significantly.
Saudi Arabia's government budget was $344 billion in 2023, an 11 percent increase over the previous fiscal year. In an announcement in December 2023, the Ministry of Finance estimated that 2024 spending would total $333 billion.
This translates to a government debt to GDP ratio of 27.5 percent, according to the IMF's World Economic Outlook in April.
This compares to the UAE's 2024 budget expenditure of $17.44 billion and Kuwait's estimated government expenditure of $80 billion, according to announcements by their respective finance ministries.
According to the IMF, Kuwait's debt-to-GDP ratio is estimated at 7.1 percent and the UAE's at 30.3 percent.
Saudi Arabia boasts the highest reserve coverage ratio among Fitch-rated sovereigns, equivalent to 16.5 months of current external payments.
According to the ministry, this budget will focus on accelerating the implementation of important programs needed to achieve the goals of Saudi Vision 2030.
It also highlights the importance of strong partnerships with the private sector to advance economic diversification and enhance employment opportunities for the Saudi workforce.
