Moody's Investors Service has revised its outlook for the Saudi Arabian banking system to stable from negative. The stable outlook reflects high risk-absorption buffers and easing funding pressures, as Saudi banks' credit profiles are expected to remain broadly stable over the next 12 to 18 months, said Moody's Investors Service. "Despite low oil prices, which we expect to fluctuate between $40 and $60 a barrel over the next 18 months, and cuts in oil production, the Saudi economy will gradually recover, supported by government spending. As a result, Saudi banks' liquidity and funding conditions will improve. Although profitability and loan performance will continue to soften, Saudi banks will maintain robust capital and loss absorption buffers compared to regional and international peers over the outlook horizon," said Olivier Panis, a Vice President at Moody's. According to Moody's, the operating environment for Saudi banks will recover. Whilst the rating agency expects real GDP growth to contract by -0.2% in 2017, increased government spending and projects to diversify economic output will support a gradual recovery of the non-oil economy, which will grow by 2% in 2017 versus 0.2% in 2016. Consequently, Moody's expects credit growth to remain low at 3% in 2017, but to gradually pick up from 2018. Moody's expects non-performing loans (NPLs) to increase to 2.5% of gross loans over the outlook horizon, from a low level of around 1.4% as of September 2016. Although banks will also remain vulnerable to high single-party exposures and opacity in the corporate sector, banks will maintain the highest level of loan-loss provisioning coverage in the region. Banks will maintain a solid operating performance, although subdued loan growth, rising provisioning charges and lower fee and commission income will weigh on profits. The impact will be partly mitigated by stable margins, low operating costs and easing pressure on funding costs. Despite Moody's expectation of reduced profitability, subdued loan growth will support capital adequacy, which will strengthen from already strong levels. Moody's anticipates the sector's average tangible common equity (TCE) ratio will increase to around 17% by the end of 2018, up from around 16.2% in September 2016. Moody's says that access to funding will improve owing to liquidity injections from international sovereign debt issuances, the clearing of large volumes of overdue payments to contractors by the government in Q4 2016 and modest credit growth. However deposit growth will remain low until economic activity picks up more materially in 2018. Moody's expects Saudi authorities' willingness and capacity to provide financial support to the local banks to remain high, but notes that the policy stance of the Saudi authorities may evolve as the regulator is contemplating the adoption of the Financial Stability Board's best practice on the resolution of distressed banks. — SG
