The outlook for the Saudi Arabian banking system is stable, said Moody's Investors Service in a report.

The outlook, which has been stable since September 2009, reflects the benign operating environment, continued low problem loan levels, the banks' strong loss-absorption capacity, and the benefits of low-cost deposit-based funding, said the report entitled ‘Banking System Outlook: Saudi Arabia.’

However, the rating agency identifies competitive pressures on lending margins and some corporate sector weakness, which will constrain further improvements in Saudi banks' profitability.

Over the 12- to 18-month outlook period, Saudi Arabia's banking system is expected to continue to benefit from expansionary fiscal policy, it said.

It is also anticipated that the non-oil sector, where most bank lending is extended, will continue to expand, growing by almost 6 per cent this year and just over 5 per cent in 2014. Balancing these factors is the kingdom’s high unemployment rate as well as tail risks stemming from ongoing regional geopolitical tensions and a sustained drop in oil prices.

As a result of the benign operating environment, Moody's expects problem loan formation to decline, which, in addition to continued loan growth, will lead to an improvement in the problem loans-to-gross loans ratio to around 2 per cent over the next 12 months.

Although the improving trend is expected to continue, asset quality will remain exposed to event risks, owing to persistently high, albeit declining, single-party exposures in Saudi banks' loan books, and some vulnerabilities in the corporate sector such as the low transparency of family-owned businesses and the intermingling of investment activities with operating activities.

Saudi banks are also expected to sustain their strong pre-provision profitability over the outlook period, with the prevalence of low-cost funding, strong operational efficiency, lower loan loss provisioning expenses and continued growth in business activity balancing the margin pressures caused by increasing competition and the low interest-rate environment, said the Moody’s report.

The banks’ high profitability is expected to continue to drive internal capital generation and substantial loss-absorption capacity. While Tier 1 capital levels may decline slightly from around 16 per cent at the end of June, capital buffers remain strong, it said.

The banking system will maintain a solid deposit base, reflecting the system's strong funding dynamics, underpinned by a cash-rich Saudi government, a growing population and the banks' well-established deposit franchises, said the report. - TradeArabia News Service