Fitch: Saudi Islamic banks' financial metrics deteriorated, but sound

Fitch Ratings-London/Dubai-19 May 2020: Saudi Islamic banks' financial metrics deteriorated mildly in 2019 but remained sound, Fitch Ratings says in a new report. Saudi Islamic banks remain well placed in the banking sector with larger retail franchises supporting a lower cost of funding and better asset quality.

Saudi Arabia has the largest Islamic banks' financing share (79%) of any country that allows conventional banks to operate alongside Islamic banks.

As for conventional banks, the impaired financing ratios continued to increase in 2019, particularly due to pressure in the contracting, auto, retail and retail/wholesale trade sectors. Islamic banks enjoy lower impaired financing ratios and financing impairment charges (FICs) than conventional banks due to a lower proportion of corporate banking.

Islamic banks' profitability metrics remained above conventional banks' in 2019. This was owing to higher margins, which benefit from both a higher proportion of retail financing and lower cost of funding (due to stronger retail franchises and a higher share of non-profit-bearing deposits)..

Strong deposit growth at Islamic banks in 2019 allowed their financing/deposits ratio to drop below their conventional peers'. Deposit concentration is high, except at Al Rajhi, which benefits from a granular retail deposit base. Islamic banks benefit from the Ministry of Finance's Saudi riyal-denominated sukuk programme to manage their liquidity.

Islamic banks remain well capitalised, with an average common equity Tier 1 ratio of 17.8% at end-2019 (in line with their conventional peers'). Islamic banks have higher proportions of retail banking assets and lower off-balance-sheet activities, which result in lower risk weightings. This explains why they operate with lower equity/assets ratios.

In February 2020, the Saudi Arabian Monetary Authority (SAMA) issued a sharia corporate governance framework for banks engaging in Islamic banking, aiming to establish standards for sharia governance practices. While the outcome of the new framework is unclear, slower progress on this is likely as a result of lower oil prices and the coronavirus.

Saudi Islamic banks will be impacted by the coronavirus and lower oil prices, despite the timely support measures introduced by SAMA. Profitability will be pressured by lower official profit rates and higher FICs. Asset quality will also weaken, although possibly less than at conventional banks owing to the high portion of lower-risk retail financing.

If the current economic disruptions remain in place for longer, weaker asset quality and profitability are likely to put pressure on capital. Liquidity is less of a risk as the government has already taken measures, including debt issuance, to inject deposits in the banking system.

The full report, "Saudi Islamic Banks: 2019 Results Dashboard" is available at www.fitchratings.com or by clicking the link above.

Copyright Press Releases 2020