Saudi Arabia's banks have had little reason to celebrate since May, when the central bank froze the accounts of Maan al Sanea, the chairman of Saad Group and one of the kingdom's most influential businessmen.
That event triggered what has become the Middle East's biggest financial scandal, while the intervening three months have shaken confidence in Saudi Arabia's banking system as wary investors keep a tally of debt defaults from the Saad Group and Ahmad Hamad Al Gosaibi and Brothers. The two family conglomerates are estimated to owe as much as US$20 billion (Dh73.46bn) to about 100 regional and international lenders.
But signs are now emerging that the kingdom's battered banking sector is poised for revival - having already made provisions for likely defaults related to the two groups - and is now looking forward to the economic benefits of rising oil prices and a young population. Fears over bad debt related to Saad and Al Gosaibi already pushed up second-quarter provisions at most Saudi banks, but none have quantified their exposure nor specified whether any of the write-downs are related to the two groups.
"The bulk of the news flow regarding Saad and Al Gosaibi is out, and the current lack of transparency has led investors to assume worst-case scenarios," Bank of America (BofA) Merrill Lynch writes in its new report entitled "Beyond Crude". Al Rajhi Bank, Saudi Arabia's largest lender by market value, booked 421.6 million riyals (Dh413m) in provisions in the second quarter, while the much smaller Saudi Investment Bank (SAIB) lifted second-quarter provisions 11 times from the year earlier.
"Actual levels of exposure and expected losses at the individual bank level are guesswork," says Victor Lohle, an analyst at Standard Chartered. Mr Lohle estimates that Saudi banks are carrying about $5bn in exposure to Saad and Al Gosaibi. Yet despite the apparent escalation of the crisis in recent weeks as the two family groups and their lenders file claims and counter-claims, analysts say the local financial fallout may not be as great as previously thought.
"We argue that the alleged fraud is an isolated event and should not have an impact on other banks in the kingdom," says Mr Lohle. Saudi banks remain in good shape compared to many of their western peers, as they benefit from growing numbers of petrodollars and a very young and fast-growing population; a younger population is seen as spending more freely. While the Saudi economy is expected to shrink by about 0.9 per cent this year, massive oil windfalls have allowed the government to pledge $450bn in infrastructure investments over the next five years. Oil is trading at about $72 a barrel, about double its lowest price this year.
"It is unclear if the banks have taken impairment charges in [the first half] against these exposures and it is difficult to know if they will do so during the second half of the year. But even if the whole lot has to be written off, it is not going to sink the entire banking system," says Robert Thursfield, the director of financial institutions at Fitch Ratings in Dubai. As a result, Saudi banks should be able to absorb the still-emerging financial fallout from Saad-Gosaibi without representing a systemic risk within the kingdom's financial sector.
Mr Lohle argues that even under an extreme scenario where a bank has lent up to 50 per cent of its equity to Saad and Al Gosaibi, it would still be likely to remain solvent. This is because Saudi banks have comparatively strong capital ratios. In addition, the government holds substantial stakes in banks, overlooks a robust regulatory framework, and has never let a single lender go bust. "We have always felt the Saudi banks are generally the strongest banks in the region. There are a small number of banks with consistent levels of reasonable profitability. They are generally well capitalised and well run," Mr Thursfield says.
"Domestic demand is not reliant on expatriates, giving the banks a far larger and more stable population to target" he says. Two-thirds of Saudi's population is under the age of 30. But that does not mean the Saad-Gosaibi defaults will not leave their mark on the kingdom's close-knit banking community. Defaults are likely to be felt most within the sphere of so-called "name lending", loans made on a creditor's reputation rather than their financial strength or credit history. There are already reports of other Saudi family-held businesses struggling to repay loans.
"Merchant family issues have not fully played out," analysts at BofA Merrill Lynch say. "There is more potential for one-off shocks resulting from name lending to family-owned businesses." Another strength of the Saudi banking sector has been its local focus, which has left it less exposed to soured investments involving complicated derivatives that have caused so much financial distress elsewhere in the world.
Like the UAE, Saudi Arabia injected substantial funds into the banking system from last October when the financial crisis first hit the region. But unlike its smaller Gulf neighbour, Saudi Arabia was slow to attract large volumes of foreign deposits, so-called "hot money", during the boom years. The rapid withdrawal of that hot money following the Lehman Brothers collapse last year sent some stock markets reeling and left financial institutions short of deposits to support credit creation.
Saudi banks, however, never suffered a comparable funding gap for their lending. "They have not had the funding pressures seen by their UAE peers and their loan-to-deposit ratios did not balloon like in the UAE," says Mr Thursfield. The kingdom's banks have also taken a more conservative approach to retail lending, largely because of local restrictions such as those limiting loans to a third of a borrower's salary.
In addition, the Saudi real estate market never became a massive source of speculation as a result of foreign land ownership restrictions. But the Saudi banking system does face other risks, such as slowing credit growth and declining bank deposits, and including reduced capital injections from the government. Despite such fears, the saga of Saudi banks, described by the BofA-Merrill Lynch as an "unloved story", may have largely played out.
"With little leverage and plentiful savings, Saudi Arabia is in a good position to handle any likely contingency" says BofA Merrill Lynch. The Saad and Gosaibi saga may still be unfolding in courtrooms and boardrooms around the world, but for Saudi banks at least, the worst of the crisis could have already passed. email@example.com