OREANDA-NEWS. The Saudi Arabian Monetary Agency's decision on 31 July to extend SAR15bn (USD4bn) of one-year loans to Saudi Arabian banks should ease short-term liquidity pressure, says Fitch Ratings. The banks, already facing a tougher operating environment as lower oil prices and slowing government spending take their toll on the wider economy, have experienced a downturn in liquidity since 2H15.

Funding stability and ample liquidity have long been key strengths supporting the banks' standalone ratings. We assign ratings to 11 Saudi Arabian banks and their standalone Viability Ratings (VR) range from 'a-' to 'bb+'. But the deteriorating operating environment and tighter liquidity are starting to put pressure on the 'a-' VRs.

Saudi Arabian banks are largely deposit funded, with mainly non-interest bearing customer deposits representing around 60% of total sector deposits. The 1% fall in sector deposits in 1H16 is the first downturn in many years and reflects tightening liquidity across the economy, starting at the state level and spreading across the private sector.

The 7% decline in public sector deposits, which represent 20% of total system deposits, is a concern for the banks. Government and government-related deposits are highly concentrated and withdrawals can expose banks to liquidity pressures. The top 20 depositors represent around 35% of total deposits on average among rated banks. Pressure on state oil-related revenues has triggered some withdrawals of liquidity.

In February, SAMA relaxed the loan-to-deposit ratio ceiling to 90% from 85% for Saudi Arabian banks in an effort to ease liquidity pressure and encourage them to lend rather than hoard liquidity. This measure resulted in a reduction of liquidity ratios. Liquid assets fell as a share of total banking sector assets to 17.1% at end-March 2016 from 19.7% at 1Q15, and liquid assets covered 26% of short-term liabilities at end-1Q16, down from 30.2% a year earlier.

Tighter liquidity has driven up funding costs. Remunerated time deposits have been increasing over the last 12 months and the three-month SAIBOR rate rose to 2.2% at end-June 2016, considerably higher than the 0.8% charged at end-June 2015. Interbank funding is not a significant source of funding for the sector, but we believe the increased costs are symptomatic of general cost pressure in the sector.

Media reports suggest that SAMA's loans to the banking sector are extended for one year at a discount, although the terms of this discount are undisclosed. We understand that the funds have been made available to a number of banks, although again this is undisclosed, some of which have accepted the offer. This should help ease liquidity in the system and could contribute to a fall back in funding costs, which could avoid margin compression and is supported by the endowment benefit from last year's 25bp base rate rise. Banks are actively repricing loans but this takes time, while deposit repricing is more immediate.

We warned of tightening liquidity, slower loan growth and a tougher operating environment for Saudi banks at end-2015. The banking sector outlook is negative, and the rating Outlooks for all 11 Saudi banks are Negative, as is the Outlook on the sovereign rating.