Saudi central bank fights to curb money rate rise

Saudi Arabia's central bank is having only mixed success in using money market tools to fight a surge in market interest rates caused by low oil prices, and may need to resort to more radical steps, commercial bankers say.

Such steps could include raising the ratio of deposits which commercial banks are permitted to lend out and reducing the amount of reserves which banks must place with the central bank, the Saudi Arabian Monetary Agency (SAMA).

By slashing government revenues, low oil prices have cut the volume of petrodollars flowing into the Saudi banking system. Total deposits at commercial banks, which grew continuously for years, were 3.3 percent lower in June than they were a year ago.

This has strained liquidity in the banking system, pushing interbank money rates higher. The one-year Saudi interbank offered rate has jumped more than 1.5 percentage points in the past 12 months.

That in turn threatens banks' ability to lend to the private sector at affordable rates, a key consideration as the government tries to limit damage to the economy from cheap oil, and raises borrowing costs for the government, which is selling bonds to the banks every month to finance a big budget deficit.

"SAMA warned of a liquidity shortage almost a year ago," said a local banker, speaking about central bank policy on condition of anonymity. "Now it is facing such a situation."

The central bank, which is traditionally secretive about many of its operations, did not respond to requests for comment.

In normal times, SAMA uses its repo rate to lend money to banks when they face liquidity shortages. But repo operations are very short-term and cannot address the structural, longer-term fund shortage which is emerging due to low oil prices.

So since the first quarter of this year, SAMA has been taking bigger steps. It has scaled back its sales of bills to banks; they held just 52.8 billion riyals ($14.1 billion) of SAMA bills in June, down from 215.8 billion riyals 12 months ago and the lowest level since at least 2010.

Since the second quarter, SAMA has also been making special provisions of longer-term funds to banks which need them.

"In the second quarter SAMA made direct deposits at some of the banks to ease stress on liquidity, and we were among the banks that received these deposits," Abdulaziz al-Onaizan, chief executive of Bank alBilad, told Al Arabiya television late last month. Alinma Bank also said it got money.

Some bankers say they have obtained money in the form of deposits; as part of its monetary arsenal, SAMA is permitted to place state institutions' funds with banks. Some bankers believe proceeds of a $10 billion international loan obtained by Riyadh in May were placed with banks.

Other bankers describe the fund injections as low-interest loans. This raises the possibility that SAMA has introduced a new monetary tool similar to the European Central Bank's long-term refinancing operations, which the ECB employed to address liquidity shortages during financial squeezes in recent years.

SAMA's strategy has had some positive effect. Total deposits at commercial banks edged up in June from the previous month, and bank lending to the private sector has continued to grow robustly, climbing 8.1 percent from a year ago in June.

But there are signs of continued pressure on liquidity. While interbank rates levelled off in late June, they have resumed creeping up in the last few days; at 2.498 percent, the one-year rate is at its highest since January 2009.

Also, the rise in Saudi banks' holdings of government bonds slowed in June, increasing by just 3.1 billion riyals during that month. This suggests that because they lack spare funds, banks may no longer be showing much appetite to buy in the government's monthly offers of about 20 billion riyals of bonds.

The bond offers are shrouded in secrecy, so bankers say it is impossible to be sure how much debt the government is succeeding in selling. But if banks stop buying the bonds, Riyadh may be forced to borrow more from abroad or draw down its financial reserves faster to finance its deficit.

So bankers think SAMA may take regulatory steps to bolster liquidity, either by raising banks' maximum loan-to-deposit ratio, or by reducing the share of deposits that must be held in cash reserves at the central bank.

The loan-to-deposit ratio has already been lifted once, in February, to 90 percent from 85 percent.

The 90 percent ceiling has been reached for the system as a whole, "which leads us to believe that SAMA will further ease the limit", Jadwa Investment said in a report this week.

The ceiling is still lower than in other countries and Jadwa argued that Saudi banks' profits were still healthy so it could be relaxed without excessive risk.

Banks are also now required to keep 7 percent of demand deposits and 4 percent of time and savings deposits in cash reserves held at the central bank.