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The SAIBOR recently broke the historical barriers that remained intact for years. The economic scene suddenly becomes a center point of gravity for everyone who tries to exert efforts in interpreting the SAIBOR events. These steady rises have a different dimension from the previous interest rate hiking cycles.
Is it logical that SAIBOR prices reach above 3.00% (which was below 1.00% levels a few months ago), especially if we compare it to the movement of its U.S. LIBOR counterpart? Here are some key aspects where I explore the root causes and put forward some views.
First Aspect: Rises in U.S Interest Rates
It is an evident cause, and it only explains a part of our story. This year, the Fed initiated raising the interest rates by 0.25% in March, followed by a 0.5% hike in early May. According to the Fed projections, the upcoming hikes will continue at the same pace as before; half a percent, until the price later this year exceeds 2.50%; currently at 1.00%, after which inflation levels would be thoroughly reviewed.
The Fed continues to be concerned about inflation numbers that have gone out of hand, recording 8.5% in March. Fortunately, the last reading for April indicated an 8.3% increase, though high, but showed a breaking pace from the previous one. The Fed is determined that the interest rates should slow inflation numbers until they return to their desired levels over the next two years.
Therefore, we found that the Saudi Central Bank (SAMA) has also boosted the interest rates by the same amount, a 0.25%, and then 0.5%. This has increased SAIBOR, but not necessarily by the same size because SAIBOR is also subject to other factors that we will address here.
Second Aspect: Calculation Methodology of SAIBOR
As of January 1, 2022, the methodology used by banks to calculate and publish the daily SAIBOR rates has changed. The enhanced methodology is more linked to the banks’ assets and liabilities management activities. For example, SAIBOR relies on a volume weighted average price (VWAP) of eligible transactions, such as the deposit rates, reflecting the foundation on which the SAIBOR rate is built.
Hence, we realize that the prices may be more vulnerable to fluctuations than before, leading to a faster manifestation of local liquidity stress and tightness. I believe that the enhanced methodology is more transparent, realistic, and better governed than before. In 2022, the main component of SAIBOR rates was not controlled by qualified transactions, perhaps giving banks too much flexibility. Therefore, the mechanism is now fairer and more dynamic in reaching the actual cost of funds.
Does this mean that the enhanced methodology has revealed a scarcity of local liquidity faster than before? Of course, that is true. The banks are heavily competing to attract deposits and build a safety valve to absorb any shocks around their asset and liability management. Here we can compare the quality of each bank in managing its financial position, overseeing its challenges, and anticipating its liquidity events.
Third Aspect: Indicators of Liquidity at Local Banks
When reading the monthly and periodic SAMA reports, most liquidity indicators do not imply any disturbances. The money supply level is stable and grew steadily from the fourth quarter of 2021 to the end of the first quarter of 2022. After reviewing the loan-to-deposit ratios, we found they are at a healthy level and have not escalated dramatically.
But what has dominated the scene as the main reason was the excess liquidity levels in the banking system represented by the daily operations of the Reverse Repurchase Agreement (reverse repo) transactions. Reverse repo resembles the interest rate paid by the central bank to the commercial banks for their excess liquidity at the end of each day. According to the data published by SAMA, the average daily transactions during the week of May 21, 2022, the liquidity has averaged less than six billion riyals. After reaching sixty billion at the beginning of this year, the figures have fluctuated downwards to the lowest point in that reading.
When banks observe these figures, they address their anxiety of tight liquidity through fierce competition in attracting deposits. Let us not forget what we mentioned earlier (the second aspect); this feeds directly into the SAIBOR increases based on the enhanced methodology. This is what we have been going around since the start of the year.
How Will the Central Bank Manage This Phase?
When considering the above aspects, the first thing that comes to mind may be that the solution would be accessible to the central bank by injecting liquidity into the system and curbing the surge in SAIBOR rates, especially amid the current high oil prices. This logic is understandable.
However, there is something important here. We should also know that the rise of SAIBOR originated from the massive and unprecedented expansion of lending. A quick reading of what happened in 2020 and 2021 concludes that the tight liquidity situation currently faced, as discussed earlier, was merely a matter of time.
After examining the latest official government statements regarding the liquidity infusion created by the current oil levels, patience is the answer. The liquidity will be the way to restore and rebuild the strategic cash reserves depleted during the previous years and accelerate Vision 2030 plans. This would reduce the effect of future economic shocks and steadily build the path towards economic diversification and financial stability.
Let us think again about SAIBOR rates and their historical movements; 3-Month SAIBOR has maintained a spread above the U.S. LIBOR of about 0.6%. This spread widens and narrows according to economic parameters (global and local), and if it goes out of range, it soon returns to its usual range.
This spread is currently close to 1.50%, double and a half above the historical average of the last six years, coupled with lower amounts of “reverse repo” transactions. If this trend continues, this may affect lending expansion or at least decelerate such credit growth. Over time, this could create healthy liquidity levels and readjustments, but how long will this process take without the central bank’s intervention?
There is no doubt that the central bank closely monitors the liquidity indicators and pays significant attention to monetary and financial stability. In my opinion, the current fluctuations and rises in SAIBOR rates are a temporary phase. This situation has not extrapolated to affect the prices of medium- and long-term swap markets, which maintain healthy levels compared to their U.S. swap rates. USDSAR Exchange rate is also stable, both for spot and forward rates.
The Impact on Local Corporations
As the substantial rises in SAIBOR happened recently, the actual effect would be seen in the coming quarters and periods. Analysts and investors need to look carefully at financial statements, consider the variable floating interest rate exposure, and determine whether there are prudent hedges for such borrowings and exposure.
The higher the financial leverage, the higher the risk from the SAIBOR impact (assuming all other factors are constant). It is never late for a financial risk management strategy.
The Management of Financial and Interest Rate Risks
Financial risk management undoubtedly raises the awareness of certain factors that could threaten the business’s financial stability, and it even helps explore opportunities. Therefore, a comprehensive and implementable hedging policy has become vital amid these continuous market variables.
We have observed a few companies successfully follow a hedging policy of interest rate risk before a recent rise. These companies were not tricked by the low projections of interest rate markets at the time. These companies base decisions on protecting predetermined targets and KPIs, regardless of the market expectations and speculations.
The company’s hedging policy cultivates a risk management culture and sound governance. It helps the organization anticipate, identify, measure, manage, and report relevant market risks. Hedging policy also clearly enhances the distribution of roles and responsibilities and determines a certain rhythm for stakeholders to facilitate informed decision-making.
Muadh Alhusaini, CFA, FRM, CAIA