DUBAI — The outlook for Saudi Arabia's banking system is stable as the nation's economy will return to growth this year, bolstered by higher public spending and other stimulus, says Moody's Investors Service in a report published Monday.

The report, "Banking System Outlook — Saudi Arabia; Government spending and strong margins underpin stable outlook," is now available on www.moodys.com. Moody's subscribers can access this report via the link. The research is an update to the markets and does not constitute a rating action.

The Organization for Petroleum Exporting Countries' (OPEC) agreement to freeze crude oil production at current levels until the end of 2018 will remain a headwind for Saudi Arabia. Nonetheless, Moody's expects the Saudi economy to grow by 1.3% this year, after contracting by 0.7% in 2017.

Against this backdrop, lending growth, driven by corporate and real estate lending, will increase by 4% in 2018.

"Recovering oil prices, record budget expenditure and government efforts to protect households from the impact of economic reforms will be the main drivers of credit demand in 2018 and 2019," said Olivier Panis, vice president and senior credit officer at Moody's.

"While lending to corporates will recover only gradually, particularly in the construction, manufacturing and transport sectors, retail lending will remain supported by solid growth in mortgages."

Saudi banks' profitability will remain the highest in the Gulf Cooperation Council (net income-to-tangible assets stood at 2.0% in 2017 versus 1.9% in 2016).

Moody's expects stronger margins as rising interest, moderately higher credit growth, higher fee income, and low operating costs will outweigh rising provisions.

Stable profitability and moderate loan growth will reinforce banks' already strong capital adequacy. Moody's expects an average tangible common equity (TCE) ratio of around 17.8% by the end of 2019, up from 16.8% in September 2017.

"However, Saudi banks' ratio of non-performing loans to gross loans will marginally increase to around 2.5% in the next 12 to 18 months, from 1.8% as of December 2017" said Ashraf Madani, vice president at Moody's.

"Fiscal consolidation measures and slowing economic growth have affected banks' asset quality since global

oil prices fell sharply in 2014." — SG