Saudi banks vulnerable to fallout of prolonged war

• New report from Fitch
• Drawn-out war would reduce lending
• Strongest banks would remain profitable

Saudi Arabian banks’ asset quality, profitability and funding could come under pressure if the Iran war endures, Fitch Ratings warned in a report this week.

The US-Israeli war on Iran, which began on February 28 and has spiralled into a wider Middle East conflict, has so far affected Saudi Arabia less than neighbouring Qatar, Kuwait, Bahrain and UAE.

The kingdom has maintained oil exports at about two thirds of pre-war levels, despite an Iranian near-complete blockade of the Strait of Hormuz – through which about one-fifth of global oil and liquified natural gas supplies would usually be transported – thanks to a pipeline to its Red Sea coast.

Saudi Arabia’s domestic economy, which is based upon demand from its large population of Saudi nationals, provides further insulation. This has helped Riyadh’s stock index to make gains since the conflict started and contrasts with steep declines on UAE and Qatari bourses.

Nevertheless, the banking sector faces headwinds. Saudi Arabian banks’ “asset quality, profitability and liquidity could come under pressure if the Iran conflict is more prolonged or severe” than Fitch Ratings anticipates.

Fitch, which covers 11 Saudi banks, describes an “adverse scenario” in which a protracted Iran war, weaker economic growth and muted business activity would cause banks to expand lending more slowly and for non-interest income to decline.

“Higher inflation and higher-for-longer interest rates would pressure net interest margins, with increased competition for liquidity raising the cost of funding,” the Fitch report states.

Net interest margins are the difference between interest income generated on assets such as loans and securities and interest expense paid on liabilities including deposits and debt.

“Higher interest rates would also put pressure on borrowers, potentially lifting impairment charges and further hurting banks’ profitability,” the report adds.

Saudi National Bank and Alrajhi Bank dominate the country’s banking sector, accounting for 24 and 21 percent respectively of total industry assets according to AGBI calculations.

Riyad Bank (11 percent of assets), Saudi Awwal Bank (9 percent) and Alinma Bank (6 percent) complete the top five.

Cost of risk represents the provisions taken relating to potential or actual loan defaults. Saudi banks’ aggregate cost of risk was just 0.3 percent, among the Gulf’s lowest, ahead of the war.

In a stress test, Fitch found that even if loan defaults were to rise fourfold, the nine banks with investment grade viability ratings would still be profitable, but the two banks with lower ratings – Gulf International Bank Saudi Arabia and Bank Aljazira – would probably make losses due to their above-average levels of non-performing loan and weaker profits in full-year 2025.

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In a scenario of materially higher loan defaults, banks would cut dividends and halt expansion plans, Fitch predicts. Such measures would enable them to maintain “adequate capital buffers”.

Banks’ core business involves re-lending customers’ deposits to borrowers. The Saudi banking sector’s simple loan-to-deposit ratio soared to a record 108 percent at the end of 2025, Fitch estimates.

Banks have raised interest rates on term deposit accounts to attract and retain customer deposits and have also issued bonds and sukuk – a more expensive funding source – to support loan growth. This has pressured net interest margins, with such market-based sources now representing 17 percent of total funding.

Little of this debt matures in 2026, but “banks’ ability to refinance existing overseas facilities may be affected if the conflict is prolonged”, Fitch wrote.

“This would increase competition for domestic funding and raise funding costs over the longer term, putting pressure on net interest margins,” the report states.

Banks would be able to cope with customers withdrawing 10 percent of total deposits without needing government or central bank support.

Government-related entities hold about SAR450 billion ($120 billion) of deposits at the Saudi Central Bank, known as Sama. This equates to about 15 percent of total deposits. Sama could redirect these to the banks themselves, “mitigating potential liquidity pressure, if needed”, Fitch added.