This Selected Issues paper assesses the importance of oil and interest rate spillovers for Saudi Arabia. Oil prices have fallen by more than 40 percent since mid-2014 while the Federal Reserve is expected in the coming months to begin raising its policy rate at the beginning of a gradual tightening cycle. Given the importance of oil to the economy and the peg of the riyal to the U.S. dollar, these are two key developments for Saudi Arabia. Although a temporary drop in oil prices would likely have little effect on the economy and banks given the financial cushions that have been built-up, a longer-lasting period of low oil prices would have a more significant impact.


This Selected Issues paper assesses the importance of oil and interest rate spillovers for Saudi Arabia. Oil prices have fallen by more than 40 percent since mid-2014 while the Federal Reserve is expected in the coming months to begin raising its policy rate at the beginning of a gradual tightening cycle. Given the importance of oil to the economy and the peg of the riyal to the U.S. dollar, these are two key developments for Saudi Arabia. Although a temporary drop in oil prices would likely have little effect on the economy and banks given the financial cushions that have been built-up, a longer-lasting period of low oil prices would have a more significant impact.

Countercyclical Macroprudential Policies in Saudi Arabia1

Oil prices drive asset prices and government spending in Saudi Arabia, which in turn, are transmitted to credit and non-oil GDP. With oil prices having declined sharply in recent months and growth risks to the downside, the environment in which the financial sector is operating may become more difficult. Saudi Arabia has implemented a wide range of macroprudential policies, including some in a countercyclical way, to strengthen capital and liquidity buffers in the banking system. In addition, expanding the use of countercyclical macroprudential policies within the context of the establishment of a formal macroprudential framework, while respecting microprudential norms, may help in mitigating adverse feedback loops between real and financial activity.

A. Introduction

1. Macroprudential policies can help mitigate systemic risks to financial stability that result from macro-financial linkages. Macro-financial linkages increase the vulnerability of the economy to systemic risks by amplifying idiosyncratic or aggregate shocks. Macroprudential policies can help mitigate these risks by building buffers to increase the resilience of the financial system, containing the build-up of systemic vulnerabilities by reducing procyclical feedback between asset prices and credit, and controlling structural vulnerabilities within the financial system. This paper examines how countercyclical macroprudential policies have been used in Saudi Arabia to mitigate systemic risks over the financial cycle and what more needs to be done. While the dependence on oil creates structurally high concentration risks within the financial system (e.g. Aljabrin et al, 2014), the use of macroprudential policies to mitigate those risks is not addressed in this paper.

B. Oil Prices Drive Real and Financial Cycles

2. Saudi Arabia is a highly oil-dependent economy. Oil exports are over 70 percent of non-oil GDP and 80 percent of total exports. With oil revenues nearly 90 percent of central government revenues, they have financed rapid increases in government spending over the past decade.

3. There is strong evidence suggesting that oil prices drive asset prices and government spending. A VAR analysis using quarterly data, finds evidence of a statistically significant positive response of equity prices and government spending to increases in oil prices (Figure 1).2 These increases in equity prices and government spending are then transmitted to higher credit and non-oil GDP. The increase in credit and non-oil GDP create a mutually reinforcing cycle as they feedback to higher equity prices. A complementary analysis used a backward-looking univariate HP filter to detrend real oil prices, real equity prices, real government spending, real credit, and real non-oil GDP, and found strong contemporaneous correlation between cycles in oil prices, government spending, equity prices, and non-oil GDP (Figure 2). These results are consistent with the existence of feedback loops between asset prices and credit driven by oil price movements.

Figure 1.
Figure 1.

Transmission of an Oil Price Shock: Results from a VAR Analysis

Citation: IMF Staff Country Reports 2015, 286; 10.5089/9781513505077.002.A003

Note: Accumulated responses from an unrestricted VAR at one and six lags. Quarterly data 1997-2014. Numbers represent a statistically significant response (in %) to a 1% shock. Numbers represented by dark blue arrows are significant at the 99 percent confidence level, while those represented by light blue arrows are significant at the 95 percent confidence level.
Figure 2.
Figure 2.

Saudi Arabia: Oil, Real, and Financial Cycles

Citation: IMF Staff Country Reports 2015, 286; 10.5089/9781513505077.002.A003

Source: IMF staff calculations.Gaps are calculated as the percent deviation from trend derived using an HP filter.

4. The exposure to oil cycles suggests a need for countercyclical macroprudential policies to mitigate the buildup of financial risks. Of course, fiscal policy is the main policy tool for managing aggregate demand and ensuring sustainability. However, the financial sector in Saudi Arabia is fairly large, and can be a source of significant adverse real sector effects.3 In this regard, macroprudential policy, if implemented in a countercyclical way, can be used to reduce the buildup of systemic risks in the financial sector during oil price upswings, and to cushion against disruption to financial services during oil price downswings.

C. Countercyclical Macroprudential Policies in Saudi Arabia

5. SAMA has implemented a wide range of macroprudential instruments over the past decade (Annex I). In addition to implementing the Basel III capital and liquidity requirements, SAMA has used a number of macroprudential instruments on banks, including:4

  • Capital tools: additions to microprudential capital adequacy ratios, leverage ratio and provisioning requirements.

  • Liquidity tools: loan-to-deposit ratio, liquid-asset-to-deposit ratio, reserve requirements, liquidity coverage ratio and net stable funding ratio.

  • Sectoral tools: loan-to-value (LTV) ratio on mortgages, debt-service-to-income ratio (DTI) on personal loans and consumer credit, and concentration limits on individual and large exposures.

Figure 3.
Figure 3.

Saudi Arabia: Financial Soundness Indicators, 2000–14

Citation: IMF Staff Country Reports 2015, 286; 10.5089/9781513505077.002.A003

Sources: Authorities data; IMF staff estimates.

6. Banks have been encouraged to build capital buffers and provision for NPLs in a countercyclical way as part of the supervisory process (Box 1).5 For instance, the minimum provisioning ratio of 100 percent of non-performing loans (NPLs) is increased to as high as 200 percent during economic upswings. Capital buffers have also moved countercyclically as bank dividend payments require SAMA approval. The countercyclical capital and provisioning has been implemented on a bilateral basis with individual banks, based on microprudential concerns such as operating performance, composition of assets, and riskiness of the loan portfolio. Considerations of aggregate macroeconomic and financial sector risks are not formally incorporated in bank-level capital buffer decisions. Reserve requirements were adjusted during the global financial crisis to manage liquidity pressures in banks. Other instruments have been introduced to limit the build-up of risks, but these have been not been adjusted in a countercyclical way over time.

7. The Saudi banking sector is well-capitalized and profitable. As oil prices and credit increased rapidly over the past decade, capital buffers and provisions for NPLs have increased to levels above those in many other commodity exporting countries (Box 2). Profitability has remained strong with return on assets of about 2 percent.

8. Recently, SAMA has taken steps towards formalizing its macroprudential framework. An internal Financial Stability Committee has been established, and a dashboard of early warning indicators has been developed. The first Financial Stability Report has been published. The framework and methodology for countercyclical capital buffers (CCBs) is being developed in line with Basel guidelines.

Countercyclical Capital and Provisioning Ratios in Saudi Arabia

Empirical evidence confirms that bank capital and provisioning buffers have been used counter-cyclically. Both the capital and provisioning ratios increase in response to higher real credit growth, oil price growth, and the credit-to-GDP gap.

Relying on a panel system GMM approach and annual data spanning 1999–2014, the capital adequacy ratio and provisioning as a share of loans, both at the bank level, were regressed on a range of macro-and micro-level indicators to help capture the Saudi economy’s cyclical position. In addition to the credit-to-GDP gap (percent deviation from the linear trend), the model includes the growth rates of non-oil GDP, real oil prices, and bank-level real credit, all lagged by one period.

Both the capital and provisioning ratios have generally moved in a countercyclical manner. The coefficients of the growth rates of real credit and real oil prices, as well as of the credit-to-GDP gap, are generally positive and statistically significant, suggesting that capital adequacy ratios and loan loss provisions have been counter-cyclical with respect to these indicators. In contrast, nonoil GDP growth appears to play a limited role. The coefficients, although large, are mostly statistically insignificant. In one specification the coefficient is statistically significant but only at the 10 percent level.

Determinants of Bank-by-Bank Capital and Provision Ratios in Saudi Arabia

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Note: Dependent variables are bank-by-bank capital ratios and provisioning to total loans for 10 Saudi Arabian banks spanning 1999-2014 (annual frequency). Relying on a system GMM approach. ***, **, and * signify significance at the 1%, 5% and 10% levels. L1 signifies one period lag. AR(1) and AR(2) signify p-values associated with the null hypothesis of lack of first and second order serial correlation. Hansen signifies p-value associated with the null hypothesis that the instruments are exogenous.Sources: Bankscope, Haver, and IMF staff estimates.

9. With oil prices having declined sharply in recent months and growth risks to the downside, banking sector stress may emerge, calling for vigilance from policy makers. As the fiscal position adjusts, weaker government spending could pressure corporate profitability and bank balance sheets, resulting in increased nonperforming loans. At the same time, the decline in equity prices would have wealth effects depressing private sector consumption and non-oil GDP. These effects are likely to be mutually reinforcing. Moreover, if banks reduce lending or sell assets in the downturn to maintain capitalization ratios at high levels, this could further intensify pressures and cause adverse feedback loops between the real and financial sectors.6

Financial Soundness Indicators in Commodity Exporting Countries

The strength of Saudi Arabia’s banking sector compares favorably with other commodity exporting countries. The banking sector is characterized by healthy capital adequacy ratios, high provisioning, and low levels of NPLs.1 The Saudi banking system is also liquid, with relatively low loan-to-deposit ratios and liquid assets of over 22 percent of total assets, although levels have declined somewhat since the early 2000s.

Financial Soundness Indicators for Selected Commodity Exporters

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Sources: Authorities data; Haver; IMF staff calculations Note: Data is for 2014 or latest year available
1 Banks hold high levels of high-quality Tier I capital and delinquency periods for recognition of NPLs are conservative (Aljabrin et al, 2014). Additionally, the provisioning ratios for some countries may not be comparable if they exclude specific provisions.

D. Countercyclical Macroprudential Policies—International Experience

10. Macroprudential frameworks and policies vary across commodity exporting countries. For illustrative purposes, the formal countercyclical macroprudential frameworks and policies in five selected emerging and advanced commodity exporting countries are explored using responses of country authorities (for Azerbaijan, Canada, Malaysia, Norway, and Peru) to the IMF’s Global Macroprudential Policy Instruments Survey (2013) and updated from country sources. In these countries (Annex II), the countercyclical use of macroprudential policy instruments (MPIs) is well-defined, supported by early warning indicators and clear guidance for action. These developments are recent—four of the five countries started implementing MPIs in a countercyclical way only after the global financial crisis, while Malaysia started earlier. The differences in the policy frameworks and tools reflect the structure of the financial system and the policy makers’ assessment of systemic risks. Some interesting aspects are:

  • Two commodity exporters are among the early adopters of the CCB. In Norway and Peru, a framework for CCBs has been established. Norway’s framework is closely aligned with the Basel III guidance and the CCB can range between 0 to 2.5 percent of risk-weighted assets. The framework specifies a role for four indicators—related to credit, asset prices, and wholesale funding in banks—and the judgment of policy makers to trigger an increase in the CCB. Market turbulence indicators and loss prospects for the banking sector are to be used to trigger a decrease in the CCB to ensure a timely policy response to emerging systemic risks. To minimize leakages, all domestic banks and foreign branches will be covered. The Ministry of Finance is responsible for making decisions related to the CCB but is required to consult with the central bank. In contrast, Peru’s CCB framework uses results from an internal methodology to calibrate the level of the CCB, and the GDP growth rate as an indicator to trigger an increase as well as a decrease in the CCB. The supervisory authority of banks (SBS) is responsible for making decisions related to the CCB.

  • The LTV and DTI limits on the household sector are among the most popular MPIs. Canada, Malaysia, and Norway use these tools to contain financial sector risks from household leverage. In Canada and Norway, the two tools are used together and can be mutually reinforcing – as house prices increase, LTV limits become less constraining but DTI limits become more binding. In Malaysia, LTV limits are implemented in a targeted way to the purchasers of multiple homes and luxury properties, and are supplemented with caps on the overall exposure of banks to the property sector and for the purchase of equities. In Canada and Malaysia, leakages to the nonbank sector and through extension of loan repayment periods are addressed by applying the measures to banks and nonbanks and introducing limits on loan repayment periods. In Norway, the measures are applied only to residential mortgages from banks.

  • Tools to limit corporate sector risks were relatively uncommon. None of the five countries have implemented sectoral capital requirements or caps on exposures to the corporate sector. Only one country, Malaysia, has implemented LTV limits on commercial real estate (CRE).

  • Liquidity tools are being used countercyclically. Liquidity indicators are being used to calibrate liquidity requirements in a countercyclical way in Azerbaijan and Canada. Peru, which was concerned with foreign currency exposures owing to volatile capital flows, has introduced high reserve requirements on foreign currency liabilities of banks. These reserve requirements have been eased recently with the impending normalization of U.S. monetary policy.

11. An important lesson from the international experience is that multiple early warning indicators can help assess the evolving nature of systemic risk and the need for tightening or relaxation of measures. The policy frameworks of the commodity exporters suggest a need for policy makers to remain vigilant about the evolving source of systemic risks. Early warning indicators can help signal when policy adjustments are appropriate, and support clear communication of policy intentions (IMF, 2014). When multiple indicators point to a build-up of risks, there is a stronger case for policy action. Over time, efforts to assess the reliability of signals provided by early warning indicators, and address data gaps (where they exist) can help improve the policy response.

12. Leakages need to be contained for policy to be effective. Leakages occur when the provision of credit migrates outside of the scope of application of the macroprudential tools. For instance, when MPIs are applied to domestic banks, their effectiveness can be reduced by the migration of credit activities and associated risks to non-banks, off-balance sheet vehicles and foreign financial institutions. Domestic leakages can be addressed by extending regulations to all financial products, including by non-bank financial institutions, and enforcing these through high standards for consolidated supervision (e.g. in Canada and Malaysia, DTI limits are supported by caps on loan repayment periods, LTV and DTI limits are extended to banks and nonbanks). Cross border leakages of capital tools may be addressed by reciprocity arrangements, or alternatively, greater host control over foreign branches (e.g. Norway). In this regard, economies with a larger nonbank sector or more open financial sector may find it challenging to implement macroprudential policies effectively. However, expanding the perimeter of macroprudential action can face legal and operational challenges, including the need for greater cooperation among supervisory agencies.

13. Preliminary evidence points to the effectiveness of macroprudential policies in reducing systemic risks during upswings, less so during downswings. Macroprudential policies are being increasingly used in emerging markets, especially since the global financial crisis. Based on the experience so far, some operational considerations with respect to the design and implementation of macroprudential policies are summarized in Annex III. Given that these policies have only recently been introduced, the evidence on their use and effectiveness is still preliminary. Some studies that have examined the effectiveness of macroprudential tools over the financial cycle have found them effective in reducing the buildup of systemic risks during booms, but less so during busts. A recent study by Cerutti et al (2015) finds evidence of asymmetric effects on the effectiveness of macroprudential policies between booms and busts. Similarly, Kuttner and Shim (2013) consider a number of macroprudential tools, and find that a tightening of the DTI ratio is associated with a significant deceleration in housing credit, and housing-related taxes are associated with a decline in house price growth. On the other hand, loosening of the DTI ratio has a comparable (but statistically insignificant) effect in the opposite direction. Somewhat stronger results for the LTV and DTI limits during downturns are found by McDonald (2015). As this literature points out, it is challenging to draw conclusions regarding the effectiveness of macroprudential policies during downturns as there are few instances of policy loosening and their effects can be difficult to isolate from those of other policies.

E. Policy Recommendations and Conclusions

14. The exposure of Saudi Arabia to volatile oil prices suggests a role for countercyclical macroprudential policies to mitigate systemic risks in the financial sector. Oil price shocks are a cause of feedback loops between asset prices, government spending, credit, and non-oil GDP. Fiscal policy remains the main policy tool to protect against fluctuations in oil prices and manage aggregate demand in a sustainable way. In this context, a more countercyclical fiscal policy could help dampen not only the economic but also the financial cycle. In addition, countercyclical macroprudential policies can be used to reduce the buildup of systemic risks in the financial sector during oil price upswings, and to cushion against disruptions to financial services during oil price downswings.

15. SAMA has implemented a wide range of macroprudential instruments to build resilience in the banking sector, but some enhancements to the toolkit could be considered. Banks have been encouraged to build capital buffers and provision for NPLs in a countercyclical way and reserve requirements were also adjusted during the global financial crisis to manage liquidity pressures on banks. As a result, the Saudi banking sector is well-capitalized and profitable and compares well with many other commodity exporting countries. Other instruments have been introduced to limit the build-up of risks, but these have been not been adjusted over time. A framework for countercyclical buffers is being developed in line with Basel guidelines. However, countercyclical buffers are considered to be more effective in building resilience than in moderating credit cycles (IMF, 2014). Given the evidence of feedback loops from oil prices to equity prices, credit, and non-oil GDP, there may be scope to expand the countercyclical use of existing time-invariant macroprudential instruments. Additionally, sectoral concentration limits (e.g. on margin lending for the purchase of equities, or on the construction sector which may be more exposed to government spending) may prove useful to address emerging financial sector risks from specific sectors/activities in a more targeted way.

16. A well-defined macroprudential policy framework is needed to guide the countercyclical use of MPIs in Saudi Arabia. In addition to measures to strengthen the macroprudential framework that are already underway at SAMA, a formal macroprudential framework would assign roles and responsibilities among SAMA, the Capital Markets Authority, and the Ministry of Finance to help strengthen macroprudential policy formulation and implementation within and across institutions. An assessment of the reliability of early warning indicators in signaling potential systemic stress would help identify triggers that would guide the countercyclical use of a broad set of macroprudential policies. The framework would provide clear guidance on how macroprudential policies will be implemented to maintain financial stability and manage systemic risks over the financial cycle.7 The framework can then guide decisions on when and how macroprudential policies can be tightened or eased to mitigate adverse feedback loops, while respecting microprudential norms to maintain confidence and an appropriate degree of resilience against future shocks. Policy makers will need to monitor a number of high-frequency and granular indicators closely to assess financial stress (see Annex III for a list of indicators that can be used for each tool). The decision to relax macroprudential policies will need to be based to a considerable extent on judgment drawing on market intelligence, supervisory assessments and stress tests.

17. Microprudential norms should be set taking into consideration the structural risks from the lack of economic diversification and concentration risks. The vulnerability to the lack of economic diversification is accentuated by the high degree of interconnectedness in the corporate, financial, and public sectors (Aljabrin et al, 2014). Moreover, data gaps with respect to real estate prices imply that staff analysis does not capture an important channel for transmission of shocks to the financial sector.8 Regulatory minima and the assessment of the policy space should be calibrated to reflect these risks.

18. Only those tools should be relaxed where policy space is assessed to be available. The relaxation of MPIs will have to consider the source of systemic stress—if liquidity pressures are the source of banking sector stress, easing reserve requirements first would be appropriate. If this proves insufficient, the loan-to-deposit ratio can also be relaxed. If the stress is on asset quality leading to loan losses and declines in bank capital, dynamic provisioning ratios may be allowed to decline first to absorb losses. A relaxation of the CCB should be considered only after dynamic provisions have been used, to limit any adverse impact on investor confidence. Strong financial supervision will remain essential to ensure the adequacy of the remaining capital and liquidity buffers.9 If the buffers after release would be inadequate, banks should be required to raise capital and liquidity instead.

19. The macroprudential policy framework needs to contain potential leakages. DTI limits are currently applicable only to personal and consumer loans and exclude debt service on residential mortgages. An expansion in the scope of the DTI limits to include all debt service to be paid by an individual borrower (as is under consideration); and extending LTV limits to CRE loans (currently applied on residential mortgages) or other corporate loans secured by real estate as collateral could increase effectiveness of MPIs. In a similar vein, MPIs should be extended to nonbanks and foreign branches.

20. Addressing data gaps and improving coordination across regulators would strengthen the ability to assess systemic vulnerabilities in Saudi Arabia. Action is needed in several aspects. First, financial information is limited in a number of areas and poses an obstacle toward building an efficient macroprudential framework and identifying systemic risks as most of the tools and models commonly used to identify systemic risk require comprehensive and granular set of data.10 Second, the process of data compilation needs to incorporate both macro- and micro-prudential aspects, looking both at the big picture and risks at the micro level. Third, information sharing and policy coordination between different regulators is essential to prevent macroprudential policy gaps and leakages.

21. Macroprudential policies will need to remain adaptable over time as the financial sector deepens to support a growing economy. Many initiatives for financial deepening are likely to have financial stability implications. For instance, promoting SME financing may increase risk taking within the banking sector. Similarly, plans to open the capital market for foreign investment would increase vulnerabilities from capital flows. Over time, as the financial sector deepens, the macroprudential framework and toolkit would need to adapt to an evolving set of systemic risks.

Annex I. SAMA’s Policy Toolkit for the Banking and Insurance Sectors

Banking Sector

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Insurance Sector

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Annex II. Countercyclical Use of Macroprudential Tools, 2013

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Source: IMF’s Global Macroprudential Instruments Survey, includes macroprudential policies as reported by country authorities.Note: This excludes macroprudential tools that are not used countercylically to manage systemic risk.

Annex III. Issues in the Implementation of Macroprudential Policies

This Annex draws on the IMF’s Staff Guidance Note on Macroprudential Policy—Detailed Guidance on Instruments, November 2014. It summarizes the main issues and operational considerations in implementing specific macroprudential tools.

Broad-Based (Capital) Tools

Countercyclical buffer (CCB): Basel III has introduced a framework for a time-varying capital buffer on top of the minimum capital requirement and another time-invariant buffer (the conservation buffer). The countercyclical buffer is expected to be phased in gradually from 2016 to 2019. The CCB aims to make banks more resilient against imbalances in credit markets and thereby enhances medium-term prospects of the economy—in good times when system-wide risks are growing, the regulators could impose the CCB which would help the banks to withstand losses in bad times.

Operational considerations:

  • The Basel committee recommends that the CCB be set at a maximum of 2.5 percent of risk-weighted assets, although it can be set higher based on broader macroprudential considerations. Stress tests can help calibrate the appropriate size of the CCB to reflect both a capital shortfall in a stress scenario and extra capital needed to maintain investor confidence in a downturn.

  • For foreign banks in host jurisdictions, the reciprocity principle under the Basel II framework requires home country supervisors to ensure that the banks they supervise apply the CCB on exposures in the host jurisdiction that has imposed the CCB. This reciprocity arrangement will apply as long as the buffer does not exceed 2.5 percent, above which reciprocity is voluntary or based on further bilateral or regional agreements between home and host country authorities.

  • It may take time for banks to raise capital so the process of increasing the CCB should begin early in the financial cycle. Increases in the buffers should be preannounced for 12 months to give banks time to meet the additional requirements. At times of financial stress, reductions in the buffer could take effect immediately to help reduce the risk of a credit crunch.

  • The BCBS suggests that triggers to tighten CCBs can be based on estimates of the credit gap (derived as the deviation of credit-to-GDP ratio from trend). Other early warning indicators (e.g. credit growth, deviation of real estate and equity prices from long term trends, measures of market volatility and spreads, debt service and leverage ratios, reliance on wholesale funding, current account balances) that reflect country-specific systemic risk can also be incorporated. Over time, performance of these indicators in identifying systemic risk will need to be monitored.

  • Triggers to ease CCBs could be based on high-frequency market-based indicators of banking sector distress such as asset prices, credit spreads, and measures of market volatility in equity and foreign exchange markets.1 Additional indicators could include growth rate and leverage on new loans, credit conditions, and increases in nonperforming loans. To ensure that banks use the released capital to absorb losses, dividend payments should be restricted when the CCB is released.

Dynamic loan loss provisioning requirements (DPR): help smooth provisioning costs over the financial cycle and insulate bank income and lending in bad times. This pool of provisions, set aside in good times, can be used to cover realized losses in bad times when specific provisions for impaired loans exceed the average specific provisions over the economic cycle.

Operational considerations:

  • There are four main approaches to the DPR (i) through the cycle accumulation (formula-based approach) builds up general provisions in line with expected losses on new and existing loans, net of specific provisions on losses incurred during the period, (ii) trigger-based systems use thresholds of indicators to increase or release DPR buffers, (iii) loan by loan provisioning based on expected losses and probability of default data, and (iv) a hybrid approach combining (i) and (ii) with a trigger for allowing banks to access DPR reserves.

  • The formula-based approach is the least data intensive DPR framework (e.g. Spain, Uruguay) and accumulates and releases DPR buffers automatically and gradually as actual loan losses vary over the cycle. On the other hand, trigger based systems require estimation of thresholds of indicators that would signal the release of the DPR, but can allow reserves to be saved for rapid deployment during periods of stress.

  • A hybrid approach can be based on an accumulation formula but would add a trigger rule for release based on the same indicators identified for the release of the CCB. A bank would not be allowed to access its dynamic loan loss reserves unless indicators signal a downturn. As in the release of CCB, dividend payments should be restricted when DPRs are released.

Sectoral Tools

Household sector: vulnerabilities from excessive credit to the household sector and procyclical feedback between credit and asset prices can be addressed through sectoral capital requirements, loan-to-value (LTV) and debt-service-to-income (DTI) limits.2,3

Corporate sector: vulnerabilities from increases in corporate leverage, lending to commercial real estate (CRE) or from forex lending to the corporate sector can be addressed through sectoral capital requirements and exposure caps (e.g. higher risk weights for foreign currency credit, caps on growth of corporate credit and in foreign currency). To deal with risks from CRE lending, LTV limits can also be used.

Operational considerations:

  • Capital requirements and risk weights build resilience by forcing lenders to hold extra capital against their exposures to a specific sector and can be calibrated using results of stress tests. Caps on credit growth slow the supply of credit, while LTV and DTI limits reduce demand. LTV and DTI limits reinforce each other and can be used in an interlocking way—as asset prices rise relative to income, LTV limits become less constraining but DTI limits become more binding.

  • These tools can be differentiated between types of borrowers, across regions, and by currency and type of loans.4 There are no fixed thresholds for early warning indicators to suggest a tightening or relaxation. Tools can be calibrated to reflect country specific risks.

  • Sectoral capital requirements are less distortionary and can be applied first on either the entire stock of loans or to new lending. If sectoral capital requirements are tightened on the entire stock of loans, they may require significant adjustment and will need to be announced well ahead of the planned enforcement date. LTV and DTI limits can be subsequently imposed on the flow of new loans, if capital requirements fail to slow the growth of credit.5 A cap on sectoral credit growth has little direct effect on the resilience of the banking system and is more distortive and could be implemented if other measures prove inadequate. Decisions to ease sectoral macroprudential policies can be sequenced in the same way as a tightening.6

  • When several indicators signal elevated systemic risk, policy tightening should be gradual to overcome uncertainty over strength of economic transmission.7 Stepped up communication and supervisory guidance prior to introducing measures can reduce the burden on borrowers and lenders while strengthening the expectations channel. Loosening decisions may need to be taken more rapidly than tightening decisions.

  • For the household sector, indicators that could be used to assess a need for tightening include household loan growth and house price growth (jointly), to help prevent feedback loops between asset prices and credit.8 Other indicators could include mortgage loan growth, house price to income and house price to rent ratios, and the share of households in total credit in local and foreign currency. Further indicators may help a targeted policy response (e.g. house prices in different regions, average risk-weights on household loans and capital buffers above minimum, the average and distribution of LTV and DSTI ratios across various income groups, share of foreign currency denominated or interest-only loans).9

  • Easing macroprudential policies on the household sector can also rely on similar indicators as used for tightening decisions. In addition, fast-moving indicators could include transaction volumes, spreads on household loans, and CDS spreads of financial institutions to help policy makers respond in a timely fashion.

  • Corporate credit indicators that could be used to assess a need for tightening include the growth rate of corporate credit and the share of corporate credit in total credit in local and foreign currency (both stocks and flows). A range of additional indicators such as leverage on new and old loans, debt service ratio (debt service as a share of operating surplus), corporate credit/operating surplus (share and growth rate), corporate credit gap, and lending standards could also be considered.

  • In addition to indicators used for tightening decisions, fast-moving indicators such as spikes in corporate CDS spreads can help policy makers respond to corporate sector stress in a timely fashion.

Liquidity Tools

A variety of liquidity tools are available to promote a more sound funding profile in banks. Liquidity buffer requirements (e.g. a liquid asset ratio) oblige banks to hold a certain amount of liquid assets as a share of all short-term funding. A liquidity coverage ratio (LCR) can help ensure that banks hold sufficient high quality liquid assets to fund net cash outflows over a 30 day period. A stable funding requirement ratio (e.g. Net Stable Funding Ratio (NSFR), loan-to-deposit (LTD) ratio, core funding ratio (CFR)) can help ensure that banks hold stable liabilities (e.g. deposits) to fund their relatively illiquid assets.10 Liquidity charges impose a levy on non-core funding and can be differentiated by currency and can be accumulated for the budget or a dedicated fund that is used to provide liquidity during times of stress. Reserve requirements can be applied on short-term liabilities and adjusted for financial stability purposes. In addition, constraints on open FX positions and on FX funding may be used as well as tools to manage risks in nonbank financial institutions. Liquidity tools can be designed to target risks by currency and maturity and tailored to reflect country circumstances.

Operational considerations:

  • Tightening liquidity tools is not only likely to boost resilience to liquidity shocks, but is also likely to slow the growth of credit by making funding more costly during a financial cycle upswing. Given the limited experience with countercyclical use of liquidity tools, a gradual tightening is recommended. When tightening reserve requirements, the volume of open market operations may need to be adjusted to sterilize the impact on banking system liquidity and keep interbank rates close to the policy target.

  • Indicators that can be used to assess a need for tightening include the LTD ratio and the CFR. In addition, indicators of general credit conditions (based on surveys, movements in interest rates, short-term capital inflows, gross open FX positions) are also useful to guide the use of liquidity tools to moderate (liquidity-driven) credit cycles. There are no fixed thresholds for the indicators to assess a need for tightening, and stress testing can be used to assess specific risks and calibrate the policy response. Sharp movements in the indicators could also signal a need for policy action.

  • During times of liquidity stress, a relaxation of liquidity tools is appropriate and liquidity buffers should be released promptly. Authorities can allow temporary declines in liquidity buffers (reserve requirements, liquid asset ratio) without changing the formal requirements. If this proves insufficient, the stable funding ratio can be relaxed temporarily to prevent fire-sales of assets and abrupt deleveraging. In the event of extreme funding stress, central bank liquidity support should also be provided.

  • Indicators that can be used to assess liquidity stress include increased usage of the central bank’s overnight or emergency facilities, increases in unsecured interbank rate spreads, margins and haircuts on repo collateral, FX swap rates, bid-ask spreads in FX, and CDS-bond spreads.

Tools for the Nonbank Sector

Nonbanks are also a significant source of systemic liquidity risks. Data collection and basic oversight of nonbank institutions and markets are important first steps in addressing risks in this sector. Macroprudential measures can be extended to nonbank intermediaries. Leverage ratios, liquidity buffers and stable funding requirements, sectoral concentration limits, regulations on margin lending are some of the tools that can help manage systemic risks in the nonbank financial sector and ensure a level playing field.


  • Al-Darwish, A., N. Alghaith, P. Deb, and P. Khandelwal, 2015, “Monetary and Macroprudential Policies in Saudi Arabia,” in Saudi Arabia: Tackling Emerging Economic Challenges to Sustain Growth, International Monetary Fund, Washington, DC.

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Prepared by Hussain Abusaaq, Ayman Alfi, Padamja Khandelwal, Ken Miyajima, and Ben Piven.


An unrestricted VAR was run to capture the dynamics between five real and financial sector variables. The variables included were real oil prices (deflated by US CPI), real equity prices, real government spending, real credit from domestic banks to non-bank private sector, and real non-oil GDP. Data for equity prices, government spending and credit were deflated using Saudi CPI. Quarterly data from 1996–2014 was used for oil prices, equity prices and credit, while government spending and real non-oil GDP were interpolated from an annual series using a quadratic trend. The VAR was specified in log first differences, with 1, 4 and 5 lags.


Assets of commercial banks are over 130 percent of non-oil GDP, and equity market capitalization is near 115 percent of non-oil GDP. Non-bank financial intermediaries include the public pension funds, mutual funds, finance and leasing companies, and insurance companies. Excluding the public pension funds, the non-bank sector is likely to be small although relatively little data are available for this sector.


SAMA also licenses and regulates insurance and finance companies in Saudi Arabia. Some time-invariant macroprudential tools are enforced on insurance companies. Finance companies are also subject to LTV limits on mortgages.


See IMF Selected Issues Paper, “Assessing the Importance of Oil and Interest Rate Spillovers for Saudi Arabia.”


For instance, the framework will need to identify the minimum regulatory capital requirements and set the countercyclical buffers in line with Basel III capital requirements. Regulatory minima will also need to be set for other tools that can be used countercyclically.


Real estate loans by banks are a fairly small share of total credit, although real estate has been used as collateral for corporate and consumer loans. Lending by finance and leasing companies has only recently been brought under the purview of SAMA supervision. To the extent that real estate lending has been previously conducted by the non-bank sector, there is limited data on these activities and risks may be associated.


Although the Saudi banking sector is assessed to be well-capitalized and profitable at the current juncture, supervisors will need to assess if policy space may be diminished by low risk-weights or adjustments to the computation of regulatory capital.


Some of the data gaps that need to be filled include: data on commercial and residential real estate prices, household balance sheets (distribution of equity and home ownership, household debt, LTV and DTI ratios), corporate balance sheets (e.g. debt and debt service coverage ratios including for non-listed firms), characteristics of bank loan portfolios (fixed versus variable interest rate loans, secured and unsecured loans etc.), and cross border exposures vis-à-vis non-BIS-reporting banks/countries.


Credit usually lags the business cycle, so the credit/GDP gap does not work well as an indicator for releasing the CCB.


LTV limits cap the size of the loan relative to the appraised value of a property, while DTI limits cap the debt service as a share of borrower income.


Where supply constraints are an important driver of real estate price increases, macroprudential measures are likely to be of limited effectiveness. In such situations, measures to alleviate supply constraints are appropriate.


For example, they may be applied only to mortgages that are interest-only, in foreign currency, or on luxury and investment properties.


LTV limits are often applied in commercial and residential real estate markets, but can also be applied to other secured loans, such as car loans.


Defining minimum capital buffers and maximum LTV and DSTI ratios that are considered safe in a downturn is critical to ensure that microprudential norms are respected and financial stability is maintained.


Mixed signals from multiple indicators are not sufficient for action.


LTV limits are often applied in mortgage markets, but can also be applied to other secured loans, such as car loans.


Where supply constraints are an important driver of real estate price increases, macroprudential measures are likely to be of limited effectiveness. In such situations, measures to alleviate supply constraints are appropriate.


International discussions on liquidity tools are ongoing as minimum standards for the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR) are being negotiated under Basel III.

Saudi Arabia: Selected Issues
Author: International Monetary Fund. Middle East and Central Asia Dept.