Even in normal times, it is because banks have a special place in any economy that their business is discussed not so much in terms of how they may perform as entities and a sector to invest in, but more as to whether and how they help deliver economic growth.
After all, they perform the role of intermediaries for the rest of the economy, all the non-financial sectors, particularly between households and corporates, between savings and investment, and between short-term deposits and longer-term employment of that funding.
Of course, this key function of matching lending and borrowing has been muddied to the point of grotesque distortion in some parts of the industry around the world, with the breaching of the division between traditional interpretations of banking on the one hand and, to some extent, speculative trading on the other. That blurring has only been mutated further by the unwelcome ability of banks of a certain size to ‘privatise profits, socialise losses’ because they are too systemically important to allow to fail.
It is an issue that has dominated perceptions of the sector since the global financial crisis, and regulators and governments have respectively sought to apply stringencies on risky banking exposures, and yet to urge the banks to provide credit across the economy to keep it from stalling. Much debate has arisen over these conflicting concerns, and over the nature of such overarching interventions as the Basle III reforms.
Behind all the confabulation, however, rests the central fact that the banks generate themselves and steer the nominal demand that sustains real economic activity, insofar as, subject to prudential and supervisory issues, they literally create the money that enables and put a price to it.
So-called fractional banking means that these institutions maintain only a modest proportion of funds in liquid form, while pumping substantially unbacked credit to consumers and businesses alike, besides their investment portfolios and other exposures. And the money supply, by its various measures, is a critical factor for economic growth, pretty much wherever you belong on the spectrum of economic argument.
Thus, it never does any harm to keep an eye on both the intrinsic health of the banks, and what degree of assistance they are giving to the recovery process. That, naturally, is somewhat a circular matter, since faster economic growth itself is liable to lead to improved earnings, which provide the basis for further expansion.
Equally, as everyone knows by now, that process can get seriously out of hand if not tempered by the authorities, which inevitably are thoroughly implicated in determining the parameters of credit creation, whether by the application of interest rates (via central banks) or administrative measures (that is, controls).
Indeed, when money and credit are nationalised (as they implicitly, systemically are), then ultimately responsibility must rest with governments, before and after their own finances become vulnerable to bailing out any overextended system. The complaints often heard among politicians that bankers are to blame for exaggerated state deficits, their derivative sovereign debt burdens and indeed most of the world’s economic ills are rather fatuous in that sense.
Strangely enough, while preoccupied with the state of their respective banking sectors, and their ability not only to avoid catastrophic systemic rupture but also fuel economic revival, much of the world is relying on suppression of interest rates, along the whole length of the yield curve, to try to maintain the demand for borrowing, and therefore level of spending. (The frightening scale of the dependence on cheap money has been shown by many disturbed emerging markets in the past couple of weeks.)
Yet that very intrusion has limited the willingness of banks to extend the supply of finance, given that their returns are essentially based on the differential between short and longer maturities! Moreover, compressed margins surely mean a need for both higher volumes and lower quality to achieve the same rates of return, that is, engaging with greater risk. It really is a funny old world.
As to the Gulf region, fortunately there appears very little basis for concern about the creditworthiness of the banks themselves, which — though having been through the mill of discomfort — are routinely described as well-capitalised, with comfortable liquidity and rising profitability. As the region’s economies have picked up pace — seemingly isolated to some extent from the rest of the globe’s difficulties — so have earnings performance responded and non-performing loans receded as an issue.
Last week rating agency Standard & Poor’s confirmed the benefits of the uptrending economic cycle, with “healthy” economic prospects this year keeping demand for bank credit high and promoting earnings, although, inevitably, “dependence on the hydrocarbons sector remains a structural risk factor”.
With the global situation pivoting on the US Federal Reserve’s shifting policy stance — though merely to restrict easing rather than tighten per se — the GCC’s banks are “well-positioned”, S&P assesses.
On the UAE’s banking system, recent research by Bank Audi noted that bank lending had accelerated by two and a half times in the nine-month period January-September 2013, year on year, while the central bank has taken a number of initiatives to protect asset quality and balance sheet strength. It reckoned that any risk of duration mismatch represented by a shift towards private sector shorter-term retail funding would be offset by the cash-rich public sector’s wholesale contributions.
That being said, the usual caveat springs to mind. As Moody’s reminded in a release in November, “oil contributes 62 per cent of GDP, and hence we consider the oil price as a barometer for overall economic performance and confidence within the country”.
Besides a very accommodative monetary policy, it’s difficult to get away from that criterion as the mainstay of the systemic banking and economic condition in the GCC, especially if the potentially still volatile real estate sector is to be regarded as an element of non-oil diversification.
