Dubai: The unique interlinkages that exist between oil, public spending and banks in the region will result in reduced banking system liquidity, with secondary effects on credit growth and profitability, according to rating agency Moody’s Investor Service.
The impact of oil prices on the banking sector is not transmitted through its direct exposure to the oil sector, but rather through reductions in its government-related deposits and the heavy reliance of the economy on public spending, both of which will be affected by lower earnings from oil.
“As a result of sustained low oil prices, we expect banking systems in the region will primarily face a decline in liquidity as government-related deposit inflows are reduced,” said Khalid Howladar, Senior Credit Officer at Moody’s.
The rating agency assumes oil (Brent) prices to average at $55 (Dh202)/barrel in 2015, rising to $65 on average in 2016. The cumulative impact of low oil prices is expected to primarily impact the GCC banks’ loan growth and, ultimately, profitability, channelled through weaker deposit inflows and weaker economic activity. The overall asset quality is projected to remain stable for most GCC banking systems, while a more pronounced and more prolonged oil price decline than assumed would ultimately trigger some asset quality pressure.
In the GCC, governments play a dominant role in their domestic banking systems. They are often simultaneously the biggest borrower, depositor and shareholder. Banks play a key role in implementing economic policy by helping to channel the oil surpluses into the local economy.
In fact, governments, related entities and particularly the National Oil Companies (NOCs) are among the largest depositors in the banks with aggregate balances that provide around 10 per cent to 35 per cent of non-equity bank funding. As such, a material reduction in oil-related earnings across the government and its related entities would unavoidably reduce the level of their deposits impacting the liability side of the banks’ balance sheets and leading to reduction in banking system liquidity.
“The GCC banks’ stock of liquid assets are healthy and their reliance on market funding is generally limited, leaving some headroom for banks to adjust to changing funding conditions in an orderly fashion,” said Howladar.
GCC banks generally have robust buffers and are expected to be resilient in their fundamental credit profiles. Nevertheless, each of the GCC banking systems displays vulnerabilities that are broadly in line with the pressures faced by their respective sovereigns, with banks in Bahrain and Oman seen as most vulnerable.
The rating agency said that Kuwait, Qatar, Saudi Arabia and the UAE are able to better support their economies and banking systems due to their sizeable reserves, whereas banks operating in Bahrain and Oman are more vulnerable to a more pronounced or more prolonged period of low oil prices than expected.
“The Oman and Bahrain banking systems are the most vulnerable to a long-term drop in prices. Both sovereigns have a weak combination of high fiscal break-even oil prices and relatively low or near zero reserve buffers,” Nitish Bhojnagarwala, assistant vice-president at Moody’s, said.