Business | Opinion
Capital is crucial as banks prepare for tougher times
Within the next few weeks, the long-term impact on Gulf banks of turmoil in global financial markets and the recent decline in oil prices will start to become apparent.
- By Andrew Cunningham, Financial Times
- Published: 23:46 December 15, 2008
Within the next few weeks, the long-term impact on Gulf banks of turmoil in global financial markets and the recent decline in oil prices will start to become apparent.
So far, the region's banks have, with a few exceptions, been able to shrug off the effects of the asset writedowns that have caused such havoc in western financial markets.
Saudi banks, which account for about 40 per cent of all Gulf banking activity, remain robust, with 6 out of 11 reporting interim profits ahead of those seen last year, in spite of the effect of asset revaluations.
The other five have announced reduced income, but remain profitable. All leading banks in the UAE are reporting increased profits, and the story is the same for larger banks in other Gulf states.
There have been casualties. In October, the Central Bank of Kuwait had to step in to support Gulf Bank after one of its customers defaulted on derivative transactions. Earlier in the year, Arab Banking Corporation and Gulf International Bank each had to seek capital injections of $1 billion (Dh3.67 billion) to cover trading losses and asset writedowns.
At a systemic level, Gulf central banks have made liquidity available to their banks, issued formal statements guaranteeing bank deposits and, in the case of Qatar, announced that state funds stand ready to inject capital into domestic banks.
Oil prices
Yet the Gulf has not suffered the wrenching structural changes that have afflicted western markets. While the US and Europe have seen institutions such as Washington Mutual, Merrill Lynch, Fortis and HBOS falling into the arms of stronger partners, the flagships of the Gulf remain independent and profitable.
But that is no reason for complacency. The price of oil - always by far the most important indicator of banking performance in the region - has fallen by more than two-thirds in the past four months. Average oil prices for 2008 remain historically high, but prices today are back where they were in 2004. A price of $40 a barrel was sufficient to maintain sound economic growth four years ago, but it falls far short of what is needed to support the grandiose schemes launched since then.
High oil prices have fuelled a rapid increase in bank lending. In the three years to the end of 2007, private sector credit in Qatar increased 270 per cent, in the UAE 154 per cent and in Kuwait 104 per cent. The trend continued this year.
Qatari banks increased private sector loans by 26 per cent in the first six months, and UAE national banks increased their portfolios 27 per cent. Private sector credit by retail banks in Bahrain rose 33 per cent in the first nine months.
A substantial proportion of credit now outstanding in the region was extended at a time of buoyant economic growth, strong liquidity and high business confidence. Barring a dramatic upswing in oil prices, these loans will have to be serviced in an environment of financial retrenchment and unusually tight liquidity.
Next year, Gulf banks are likely to face far more difficult and longer-term challenges of loan quality as their clients struggle to adjust to new economic conditions.
Will the banks survive? As earnings falter, capital will be crucial, providing a cushion to absorb the shock of asset writedowns.
Loan portfolios
The critical indicator to watch is how much capital Gulf banks are holding against their private sector loans. In simple terms, what proportion of their current loan portfolios can they write off before they burn through their capital and become insolvent?
At the end of June 2008, Qatari banks had capital and reserves equivalent to 32 per cent of their private sector loans, and Bahraini retail banks had 31 per cent. Local Emirati banks showed a ratio of 25 per cent, while the other Gulf states had about 20 per cent of their private sector loans backed by capital and reserves.
Clearly, not all of a bank's capital can be depleted if it wants to remain a going concern. But most Gulf banks can afford to run down about half of their existing capital resources before alarm bells start to ring.
Saudi banks, which have seen more modest credit growth than most of their neighbours, seem well placed to withstand a downturn.
- Andrew Cunningham is a managing director at the Financial Services Volunteer Corps in New York.
Your comments
In my opinion, UAE banks have issued more housing loans and credit cards to their customers than usual. Many people have around six credit cards. Banks seek profit and business while not looking at their financial strategy. I agree with your comment that banks in the Kingdom of Saudi Arabia have seen a more modest growth than banks in UAE.
Jaya Sankar
Machilipatnam,India
Posted: December 16, 2008, 13:23
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