Dubai: The banking sector in the Gulf Cooperation Council (GCC) is expected to deliver a stable performance in 2018, reflecting strong financial fundamentals, particularly in the largest banking systems such as the UAE and Saudi Arabia, according to rating agency Moody’s.

While slow economic growth, fiscal and geopolitical risks are expected to pose challenges to profitability and loan quality of the region’s banks, the raging agency expects strong capitalisation levels with high loan-loss reserves providing banks strong loss-absorption capacity.

“Low oil prices and [the] resulting fiscal consolidation measures have dampened economic activity in the GCC. Non-oil economic growth will remain modest but will pick up slightly in 2018 to 2.6 per cent as Brent oil prices stabilise at the upper end of our $40 (Dh146) and $60 (Dh220)/barrel band, opening some room for more gradual fiscal consolidation. Having said that, expected VAT [value-added tax] introduction could initially dampen non-oil growth, while extension of Opec [Organisation of the Petroleum Exporting Countries] production cuts throughout 2018 will weigh on real oil sector growth,” said Olivier Panis, a Vice-President and Senior Credit Officer at Moody’s.

Moody’s forecasts that real gross domestic product (GDP) growth in the region will pick up slightly, to around 2 per cent in 2018 from zero per cent in 2017. Although fiscal consolidation efforts in the region will persist, key regional infrastructure projects such as UAE Expo 2020, World Cup Qatar 2022 and the Saudi National Transformation Programme (NTP) are expected to support capital spending and credit growth, which should expand by 5 per cent in 2018. Low credit growth will weigh on interest income and on fees and commissions, and provisioning charges will increase.

Challenges faced by the region to diversify economies and government finances, and regional political tensions are common to all GCC sovereigns, but according to Moody’s, Bahrain, Oman and Qatar are more exposed than Kuwait, Saudi Arabia and the UAE.

“Individually, in the UAE, Saudi Arabia and Kuwait, which account for around 75 per cent of GCC banking assets, the outlook is stable; however, Bahrain and Oman are more weakly positioned in respect to their fiscal position,” said Panis.

Asset quality

Loan performance is expected to remain solid overall with non-performing loans (NPLs) likely to edge higher in a context of sluggish economic activity in the range of 3 to 4 per cent. Sectors sensitive to fiscal consolidation such as contracting, construction, real estate, retail and small- and medium-sized enterprises are likely to face higher loan impairments.

Loan quality of banks across the region are likely to be impacted by exposure to large single borrowers and some sectors’ exposure to unexpected shocks. However, the introduction of credit bureaus and the use of forward-looking credit management tools in line with new IFRS 9 accounting standards will further improve banks’ risk controls and strong provisioning coverage levels.

Analysts expect GCC banks to remain vulnerable to high borrower and sector loan concentrations and uneven disclosure in the corporate sector. While nonperforming loan (NPL) ratios will remain low in 2018 with a GCC average 3 to 4 per cent, overall NPLs are expected to increase incrementally, driven by factors such as slowing economic conditions and loan restructurings. Overall, banks are expected to be selective in risk appetite.

Contracting, construction and real estate sectors will take the brunt of fiscal pressures and low oil prices. Small- and mid-sized companies (SMEs) are most exposed to slowing economic activity, although GCC banks have been cautious in lending to that segment in recent years.

Loan demand is also negatively impacted by subsidy cuts and VAT implementation in the GCC. These measures are expected to dent consumer disposable income and demand. This will weaken the performance of consumer loans and of retail and commercial industries.

“Any increase beyond our expected scenario in fiscal consolidation measures in Bahrain and Oman, where deficits are the highest, would increase stress on borrowers’ repayment capacity. Borrowing costs are increasing as most central banks are replicating US Federal Reserve interest rate hikes,” said Panis.