Dubai: Banks across GCC are expected see a modest turn around in revenues and margins in the first quarter of 2017, while the overall credit conditions are expected to remain tough in the context of slow economic growth resulting from low oil prices and a slew of fiscal adjustment measures implemented by governments.

Although loan growth is expected to remain in single digits, liquidity conditions have in banking systems across GCC are improving on account of large external government borrowings reducing the liquidity pressure on banks from domestic government borrowings, particularly in Saudi Arabia.

“We expect the GCC banks to see marginal improvement in revenue generation in the first quarter of 2017 as net interest margins (NIMs) start to stabilise amid improvement in liquidity and increase in rates,” said Jaap Meijer, Head of Equity Research of Arqaam Capital.

Analysts expect revenue growth in 2017 to improve slightly from last year, as NIM compression comes to an end with less crowding out from local bond issues and funds drain from government deposit withdrawals. While gradual rate increases are expected to filter through the loan and investment books, credit costs are likely to remain elevated this year as non-performing loans (NPL) recoveries soften, limiting earnings growth.

Competitive rates

Economic risks for the GCC region appear manageable despite recent oil weakness, supported by only gradual US rate hikes, improvement in interbank/credit default spreads, phased out fiscal, implementation of Basel III liquidity and capital requirements and reduced risks from contractors.

Despite an increase in cost of funds resulting from gradual increase in interest rates, GCC banks are better placed to manage this because of the relatively high share of current and savings (CASA) deposits and low cost term deposits in the funding mix. In addition, a number of banks have front-loaded their medium term fund raising through bonds last year ahead of the rate hikes and many banks have been tapping wholesale markets at competitive rates.

Analysts expect that endowment effects will start to outweigh the increased cost of liquidity, but going forward banks should pay greater attention to align credit expansion and deposit growth to avoid yield compression.

The overall revenue growth of banks are expected to remain in low single digits next year compared to historically high double digit growth, according to Boston Consulting Group.

Profits declined

A recent study by The Boston Consulting Group found that in 2016, GCC banks’ revenues grew by 5.2 per cent, down about 2 percentage points from 2015, after a drop of three percentage points from 2014. Revenue growth is expected to remain in single digits of 7 to 8 per cent during the current year.

Due to a sharp increase in provisions by 20.8 per cent, an increase in cost by of 6.3 per cent and a drop in extra ordinary income, profits declined by 3.2 per cent for the first time since 2008 in 2016.

For the GCC as a whole, with the exception of Qatar all countries witnessed low single digits growth in revenues last year with flat or negative profit growth. “In 2016, only 10 per cent of GCC banks were able to achieve double digit revenue and profit growth. Slightly more than 50 per cent of banks experienced declining profits and many more banks entered the slower growth range,” said Dr Reinhold Leichtfuss, Senior Partner & Managing Director at BCG’s Middle East office

The main customer segments — retail and corporate banking — grew revenues with 5.7 per cent and 4.5 per cent growth rates, respectively last year. With slow growth in loan originations, fee & commissions incomes of banks across the region are likely to be very slow as loan origination fees are often recognised up front.

Expensive branch networks

Banks are likely to continue to rein in operating expenses growth despite continued increase IT, compliance and regulatory costs. Analysts expect banks to trade off expensive branch networks for access to cheap deposits.

“NPL formation has turned the corner in FY 16A, masked by accelerated write-offs, while cost of risks (CoR) is likely to remain sticky as NPL recoveries soften. We see only limited possibilities to cushion earnings from the worsening asset quality given the implementation of IFRS 9 by 2018, which forces the bank to provide for on expected losses, rather than incurred losses; relatively limited over provisioning of existing NPLs given overall low NPL levels, and stress in the SME sector which is likely to start affecting larger corporates,” said Maijer.