Dubai: The economic slowdown experienced by the GCC countries following the oil price decline and consequent fiscal tightening will continue to apply pressure on asset growth and profitability of banks including Islamic banks in 2017 and 2018, according to rating agency Standard & Poor’s (S&P).
S&P forecasts oil prices will stabilise at $50 per barrel in 2017 and 2018, with unweighted average GDP growth in the six GCC countries at 1.9 per cent in 2017 and 2.4 per cent in 2018, after 2.3 per cent in 2016.
Asset growth stabilised at 6.4 per cent in 2016 for Islamic and conventional banks, compared with 6.6 per cent and 6.9 per cent respectively in 2015. “In our base-case scenario, we assume that asset growth will drop to about 5 per cent as governments’ spending cuts and revenue-boosting initiatives, such as tax introductions, reduce opportunities in the corporate and retail sectors,” said S&P Global Ratings Head of Islamic Finance Dr. Mohammad Damak.
Sluggish asset growth
Analysts expect region’s banks to become more cautious and selective in chasing high-quality lending opportunities resulting in lower asset growth. However analysts say the story is not the same for all Gulf Cooperation Council (GCC) countries. Although the economic slowdown was and will remain more pronounced in Saudi Arabia, Islamic banks’ growth accelerated there in 2016, thanks to their strategy to increase their foray into the corporate and small and mid-size (SME) sectors.
By contrast, the slowdown was deeper in Qatar, where a mix of lower liquidity and government spending cuts prompted banks to curtail their pace of expansion. Asset growth was about nil in Kuwait over the past year, hit by the depreciation of some foreign currencies and the ensuing impact on the financials of some leading Kuwaiti Islamic banks. Despite the tepid economy and the drop in real estate prices in the UAE, Islamic banks continued to expand at high single digit figure.
Asset quality weakens
Asset quality of GCC banks in general are strongly correlated to the economies in which they operate. According to S&P the asset quality indicators of GCC Islamic banks remain on a par with those of their conventional counterparts. Both Islamic and conventional banks are well entrenched in their local real economies in the GCC.
“As the economic cycle turns, we think that asset quality indicators will continue to deteriorate in 2017-2018. The weakening that has already occurred was not noticeable in 2016 because — as is typical — banks started to restructure their exposures to adapt to the shift in the economic environment. Therefore, we saw an increase in restructured loans in the GCC in 2016, but we didn’t observe a marked increase in nonperforming loans (NPLs) or cost of risk,” said Damak.
The deterioration in asset quality is expected to be more visible in 2017-2018. Although some market participants maintain that Islamic banks will fare much better than their conventional counterparts due to the asset backing principle inherent to Islamic finance. However, S&P expects both conventional and Islamic banks will be on equal footing when it comes to impairments because bankruptcy laws remain underdeveloped, and the foreclosure of underlying assets remains generally difficult in most GCC countries, especially because the predominant type of collateral is real estate.
Typically, asset quality issues in the banking sector show up with a lag. As subcontractors, small and medium enterprises (SMEs), and expatriate retail exposures will bear the brunt of the turning economic cycle and are expected to contribute to the formation of new NPLs in 2017 and 2018.
Despite the emerging challenges analysts see as positive the buffers that GCC Islamic banks have built in previous years, when the cycle was more supportive. The ratio of NPLs to total loans was 3.1 per cent on average at year-end 2016, with an average coverage ratio of 133.9 per cent. “Under our base-case scenario, we think NPLs could increase to 4 per cent to 5 per cent over the next two years,” said Damak.
