The sharp drop in oil prices and measures implemented by governments to contain transmission of the coronavirus (COVID-19) are expected to reduce revenue and credit growth of GCC banks in 2020, according to credit rating agency Standard & Poor's. Image Credit: Gulf News Archives

Dubai: The sharp drop in oil prices and measures implemented by governments to contain transmission of the coronavirus (COVID-19) are expected to reduce revenue and credit growth of GCC banks in 2020, according to rating agency Standard & Poor’s.

Both oil prices and temporary lockdowns across GCC are likely to take a toll on important sectors such as real estate, hospitality, and consumer-related sectors.

“Under our base-case scenario, we assume that these measures will be relatively short lived and forecast a gradual recovery in non-oil activity from third-quarter 2020,” said Mohamed Damak, director of research at S&P. “If the recovery takes longer than we expect, GCC banks could feel greater pressure.”

Slowdown in loan growth

S&P expects a significant slowdown in credit growth across GCC in 2020.

Although growth rates last year were almost the same as 2018, GCC conventional banks saw faster increases than Islamic banks. This was mainly explained by acquisitions. Emirates NBD, for example, acquired DenizBank in Turkey, increasing its total assets by almost one-quarter. Other transactions were mainly local or regional with Abu Dhabi Commercial Bank absorbing two other local banks (including one Islamic) and Saudi British Bank taking over another local bank.

GCC banks
Image Credit: Standard & Poor's

“In 2020, we expect slower organic and non-organic growth, with Islamic and conventional banks seeing similar rates of 2 to 3 per cent [financing growth],” said Damak.

The rating agency projects average real GDP growth for the six GCC countries will slightly accelerate in 2020 compared with 2019, but this will be primarily spurred by higher oil production. With the significant decline in oil prices they assume the averages oil price for 2020 at $30 per barrel, down from $60 at the start of the year.

In S&P’s forecasts, they assume that measures implemented by the GCC governments to contain COVID-19 are relatively short lived.

Increased cost of risk

Lower economic growth and significant shocks to vital economic sectors such as real estate, hospitality, and consumption mean that GCC banks’ asset-quality indicators will deteriorate in 2020.

At year-end 2019, the average nonperforming financing (NPF) ratio reached 2.8 per cent for Islamic banks compared with 3 per cent for conventional banks. For 2020, analysts expect NPF ratios could easily double, and cost of risk could reach 1.5 per cent to 2 per cent of total loans with most of the deterioration would come from small and midsize enterprises (SMEs).

Considering these factors S&P expects banks to focus more on asset-quality indicator preservation than generating new business. If banks fail to address the asset quality issues this year, problems could linger in to 2021.

Funding and liquidity to remain good

Growth in customer deposits was strong in 2019 for both types of banks thanks to the recovery in oil prices. The funding profile of Islamic and conventional banks also remained stable, with total financing to total deposits of about 93 per cent at year-end 2019.

Mohamed Damak

“We see two main risks in 2020. These include the concentration of the deposits base on government and government-related entity (GRE) deposits, which account for 10 to 35 per cent of total deposits. These entities might burn cash as the drop in oil prices and less supportive economic environment affect their activities,” said Damak.

Additionally risks related to deposits outflows once the COVID-19 pandemic is contained and the full effect on employment is known. Some expatriates might increase remittances to their home countries.

Despite this pressure, S&P believes banks’ funding profiles remain a strength in most GCC countries. In addition the governments’ strong capacity and willingness to provide the sector with support in case of need.

Most banks to remain profitable

S&P anticipate that both Islamic and conventional GCC banks’ profitability will take a hit in 2020.

This is because financing growth will remain limited, with banks focusing more on preserving their asset-quality indicators than generating new business amid the COVID-19 pandemic.

“We believe banks will continue to benefit from their relatively low cost base and potential additional cost-saving initiatives from 2021,” said Damak

Although some banks announced employment-preservation measures for 2020 S&P expects (job) cuts will probably come next year if the environment doesn’t improve.

Strong capital buffers

GCC Islamic and conventional banks have strong capitalization by international standards, with an unweighted average Tier 1 ratio of 17.9 per cent for Islamic banks and 16.6 per cent for conventional banks at year-end 2019. S&P expects capitalisation to continue to support the creditworthiness of GCC banks in 2020.

A second wave of M&A could begin
Rating agency Standard & Poor’s expect when the dust settles and the full effect of current conditions on banks’ financials there could be a second wave of mergers and acquisitions (M&A).
The first wave was spurred by shareholders’ desire to reorganize their assets. The second wave will be more opportunistic and driven by economic rationale. The current environment might push some banks to find a stronger shareholder or join forces with peers to enhance resilience.
“We think a second wave of M&A might involve consolidation across different GCC countries or emirates in the United Arab Emirates (UAE), for example. This would require more aggressive moves by management than those seen in the past,” said Mohamed Damak, Director of Research at S&P.

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