Dubai: Slowing business activity across the GCC from the coronavirus outbreak amplified by falling hydrocarbon revenues are expected to impact the financial performance of banking sector, according to rating agency Moody’s.
“The combination [of slowing economies and low oil prices] will impede lending growth, narrow interest margins and lead to a sharp increase in provisioning for bad loans, particularly given the new IFRS 9 expected credit loss accounting regime that requires extensive forward-looking provisioning for souring loans,” said Badis Shubailat, an analyst at Moody’s.
The rating agency sees interest margins, the main source of revenue for the banks to narrow as central bank interest rate cuts and higher borrower delinquencies dent yields on lending. At the same time, deposits will cost banks more in interest as lower oil prices slow inflows of government deposits into the banks.
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The sharp contraction in business activity across most sectors of the non-oil economy, will mean GCC banks will have to book higher provisions against rising nonperforming loans over the coming quarters.
“We estimate that lower core income and a spike in provisioning will lead to an average drop in full-year profits of more than 20 per cent for our GCC rated banks and a moderate weakening of their efficiency levels although those remain sound when compared to global standards,” said Shubailat
Focus on costs
Moody’s said the economic downturn will shift the focus of GCC bank management to reducing operating costs and to consolidation opportunities as main sources of bottom-line uplift for shareholders.
Instead of seeking relatively higher bottom-line profitability, GCC banks will become more cost-conscious, looking to sustain moderate growth and with profit and loss accounts facing assault on all fronts, their operating models and investments strategies will be in focus. This will require stringent cost optimisation at a time when scrutiny around complying with rigorous regulatory measures, such as new accounting standards, anti-money laundering (AML) and know-your customer (KYC) rules, as well as the imperative to adopt new technologies are already pushing costs higher.
Such expenses, together with the heavy burden of running branch networks in an era of rapid digitalisation, will continue to be areas to tamper with economies of scale, cost efficiency and revenue synergies.
Urge to merge
Fewer business opportunities combined with shrinking margins are expected to drive bank managements in the GCC to look for more cost efficient operations that is expected to drive more consolidation in the sector, according to Moody’s.
The current economic shock underscores how dependent GCC economies continue to be on government finances, mostly derived from hydrocarbon revenues, suggesting that economic diversification across the region remains limited.
The rating agency expects GCC banks will eventually require scale to fulfill their role in financing economic transformation plans. Bigger banks can participate in large ticket projects and attract investment flows that will help wean GCC economies from oil. Size will also become essential as banks seek greater global reach to attain increased market access.
“We expect that, once banks reach a critical size domestically, they will increasingly seek to venture outside their home markets into geographies with strong trade and economic links such as Turkey or higher growth prospects as in Egypt," Shubailat.
M&A deal-making among Gulf banks in recent years has regularly involved a common owner reorganising its bank assets under a single entity as operating conditions weakened in a bid to achieve a leaner cost structure and increase profits in a highly competitive and overcrowded banking market.
Moody’s expects pressures building from the oil price and pandemic shocks will increasingly drive purely financially driven transactions, particularly among smaller banks crowded out by larger competitors.