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Banks in the GCC are expected to face an uphill struggle in the next 18 months due to the protracted nature of the economic recovery. Image Credit: Reuters

Dubai: Banks in the GCC are expected to face an uphill struggle in the next 18 months due to the protracted nature of the economic recovery according to Standard & Poor’s.

The rating agency said the pressure on GCC banks in its rated universe is likely to mount in the context of the expected gradual withdrawal of regulatory relaxations following the COVID-19.

Recent economic forecasts by the International Monetary Fund and the IIF have indicated slower than anticipated economic recovery for the region next year. S&P has forecast that the GCC economies will expand by an average of 2.4 per cent in 2021, compared with a contraction of 5.6 per cent in 2020.

We expect that lending growth will remain muted, with the exception of Saudi Arabia, where mortgages have been expanding rapidly on the back of a government initiative to increase home ownership in the country.

- Mohamed Damak, Senior Director & Global Head of Islamic Finance, Financial Services Research, S&P.

Slowing loan growth

GCC banks’ lending growth slowed in first-half 2020 to an annualized rate of 6.6 per cent, compared with 9.4 per cent in 2019.

Banks have reduced their risk appetite and limited their activity to either recycling the liquidity injected by their respective central banks, or honoring their committed credit lines. Corporates have reduced their capital expenditure and focused on cash preservation. They have drawn down some of their committed credit lines to continue covering their operating expenses while their revenues contracted.

GCC loan growth
GCC banks’ lending growth slowed in first-half 2020 to an annualized rate of 6.6 per cent, compared with 9.4 per cent in 2019. Image Credit: S&P

“We expect that lending growth will remain muted, with the exception of Saudi Arabia, where mortgages have been expanding rapidly on the back of a government initiative to increase home ownership in the country,” said Mohamed Damak, Senior Director & Global Head of Islamic Finance, Financial Services Research, S&P.

Asset quality and margins

Measures that the various GCC governments have implemented to control the pandemic and the drop in oil prices have plunged the economies of the GCC countries into deep recession. The measures have also affected some vital economic sectors, such as real estate, hospitality, which are likely to see a spike in NPLs.

S&P’s data for the rated banks in the region showed as on June 30, 2020, the ratio of NPLs to total loans reached 3.7 per cent, compared with 3.2 per cent at year-end 2019.

The largest deteriorations to date have been in the United Arab Emirates (UAE)--due to a fraud case at one large corporate and a few cases of firms skipping payments--and in Kuwait--due to the decline in real estate prices and the activities of some Kuwaiti banks in riskier countries.

“In the next six-to-12 months, we expect the authorities to withdraw the forbearance measures progressively to maintain confidence and avoid major repercussions for their banking systems. We therefore expect the average NPL ratio to increase to about 5 per cent to 6 per cent in the next 12-24 months for our sample of banks, said Damak

The overall cost of risk is expected continue increasing as problematic asset recognition accelerates in the absence of additional support measures.

With the interest revenues remaining below their historical levels due to the US Federal Reserve’s policy of lower-for-longer interest rates S&P expects GCC banks’ profitability to continues to decline, with a few reporting losses because of their exposure to high-risk asset classes--such as small-to-midsize enterprises (SMEs) and credit cards--or in few instances, because of under-provisioning.

Funding and liquidity

S&P sees funding as a relative strength for most of the GCC banking systems. The use of wholesale funding sources remains relatively limited and will not change anytime soon. The only exception is Qatar, where the banking system still carries significant net external debt.

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Core customer deposits are the main funding source for GCC banks and we do not foresee any change in the next few years. Growth in customer deposits dropped to about an annualized 4.8 per cent in the first six months of 2020, compared with 9.7 per cent in 2019. However, the drop was primarily due to the lower oil prices and the fact that some corporates had to use their deposits to cover their operating costs while their revenues contracted.

Capital buffers

The GCC banks continue to display strong capitalization by international standards, with an unweighted average Tier 1 ratio of 17.2 per cent on June 30, 2020. This ratio has been fairly stable over the past three years, but S&P sees this might decline slightly in 2020 and 2021 as the operating environment impinges on banks’ profitability.

GCC Islamic banks could get hurt more
Dubai: GCC’s Islamic banks’ profitability and asset quality are likely to be more adversely impacted by the low growth operating environment.
“Having looked at the credit fundamentals of the 16 largest Islamic banks and 30 largest conventional banks in the GCC, we consider that Islamic banks might prove less resilient to a protracted downturn than their conventional peers,” said Damak.
This is because of Islamic banks’ strong entrenchment in the real estate sector and the absence of late payment fees; under Islamic law, banks must give such fees to charity. Moreover, the exposure of some Islamic and conventional GCC banks to weaker markets will probably add to their asset-quality problems.
Turkey is one such country. S&P expects a significant deterioration in Turkish banks’ asset-quality indicators, and therefore, in our view, the country remains a major source of risk for exposed Islamic and conventional GCC banks.