GCC banks’ capitalisation levels to remain strong
The average Tier 1 capital ratio for regional banks were at 16.3 per cent at year end 2016
Dubai: Banks across the GCC that have maintained strong capitalisation during last year and the current year are expected to maintain robust capital levels for the next two years, according to a recent assessment by credit rating agency Standard & Poor’s.
The latest tally of their risk-adjusted capital (RAC) ratios, based on their year-end 2016 financial disclosures and S&P’s own assessment as of mid-October 2017, the rating agency has calculated an unweighted average capital ratio of 11.5 per cent for the Gulf banks. Looking ahead, they expect the RAC ratios to remain relatively stable in the next 12 to 24 months.
“This result underpins our strong or very strong assessments of capital and earnings for 72 per cent of the Gulf banks we rate. Their quality of capital remains strong, even though we have observed higher recourse to hybrid instruments over the past few years,” said S&P Global Ratings credit analyst Mohammad Damak.
Credit risk and particularly exposure to corporates dominate the calculation of Gulf banks’ risk-adjusted assets. Despite the high 11.5 per cent average RAC ratio as of year-end 2016, it masks significant disparities among rated banks, ranging from 5.3 per cent to 17 per cent.
S&P rated banks based in the UAE, Saudi Arabia, and Qatar enjoy the highest capitalisation while the weakest capitalisation, but still adequate, is for rated Bahraini banks. The average capitalisation for Bahraini banks and some Kuwaiti banks is weighed down by their exposures to riskier countries such as Turkey and others in the Middle East.
“Compared with local regulatory requirements, our RAC ratios are lower primarily because we apply more conservative risk weights on most asset classes, including sovereign exposures. We have calibrated our framework so that an 8 per cent RAC ratio means that a bank should, in our view, have enough capital to withstand substantial stress in developed markets,” said Damak.
High quality
The average Tier 1 capital ratio for rated banks according to local regulatory measures reached 16.3 per cent at year-end 2016. At year-end 2016, eligible hybrid instruments represented on average 9 per cent of total adjusted capital (TAC).
Among the GCC banks, the strongest quality of capital were reported in Oman and Saudi Arabia where capital almost exclusively comprises Tier 1 instruments. The weakest quality of capital is in Qatar where hybrid capital instruments contributed to 26 per cent of TAC on average. In addition, banks in the UAE and Kuwait have made moderate recourse to AT1 [additional tier 1 capital including convertible bonds] capital instruments over the past few years.
Most Gulf banks’ capital-raising exercises in the past few years were with AT1 instruments instead of core equity injections. That’s mainly because core equity has been relatively more expensive given the favourable liquidity conditions globally.
“As shareholders and other investors are less willing to inject core capital and more interested in getting a continuous and predefined income stream from hybrid instruments, we expect the quality of capital to continue weakening,” said Damak.
Credit risk dominates
Credit risk is the main contributor in the calculation of risk weighted assets (RWA) of the Gulf banks due to the relatively simple structure of their balance sheets.
GCC banks derive most of their activity from plain-vanilla lending and their exposure to the market. At year-end 2016, credit RWA contributed to about 84 per cent of the total while market RWA contributed to about 10 per cent.
Kuwaiti banks had a higher market RWA mainly because of higher exposure to equity and more recourse to foreign currency hedging instruments for some banks. The contribution of operational RWA was limited at about 6 per cent.
Within the credit risk, it is the corporate exposures that dominate the region’s RWA, mirroring the composition of the balance sheets. At year-end 2016, corporate exposures comprised 63 per cent of RWA. The second-largest contributor was retail exposures with 17 per cent.
Banks in the GCC tend to maintain high amounts of liquidity through highly rated government bonds and financial institutions (local and international).
