Dubai: Twin challenges from the coronavirus outbreak and the drop in oil prices will severely dent profits of GCC banks this year according to rating agency Moody’s.
Economic contraction across all six GCC countries are expected to depress credit growth and sap the banks’ two main income streams; interest on loans, and fees and commissions. At the same time, the rating agency expects provisioning charges for potential loan losses to rise sharply.
“We expect weaker revenue and rising provisioning charges to push down the banks’ net profitability by more than 20 per cent on average this year,” said Nitish Bhojnagarwala , Vice President and Senior Credit Officer at Moody’s.
The rating agency expects all GCC countries toexperience sharp economic contraction as they suffer the combined effect of the coronavirus pandemic and a plunge in oil prices.
“We expect the non-oil economy - the primary area of lending opportunity for banks - to contract in all six countries, with non-oil real GDP growth dropping to between -3.5 per cent and -5 per cent in 2020,” said Bhojnagarwala.
Income streams take hit
Moody’s expect the economic contraction in the non- hydrocarbon economy to translate into significantly reduced banking activity. Both lending demand and lending appetite among banks will dry up resulting in an average lending contraction of between 0 to 5 per cent for the rated GCC banks during 2020 from a 7 per cent growth in 2019.
We expect weaker revenue and rising provisioning charges to push down the banks’ net profitability by more than 20 per cent on average this year.
Central bank interest-rate cuts will add further pressure on banking profits. The rating agency said the consequences of rate cuts for banks and other lenders are complex and depend on their individual balance sheet structure. In general, GCC banks set interest on both loans and deposits at floating rates, which follow central bank moves.
Banks with large balances of current and savings accounts that bear low interest, like Saudi banks (zero or lower yielding deposit constitute 60 per cent to 65 per cent of the total deposit base in Saudi Arabia) and some large banks based in the UAE are exceptions. Despite their varied funding structures, Moody’s expect the impact of repricing loans to lower benchmark rates for most banks will lead to lower interest income in 2020.
Asset quality deterioration
Moody’s analysts expect interest income generation of GCC banks will be slower as nonperforming loans (NPLs) are expected to rise and interest payments on these loans will stall.
Although forbearance and stimulus measures introduced by central banks are likely to delay the recognition of these new problem loans, it will not fully offset the impact on interest income from rising NPLs.
“We expect the weakening capacity of borrowers to repay their loans to trigger a migration of loans downwards to Stage 2 from Stage 1 under IFRS 9 and an increase in non=performing loans (migration to Stage 3 from Stage 2). Both migrations will bring about higher provisioning charges,” said Bhojnagarwala.
This is because IFRS 9 requires banks to make forward-looking provisions for any expected credit losses (ECL). Moody’s rated GCC banks recorded an aggregate loan-loss provisions of $11.7 billion in 2019 which equates to around 23 per cent of their pre-provision income during 2019.
“Our expectations of higher provisioning levels is driven by the size of the shock to the GCC economies combined with higher provisioning levels recorded by some banks during the first quarter of 2020,” said Bhojnagarwala.
Falling interest income will be accompanied by increased funding costs as lower government deposits will reduce the flow of domestic deposits in the system. The result will be that net interest margins NIMs) (the difference between interest generated from loans and interest paid on deposits) will narrow both this year and next.
Lower oil prices are expected to reduce government oil revenues leading to reduced deposit inflows from government and government-related entities. Moody’s estimates that government deposits make up between 15 per cent and 34 per cent of the deposits of the GCC banking systems.
Despite higher funding costs, increased debt issuance (both bonds and sukuks) by the GCC governments, particularly in Saudi Arabia,Bahrain and Oman will help to offset partially the pressure on margins.
Financial services companies stand out as key beneficiaries of the work-at-home trend triggered by the pandemic. They are expense heavy information-based businesses, in which most of the work can be done remotely, and potential cost savings are considerable. As a result, there could be further investments in IT infrastructure complementing the existing digital strategies of the banks.
“We expect that the net effect of these measures on the banks’ efficiency ratios to be marginal as we expect banks’ cost to income ratios to weaken only modestly and remain strong compared with global peers,” said Bhojnagarwala.
UAE, Qatar and Saudi Arabian banks have the lowest cost-to-income ratios and their operating income grew faster than their operating expenses in 2019. The Qatari banking system has the lowest cost-to-income ratio among the banks operating in the GCC and is better positioned to maintain stronger efficiency metrics.
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