Dubai: GCC’s banking sector is expected to maintain strong profitability, asset quality and capital adequacy ratios in 2017 despite a challenging economic environment, according to rating agency Moody’s.

The operating environment in the region remains challenging but is expected to benefit from oil price stabilisation.

Economic growth is projected to remain positive with a gross domestic product (GDP) growth of 2 per cent next year, slightly above the 2016 level of 1.9 per cent.

However, GCC countries are expected to continue posting fiscal and external deficits, which will lead to fiscal reforms, according to Moody’s.

“While operating conditions for banks in the GCC remain challenging, the stabilisation of oil prices — albeit at a low level — and resilient non-oil sectors will moderate pressures on the banking sector from slowing economic growth, fiscal reforms and spending cuts,” said Olivier Panis, a vice-president at Moody’s.

The ratings agency expects banking sector quality to remain solid overall for the GCC with non-performing loans averaging 3-4 per cent of total assets.

“We expect new problem-loan formation and increased loan restructurings due to sluggish economic activity and tightening liquidity. Certain sectors, particularly contracting, construction, real estate, retail and SMEs [small and medium enterprises], will be more affected,” said Panis.

High levels of borrower- and sector-loan concentration continue to expose banks to unexpected shocks.

Still, profitability is projected to remain sound despite a moderate increase in funding and provisioning costs and reduced business activity.

Rising yields on loans are expected to gradually offset increasing funding costs, although with a lag, and pricing competition remains intense in some markets.

Structural challenges, such as limited transparency of large corporate borrowers, as well as sizeable related-party lending will persist and can amplify downside risks.

However new macro-prudential regulations, such as large exposure limits, mortgage loan-to-value caps, consumer lending caps, and credit bureaus are expected to support loan performance over time.0

The funding of GCC banks remains anchored by low-cost deposits, a credit strength, but it is under pressure because of decelerating deposit growth. On average deposits provide 75 to 90 per cent of non-equity funding.

Deposit growth is expected to slow further in 2017. This will increase banks’ reliance on more costly and confidence-sensitive time deposits and market funding, increasing loan-to-deposit ratios and drive higher funding costs.

Lower oil revenues are leading to a decline or slowdown in government and related entity deposits and lower economic growth also means broad reductions in corporate and retail deposit inflows. However, recent international bond and sukuk issuances from Abu Dhabi, Oman, Qatar and Saudi Arabia have helped to moderate liquidity pressures, and most regional banks maintain strong levels of liquid assets, eligible as collateral at central banks in case of need.

Analysts expect capital cushions to remain solid and provide substantial loss-absorption capacity.

Liquidity buffers are expected to remain solid despite a slight decline. Currently, liquid assets are 20 to 30 per cent of total assets and the vast majority of banks are compliant with Basel III Liquidity Coverage Ratio requirements. Government support willingness remains high but capacity is facing pressure.

While core banking revenues are expected to remain resilient next year, banking sectors across the region are facing lowing credit growth and overall revenues are expected to come under pressure, according to Moody’s.

Analysts expect fees & commissions income to slow further, but it is expected to average around 20 per cent of pre-provision income. Loan-loss provisioning is increasing due to asset quality pressures and preparation for International Financial Reporting Standard (IFRS) 9 in 2018 and is hitting the bottom line.