Corniche Bay of Doha, Qatar, with the financial district in the background. Qatar's overbanked system could see more consolidation triggered by pressure on banks' profitability from the coronavirus pandemic. Image Credit: AP

Dubai: Qatar's overbanked system could see more consolidation triggered by pressure on banks' profitability from the coronavirus pandemic according to Fitch Ratings.

The rating agency said while banks with weaker franchises and limited pricing power are likely to prompt the next wave of consolidation, common government ownership is also a key driver to create better capitalised banks with enhanced competitive advantages to support the Qatar Vision 2030 development plan.

Al Khalij Commercial Bank (AKCB) and Islamic bank Masraf Al Rayan's (MAR) recently agreed merger will potentially create Qatar's largest Islamic bank by total assets and diversify MAR's business model, which is predominantly wholesale focused. This will be the second merger in Qatar between an Islamic bank and a conventional bank after Islamic bank Dukhan and International Bank of Qatar (IBQ) merged in April 2019.

Despite a weaker economic environment and expected downward pressure on valuations from the impact of the pandemic, AKCB was valued at QAR8.2 billion representing 1.14 times its tangible book value, compared with 1.027 times tangible book value for IBQ.

“In our view, this reflects AKCB's adequate capitalisation and private banking niche, an important addition to MAR's business model and funding franchise,” Fitch said in a note.

MAR (the surviving entity) will have a larger funding capacity (QAR147 billion combined non-equity funding) to finance additional government projects. This could further increase MAR's exposure to government and government-related entities, which represented 47 per cent of its financing book at end third quarter 2020, but would support the bank's asset quality. The combined entity is set to be well-capitalised with a leverage ratio of about 12 per cent, although one-off integration costs could weaken capital.

Dukhan's merger with IBQ boosted the proportion of retail and private banking deposits in its overall funding. However, the bank still lacks stable long-term funding and is yet to meet the 100 per cent net stable funding ratio regulatory requirement.

Cost synergies

Further Qatari bank mergers could generate cost synergies that alleviate pressure on profitability from compressed financing margins and higher loan impairment charges due to the pandemic.

Dukhan's cost-to-income ratio decreased to 32 per cent in the first half of 2020 from 38 per cent in 2018 after the bank realised 90 per cent of its planned cost synergies from its merger. MAR's merger should result in a cost-to-income ratio of about 20 per cent, comparing well with peers.

Asset quality risks

Fitch said mergers can increase banks' asset quality risks from collateral valuations, changes in loan classification policies and building provisions against purchased credit-impaired assets. Dukhan's Stage 2 financing ratio increased to 19 per cent at end of first half 2020 from 14 per cent at end-2018, largely due to the reclassification of some of IBQ's loans that had been recorded as Stage 1 at the time of the merger.

MAR's Stage 2 financing was only 3 per cent covered by specific reserves at end-3Q20 and its cost of risk (impairment charges/average gross financing) was 0.3 per cent in 9M20, the lowest in the sector, indicating that the bank's financing book might be under-provisioned. After the merger, MAR may find its reserve coverage is insufficient if there is significant financing migration from Stage 1 to Stage 2 after Qatar's credit moratorium expires in June 2021.