Dubai: Historically, while GCC Islamic banks have maintained higher capital adequacy levels than their conventional peers, this gap has been narrowing as a result of Islamic banks’ stronger asset growth in recent year, a trend that Moody’s expect to continue over the next few quarters.
Despite this gradual decline in capital adequacy ratios, their capital buffers will continue to be supported by stronger profitability, thus providing a comfortable cushion to absorb potential losses.
“Based on our current Islamic asset growth and profitability assumptions, we expect their average tangible common equity-to-total asset ratio to fall to around 12 per cent over next 12 months, from 12.6 per cent in December 2017. This will put their capitalisation largely on par with conventional banks,” said Nitish Bhojnagarwala, vice-president and senior analyst at Moody’s.
Real estate concentration and high asset growth remain key downside risks for GCC’s Islamic banks. Their solvency profile is likely to remain constrained by high exposures to the real estate sector and their higher pace of asset growth, both giving rise to potential asset risks.
In particular, despite their efforts at loan diversification, GCC Islamic banks will likely continue to have significant real estate concentration because the financing of property assets is regarded as closer to the Sharia principle, which requires financial transactions to be based on tangible assets.
However, these banks have made conscious efforts to reduce their exposure to the volatile real estate sector including contracting, which was a key source of past asset distress.
Since 2011, Islamic banks have refocused their strategy to increase lending to the retail (lending to individuals) and core sectors of the economy. As a result, Islamic banks’ average exposure to the real estate sector has dropped to around 24 per cent of their total loans in 2017, from 31 per cent in December 2011. This is notwithstanding that this concentration remains higher than the GCC system average despite the improvement.
Improving credit fundamentals have seen rating upgrades of a number of Islamic banks during the last two years. Moody’s upgraded the ratings of Dubai Islamic Bank, Boubyan Bank and Masraf Al Rayan. It also upgraded the stand-alone baseline credit assessment of Abu Dhabi Islamic Bank and affirmed the ratings of the world’s largest Islamic bank, Saudi-based Al Rajhi Bank.