Dubai: The Gulf Cooperation Council (GCC) banks will face increased funding costs despite easing of liquidity in the banking system, according to ratings agency Moody’s.
Over the past four years, GCC benchmark rates have risen in line with US Federal Reserve fund rate increases and subsequent moves by local central banks. Benchmark rates were also affected by the oil-related funding shortages in local markets. This has largely impacted the funding cost across the GCC banking systems with Qatar reporting the highest cost at 2.7 per cent in the first half of 2017 up from 1.5 per cent in 2014.
“While the impact from funding shortages has eased, we expect the benchmark rates to continue their upward trend in line with US rate rises,” said Ashraf Madani, Vice-President-Senior Analyst at Moody’s.
The US interest rate increases are expected to drive further increases in funding costs going forward. The US Federal Reserve started raising rates in 2015, taking the Federal funds rates to 1.75 per cent from 0.25 per cent in a series of six 25 basis point increases.
Despite the rise in cost of funds analysts say rising rates should support interest margins. “We expect GCC banks will be able to improve their net interest margins slightly despite the anticipated increase in funding costs. Over the past four years, asset repricing by GCC banks has largely offset the impact of increased funding costs. In fact, banks in Bahrain, Saudi Arabia and Kuwait have increased their net interest margins as a result,” Madani said.
Not all systems have, however, been able to improve their margins. Interest margins in Qatar came under pressure as the banking system’s high loan-to-deposit ratio and, more recently, its dispute with its GCC neighbours contributed to push the banks’ cost of funding up faster than asset yields.
In the UAE, while liquidity in the banking system remained relatively healthy, competition among banks and an exit from the higher-yielding SME (small and medium enterprise) sector, drove lending rates lower, pressuring margins.
The large portion of current and savings accounts (CASA) balances in the GCC banking systems (on average 25-30 per cent) should positively impact the net interest margins (NIMs) in a rising rate environment. “We expect systems with higher portion of these deposits like Saudi Arabia to be the largest beneficiaries as those deposits are not sensitive to interest rate hikes and hence impact on the NIMs should be positive as banks reprice their loans,” Madani said.
GCC’s banking sector liquidity has improved substantially in recent months thanks to higher oil prices, debt issuances by the regional governments and modest loan growth.
While the improved oil prices have lifted government revenues, these are still far from fiscal break-even for most GCC governments. Bahrain and Oman have the highest fiscal break-even price of $95 and $76 respectively, while Kuwait has the lowest at $47 2. This means GCC governments have had to borrow to fund their budget deficits.
GCC government have tapped international markets, which has supported liquidity conditions in these markets as government issued less local paper and part of the international debt proceeds were deposited in the banking system. GCC governments issued a total of $49.3 billion in 2017. If the governments continue to tap global market and do not tap local markets and the improving oil prices are expected keep liquidity high in the GCC banking systems.
