Dubai: The performance of the banking sector in terms of loan growth, asset quality and profitability are expected to remain resilient in 2016 amid deteriorating operating environment leading to tightening liquidity, according to bankers and analysts.

“Despite the headwinds generated by low oil prices, we expect a broadly supportive operating environment for GCC banks in 2016 due to regional governments’ commitment to their countercyclical spending policies,” said Khalid Howladar, a Senior Credit Officer at Moody’s based in Dubai.

“Events such as the UAE Expo 2020 and World Cup Qatar 2022 are providing anchors for capital expenditures in addition to other key regional infrastructure projects.”

Going forward into the year, analysts said, if the oil prices are to remain too low leading to further government spending cuts and weakening of confidence impacting economic growth, loan performance and tail risks from regional political tensions could adversely impact the outlook for banks.

Decline in loan growth and higher cost of funds are expected to reflect on banking sector profitability in the region.

“Overall for the GCC banks for 2016, we expect the relative weakness in deposits to continue, credit growth to slow down a bit more, and more importantly we expect the credit losses to visibly increase which means it will be difficult for the banks to maintain their current level of profitability,” Timucin Engin, Director, Financial Services Ratings, Standard & Poor’s Ratings.

Moody’s forecasts credit growth in the 4 to 10 per cent range in 2016, as decline in private sector loan growth are moderated by new government borrowings from local banks, helping to support profitability and margins. Core revenues are expected to remain robust, driven by bank intermediation and commissions income with little reliance on derivatives or proprietary trading.

The Institute of International Finance (IIF), a Washington-based association of global banks and financial institutions expects the banking systems in the region to cope well with low oil prices in the next few years although liquidity conditions are tightening and higher interest rates are expected to apply pressure on margins.

Going forward it expects weakening of asset quality and profitability if the oil price slump to persist over a long period of time. The IIF economists said fiscal adjustments to cope with the falling oil prices and falling business confidence will have downside risks in terms of business confidence and economic growth which could eventually impact the banking sector profitability.

“The sharp and sustained decline in oil prices makes fiscal adjustment unavoidable. But with the some GCC governments holding substantial reserves including the reserves held by sovereign wealth funds, in the short to medium term these governments do not face major challenges in spending capacity,” said Dr Garbis Iradian, chief economist for Middle East and North Africa at the IIF.

But with oil prices projected remain depressed over a long period of time; the IIF said the GCC governments need to make significant fiscal adjustments to cope with the sustained fall in revenues which will have adverse impact on banks in terms of asset growth and profitability.

 

“Some restraint in spending is necessary in countries such as Saudi Arabia, Oman and Bahrain where fiscal deficits are seen rising. In Saudi, historically, policy response has been to cut capital expenditure. But such spending cuts are going to hurt economic diversification efforts and overall efficiency in the economy,” said Giyas Gokkent, senior economist, Africa Middle East at IIF.

Rating agency Fitch agrees. Oil price weakness is slowing economic growth and this is taking its toll on bank liquidity and earnings, says Fitch Ratings. Around 70 per cent of the GCC’s GDP is driven, direct or indirectly, by oil. Fitch’s 2016 forecast oil (brent) price is $55/barrel.

Fitch forecasts slower economic growth for most GCC member countries in 2016.

Liquidity positions across the banks are adequate, according to Fitch, but these are coming under pressure because public-sector deposits are falling, in line with oil price weakness. Saudi Arabia and Oman started to tap the domestic capital markets in 2015, with take-up largely by domestic institutional investors. This has diverted liquidity away from the banks. Deposit outflows will result in higher bank reliance on more costly debt issuance and borrowings across the region.