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GCC Islamic banks to outperform their conventional peers

Profitability and asset quality expected to remain strong in 2018

Gulf News

Dubai: Islamic banks across the GCC reported improvements in their fundamentals such as asset growth and asset performance last year while sustaining growth in their franchises. According to ratings agency Moody’s, these banks are expected to outperform their conventional peers in the year ahead.

2.1% NPL ratios for Islamic lenders at the end of 2017

“Islamic banks operating in the GCC countries have benefited from sustained growth in their franchises in recent years. Their solvency has improved, supported by their efforts to reduce the stock of problem loans, and by their sound profitability,” said Nitish Bhojnagarwala, vice-president and senior analyst at Moody’s.

Credit fundamentals have improved due to better underwriting practices and higher profitability. Along with their strengthening franchise, GCC Islamic banks have achieved sustainable improvements in their credit risk profiles in the current decade. These improvements are supported by their better underwriting standards and risk management practices, a more diversified loan book, as well as higher profitability.

 We expect the Islamic banks in the GCC to continue to report higher net profitability compared with their conventional peers. This reflects our view that their lending margins will remain higher, supported by their favourable funding mix and the backdrop of a rising interest rate environment.”

 - Nitish Bhojnagarwala | Vice-president and senior analyst at Moody’s

GCC Islamic banks significantly strengthened their risk management policies and practices after 2011 in the aftermath of the global financial crisis. They reinforced their control and reporting frameworks and tightened underwriting standards to promote better risk selection and monitoring of their exposures. This was further supported by the introduction of new prudential measures by GCC central banks which applied to all banks. These measures include limits on large exposures, loan-to-value caps and credit bureau to facilitate risk selection.

2.9%
NPL ratios for
conventional banksat the end of 2017

“While both Islamic and conventional banks in GCC countries reported non-performing loan (NPL) ratios of around 5 per cent at the end of 2011, Islamic banks reported a larger decline in subsequent years, to around 2.1 per cent at the end of 2017, compared to 2.9 per cent for conventional banks,” said Bhojnagarwala.

Analysts expect the GCC Islamic banks’ NPL ratio to remain low over the next few quarters, underpinned by a continued resolution of legacy impairments primarily related to the real estate sector, lower new NPF formation as a result of their more selective and diversified credit growth, and a significant denominator effect from stronger overall loan growth.

Their cost of risk is expected to stabilise at current levels driven by improvements in asset quality and risk management practices.

“We expect the Islamic banks in the GCC to continue to report higher net profitability compared with their conventional peers. This reflects our view that their lending margins will remain higher, supported by their favourable funding mix and the backdrop of a rising interest rate environment,” said Bhojnagarwala.

GCC Islamic banks' NPL ratio continue to declineGCC Islamic banks have consistently reported stronger margins thanks to, firstly, a favourable funding structure supported by a large and stable base of low-cost current and savings accounts balances, and, secondly, higher asset yields from these banks’ traditional exposure to the real estate sector and increased focus on retail lending. Both trends should continue to support these banks’ core profitability.

A major support to net profitability is expected to come from the cost of risk, which is expected to stabilise after a period of strong recoveries coming through on the stock of NPLs. Whereas these banks had to incur high provisioning charges on their loans and investments in the past, which dragged down their profitability, these charges have fallen to levels below those of conventional peers.

New investments in distribution channels and technology could add to the costs of Islamic banks. These banks have relatively higher cost bases compared to conventional banks, which have already established their branch networks, GCC Islamic banks are still making considerable investments in building their branch network and technology because they are younger and are more focused on reaching retail customers.

 

 

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