2018: a better year for GCC banks
Banker Middle East looks at how improving economic conditions and strong capitalisation underpin the resilience and stability of financial institutions.
Industry players can relish in the fact that 2018 will potentially be better than the past couple of years. Market reports and analyses have shown that the GCC banking system will benefit from improving economic conditions. Rating agencies such as S&P and Moody’s have projected a stable outlook on the banks that it rates in UAE, Saudi Arabia and Kuwait (which account for 75 per cent of GCC banking assets); except for those in Bahrain and Oman—due to their weaker fiscal position, and Qatar—due to the geopolitical risk from the diplomatic row with fellow GCC states.
Moody’s has forecasted that real GDP growth in the region will rise to approximately two per cent in 2018, up from almost zero per cent in 2017. Oil prices are projected to stabilise at between $50 and $60 a barrel this year and through to 2019.
Additionally, strategic government initiatives and large-scale projects such as the Saudi Arabia’s National Transformation Plan, Dubai’s Expo 2020, Qatar’s 2022 World Cup and the Kuwait 2035 vision is expected to drive capital expenditure and private sector lending growth, which has been projected at between four to five per cent.
By the middle of this year, banks should have recognised most of the impact of the softer economic cycle on their asset quality. Barring any geopolitical predicaments, financial profiles of GCC banks will start to stabilise from the second half of 2018. S&P points out that this projection does not apply to Qatar whose trends in asset quality will depend on how the boycott of the country evolves.
Assets and loans
As economic growth improves, and the effects of the adjustment wear off, BMI projects assets and loans in the UAE to expand to 5.6 per cent and 5.9 per cent respectively over the course of 2018, significantly more from the four per cent and two per cent forecasted in 2017. This estimate is based on improved business and consumer confidence, coupled with an easing of oil production cuts and an expectation that the construction sector will be a key driver growth of underpinned by a strong investment pipeline.
BMI notes that UAE banks will also benefit from monetary tightening over the coming years, with the UAE Central Bank to continue following the US Federal Reserve’s hiking cycle, especially as the country’s economy appears to withstand higher rates, which will benefit UAE banks due to the fact that lending rates are indexed on the central bank’s policy rate.
Not all is positive. Moody’s has pointed out that problem loans for the region’s banks may edge higher in 2018, due to the sluggish economic activity last year. Banks remain vulnerable to high borrower and sector loan concentrations, in addition to uneven disclosure in the corporate sector.
In addition to muted loan growth, key risks for GCC banks also include a higher cost of risk, geopolitical risks and lower profitability. According to S&P cost of risk for GCC banks will increase in 2018 because of the adoption of IFRS 9 and the higher amount of restructured and past due but not impaired loans sitting on their balance sheets. However, the general provisions that banks have accumulated over the years will assist in a smooth transition to the new accounting standard.
As low credit growth weighs on interest income, fees and commissions, profitability will decline. It is however, expected to stabilise at a lower level than historically, underpinned by an increased cost of risk and the introduction of value added tax, some of which banks will pass on to clients.
Despite these projections, the outlook on banks in the GCC remain stable on the back of strong financial fundamentals that provide resilience to lower profitability and weaker loan quality issues. Albeit some signs of quantitative and qualitative deterioration, GCC banks remain well-capitalised by global standards, with levels well above Basel III requirements.
Coupled with high loan-loss reserves, this provides banks with the capacity to absorb losses, noted Moody’s. Tangible common equity ratios are expected to remain in the 11 to 16 per cent range, while problem loan coverage across the region remains high at 95 per cent. The strength of GCC banks is the low cost and stable deposit-based funding, combined with elevated liquidity buffers. In 2017, government’s injected liquidity from international debt issuances, easing a long funding squeeze stemmed from low oil prices. Liquidity amongst GCC banks improved in 2017 and this will continue into 2018 as continued debt or Sukuk issuance by governments this year will absorb some of the liquidity without a major change in risk appetite.