GCC banks told to tighten regulation, supervision

Monetary authorities in the Gulf Co-operation Council (GCC) states should closely watch their banks' off-balance sheets as part of measures to ensure a sound financial system following the global fiscal crisis and regional debt defaults, according to a prominent Western financial centre.

The Washington-based Institute of International Finance (IIF), which groups major banks in the US and other Western countries, said significant progress in prudential regulation and banking supervision has been made in the six-nation GCC but added there was scope for more improvement.

In its latest report on GCC economies, IIF said financial soundness indicators constructed from individual bank balance sheets aggregated on a country-wide basis suggested that GCC banks remained well capitalised and profitable with system-wide capital and liquidity cushions that helped them weather the global financial turmoil.

"More robust risk management systems, including stress testing, close monitoring of high-frequency data and early warning systems are needed to detect and correct problems that could become systemic. The importance of this issue stems from the lack of transparency, especially in an environment characterised by large family-affiliated conglomerates and offshore and regional banking systems," IIF said.

"This requires closer supervision of off-balance-sheet operations of banks, household indebtedness, real estate lending, and corporate health. Corporate governance codes need to be more firmly enforced."

The report said the need for greater transparency on the balance sheets of major corporate entities has become "urgent".

It added that access to further bank credit is likely to depend on the ability of these corporations to provide the market with what it described as greater clarity on the role of the sovereign funds and improved disclosure and higher financial reporting quality and frequency.

"There is also an urgent need to strengthen macroeconomic and financial statistics to address the existing weaknesses that make it difficult to monitor rapidly evolving developments in the economy and formulate appropriate and timely policy responses."

IIF said the GCC's more than 150 commercial banks have remained profitable and well-capitalised mainly due to solid economic performance during the 2003-2008 oil boom.

"Bank soundness indicators continue to exhibit stability across countries. The average capital adequacy ratio, defined as the ratio of capital to risk-weighted assets, was above 15 per cent for every banking system in the region although variations among individual banks are at times significant," the report said.

"This is well above the eight per cent Basel II framework requirement and the local regulatory minima (eight per cent in Saudi Arabia; 10 per cent in Oman and Qatar; 12 per cent in Bahrain, Kuwait and the UAE)."

According to IIF, weighted average non-performing loans (NPLs) to total loans in the region have almost doubled, increasing from two per cent at end-2008 to nearly four per cent at end-2009.

While this ratio has remained relatively low by international standards, the ratio of banks' provisions to potential losses associated with NPLs has declined significantly in Kuwait, Saudi Arabia and the UAE.

"The profitability of the banking sectors has been affected in 2009 by the higher provisioning requirements related to the exposure to the two Saudi family-affiliated conglomerates (Saad and Algosaibi), some deterioration in corporate loan portfolios, and defaults in personal loan and credit card portfolio," the report said.

"Although reassuring, financial soundness indicators have limitations, including the fact that they often are backward looking. In addition, system data can mask the deterioration in financial conditions of individual banks… Overexposure to real estate and highly leveraged companies has eroded asset quality."

IIF said uncertainty over the true state of balance sheets, especially in light of significant exposures to the two Saudi family businesses would likely persist this year, restraining bank funding and credit growth, although "we judge the risks to be manageable."

IIF urged GCC countries to create a regional bond market to reduce reliance on costly bank loans in funding projects. It said development of a debt market in the GCC could facilitate developing a yield curve and help government-related entities (GREs) improve their debt maturity profile and liquidity positions.

"It could also enhance corporate governance as capital markets demand more rigorous financial disclosure and transparency. The share of bonds in total financing for the region is less than five per cent, the lowest among emerging economies."

Follow Emirates 24|7 on Google News.