Oman's banks have sharply boosted bad debt provisions over the past months but are expected to remain strong in terms of capitalisation, an International Monetary Fund (IMF) study has said.
But the banking sector of the non-Opec (Organisation of Petroleum Exporting Countries) state still suffers from flaws and needs to be developed to achieve better risk management, the Washington-based IMF said in a working paper.
The study, which does not reflect the IMF's official view, said the main source of vulnerability of Oman's banking sector was credit risk on the grounds that credit is the main driver of banking activity. It added that non-performing loans (NPLs) by Oman's 17 banks reversed years of a steady decline and grew to 2.9 per cent of the total loans in the first half of 2009.
"The impact of the global financial crisis on Oman's banking system has been very limited – after the high level of NPLs observed at the beginning of the decade – thanks to prudential measures introduced by the central bank, which boosted banks' capital and avoided exposure to so-called toxic assets," the 30-page working paper said.
Increase in bad loans
"The limited exposure of Oman's banking sector to the international financial system also helped to contain negative spillovers. Nevertheless, liquidity support provided by the central bank and the government helped banks to weather the challenges without excessive strain on the system. Banks continue to make profits and would remain adequately capitalised even in the case of a significant increase in credit losses, with credit risk remaining the main source of risk," it added.
But the study said that despite the substantial resilience of Oman's banking sector, the smallest among the Gulf Co-operation Council states, some inefficiencies existed. "The financial system needs to develop further to provide proper incentives to banks to achieve more efficient risk management and better credit allocation. An institutional framework with less restriction on credit and the availability of benchmark rates, albeit without lowering prudential and supervisory standards, would be of significant benefit to the development of the financial system in Oman," it said.
Its figures showed that in the past few years, NPLs declined to 2.1 per cent of gross loans at the end of 2008. "In the first half of 2009, signals of deterioration in credit quality emerged, inverting the long-term trend of credit quality improvement. At the aggregate level, NPLs increased to 2.9 per cent of total gross loans. The deterioration in credit quality is still relatively limited and the coverage provided by loan-loss reserves remains adequate," the study said.
"Provisioning for impaired loans has increased, but the level of coverage has decreased. Data at end-June 2009 for the banking system show that provisioning has increased by 24.6 per cent with respect to the level at December 2008."
Higher provisioning rates
The report showed that loan-loss reserves built so far have grown in absolute terms from the December level, but are now equal to 114 per cent of impaired loans, which compares to a level 127 percent shown six months earlier.
"Banks in Oman have significantly higher provisioning rates compared to the GCC average. Part of the increase in provisioning for bad loans is due to the exposure of Oman's banks to the troubled Saad and Algosaibi groups.
"Although having a relatively limited cross-border exposure mainly concentrated in the region, Oman's banks' exposure to the two groups and to two banks linked to them –The International Banking Corporation and Awal Bank in Bahrain – amounted to RO76.5 million (Dh730.5m) or four per cent of the banking system's foreign assets as of June 2009," it said.
The report noted that the bulk of the exposure (of about RO67m) to the troubled conglomerates was concentrated in Oman's largest bank, Bank Muscat, for which the exposure accounted for 1.1 per cent of its assets at the end of last year.
It said a potential source of risk for banks' loan portfolios was the deterioration in exposures related to the real-estate sector and the reduction in the ability of excessively indebted households to repay their loans.
According to the study, Omani households' exposure to banks has registered a substantial increase in absolute value in recent years.
Liquidity remains adequate
The level of personal loans granted by the banking system has increased from RO1.3 billion in 2003 to RO3.9bn in September 2009.
"The level of household indebtedness has grown more than the estimated level of disposable incomes. The ratio of household debt to disposable income has grown from 78 per cent in 2004 to 137 per cent in 2008. Notwithstanding the quality of bank collateral, an excessive burden of debt on a borrower could always result in a strain on debt servicing capacity," it said.
Turning to liquidity, the study said it remained adequate although the ratio of liquid assets to deposits and short-term funding for the six largest banks between 2007 and 2008 fell from 33.2 per cent to 24.9 per cent. "A more in-depth analysis of the composition of assets and liabilities shows that assets that are readily marketable are estimated to be 67 per cent of short-term funding and demand liabilities," it said.
"In this calculation, liquid assets include cash and balances with the central bank as well as investments in government securities and deposits with other banks. Short-term funding excludes deposits from government and public sector entities. These should not, in fact, be considered funding at risk of withdrawal in a scenario where one or more banks or the system itself are in need of liquidity." The report noted that liquidity in Oman's banks has been strongly supported by government and public sector entities' deposits.
Funding source stable
It showed those deposits increased from 21 per cent to 27 per cent of total deposits between end-2007 and September 2009.
"Liquidity funding risk is therefore not an issue of concern for Oman's banks, as the core source of funding has proven to be stable. Private deposits have grown through the first half of 2008 and have remained stable thereafter. Deposits by government and public entities have increased their contribution to banking system funding, thus providing a further growth of financing until the end of 2008 and supporting stability thereafter. Oman's banks maintain a satisfactory share of liquid assets with stable sources of funding," it said.
"But a greater diversification of funding would be advisable. Increasing the duration of liabilities would help reduce maturity mismatches. Although this could be pursued by major banks establishing medium-term loan funding programmes, the absence of a sovereign yield curve in the country makes pricing of any bond as well as of virtually most of the existing financial products, difficult and, to some extent, arbitrary. The lack of a benchmark yield curve therefore makes long-term financing for banks and corporates more difficult."
It showed Oman's banks were adequately capitalised and the banking sector appeared stable after showing strong resilience to the crisis. "The strength and soundness of Oman's banking sector are generally in line with the GCC average. The system-wide capital adequacy ratio was at 15.5 per cent at end-September 2009 as against the minimum regulatory requirement of 10 per cent," the study said.