GCC banks remain well capitalised: IMF analysts

Asset quality improves over the past five years. NPLs stand at low levels by global comparisons. Experts call for reforms in operational aspects. (EB FILE)

Banks in Gulf oil producers enjoy a strong position and their asset quality has largely improved over the past years, but the system suffers from some flaws which should be addressed by authorities, according to International Monetary Fund (IMF) analysts.

The global fiscal distress has exposed their vulnerability. This was because banks in the six-nation Gulf Co-operation Council (GCC) sharply boosted their credit during the oil boom, which came to an end in mid-2008, said the experts at the Washington-based institution in a working paper.

The recent regional default problems have allied with the crisis to hit the banks' asset quality but they remained sound and well capitalised, they said.

"The asset quality of GCC banks has improved significantly over the past five years. The ratio of non-performing loans [NPLs] to total loans has been on a declining trend since 2003, when it was at double digits, although the underlying trend is masked by the high credit growth rate during this period," the paper said.

"NPLs stood at low levels in 2008 by international comparisons despite the crisis. However, the supervisory authorities in the GCC have required banks to take substantial general loan loss provisions in anticipation of rising amounts of NPLs in 2009, and possibly 2010. The coverage ratio of provisions to NPLs across the GCC is very high by international standards."


But the paper saw what it described as continued risks of a possible worsening of asset quality as the fallout from the crisis continues to materialise on banks' balance sheets.

It said this risk is heightened in countries with the highest credit growth rates prior to the crisis, and in systems that have significant concentration in construction and real estate, as these sectors have been hit hard.

The paper said the high concentration on lending to large business groups is also an issue as indicated by the recent default of two prominent Saudi family businesses. In addition to Saudi banks' exposure to these two groups, a number of GCC banks also had significant exposures, it said.

"The moderate impact of the global financial crisis on the GCC banking sectors has generally demonstrated the soundness of these systems," the paper said.

"Notwithstanding the general soundness of GCC banks, our analysis indicates some weaknesses associated with the operational aspects of GCC banks and the characteristics of the GCC economies. These would need to be evaluated and addressed by GCC policy makers."

High credit

According to the study, some GCC countries witnessed rapid credit growth in the oil boom period preceding the financial crisis, when oil prices were at their highest levels and members pumped oil at near capacity.

"As indicated above, this rise in available bank liquidity and the consequent increase in lending rates have been indirectly associated with higher oil prices. This linkage presents risks and introduces significant liquidity volatility for banks."

International experience indicates that rapid credit growth in periods of high real economic growth is expected to result in high levels of asset impairment once economic conditions reverse," the paper said.

"As observed in the current crisis, sharp declines in oil prices have brought about a slowdown in economic activity in the region, along with a worsening of banks' asset quality and strains on their liquidity. Policy makers in the GCC are encouraged to evaluate policy measures that could dampen the impact of oil prices on economic activity and the financial sector."


The paper said there are also issues that need to be addressed in relation to banks' asset management practices.

It noted that GCC banks generally have significant concentration risk, both in the context of lending to a few obligors and large exposures to sectors that are highly subject to market price fluctuations and asset bubbles such as real estate and equities.

"Additionally, some GCC banking systems have high exposures to households. While household lending in the GCC is generally secured by borrowers' salaries, household defaults could pause risks. These would typically be associated with a slowdown in economic activity and massive layoffs of expatriate workers."

A third issue cited by the paper is the banks' liquidity management practices, which it said need to be evaluated.

"GCC banks appear to maintain low liquidity levels by international comparison. While the banking sector in the GCC still relies on relatively stable deposits as the main source of funds, the fact that banks continue to have a very small share in bond financing complicates banks' ability to manage the maturity mismatches between assets and liabilities," the paper said.

"Furthermore, the increasing dependence of banks on external financing in some GCC countries in recent years has increased banks' vulnerability to external credit conditions. This was demonstrated in the current crisis as banks' liquidity was squeezed with the tightening in global liquidity conditions."

Highlighting the oil boom period, the paper said the GCC region has witnessed rapid credit growth to the private sector because of a surge in business.

Over the period 2003–2008, the UAE and Qatar experienced significant private sector credit growth at about 45 and 35 per cent, respectively, while Oman had the slowest rate in the region at about 20 per cent, the report showed.

It said that in view of this growth, the ratio of private sector credit to GDP compares favourably to other emerging countries.

When measured in relation to non-oil GDP, credit to the private sector in the GCC registers the highest rates among emerging countries. "Notwithstanding the positive impact of increasing bank intermediation in the GCC on economic activity, as international experience shows, high rates of credit growth during an economic upturn almost invariably lead to high levels of credit defaults when economic activity slows," the study said.

"Therefore, high rates of credit growth witnessed in some GCC countries during 2003–2008 have increased these systems' vulnerability to a downturn in economic activity. Albeit indirectly, credit to the private sector has been spurred by the increase in oil prices. Higher oil prices have boosted government spending and non-oil GDP growth and, as a result, spurred business confidence and local and regional private sector activities and investments."

It said the impact was translated into a "concomitant increase" in the domestic demand and supply of credit.

"As regard to supply, deposits in the banking sector grew as private sector income increased. This in turn boosted banks' lending capacity. As for demand, banking sector credit was reoriented from the public to the private sector, where the latter expanded economic activities and investments."

Deposits and liabilities

The report showed client deposits were the main contributor to credit growth in the GCC during the oil boom.

But it added that the funding patter has been relatively volatile, which increases banks' funding risk generally.

It said a closer look shows that foreign liabilities have played a significant role in explaining the rapid credit growth for the UAE, the second largest Arab economy.

The sharp increase in 2006 in net foreign liabilities in the UAE relates largely to banks' issuance of foreign debt to support credit growth and also to address asset/liabilities maturity mismatches through the issuance of medium-term notes.

In 2007, the increase in other members reflects short-term capital inflows in speculation of an appreciation of GCC currencies.

"As oil prices declined in the second half of 2008, foreign financing markedly declined as speculative capital inflows reversed and, to a lesser extent, international capital markets dried out," the IMF study said.

"The concentration of credit portfolios in GCC countries varies considerably within the GCC. Banks' exposures to the construction and real estate sectors are significant in Kuwait and Bahrain and are also important in Qatar and the UAE. This exposure has increased sharply since 2002 in Qatar and Bahrain and, to a lesser extent, Kuwait… UAE banks' exposure to the construction and real estate sectors appears relatively low in view of the construction and real estate boom that the country witnessed during this period."

The study attributed this low exposure in the UAE to the presence of domestic real estate and mortgage finance companies and to direct external financing of large real estate projects, in particular by Dubai corporates.

"As regards large exposures, GCC banks have a relatively high concentration of credit to large business groups and high net worth individuals."


Turning to their financial position, the paper said the GCC banking sectors are well capitalised across the board with capital adequacy ratios (CAR) well above minimum CARs, and comfortable leverage ratios by international comparisons.

It said these capitalisation levels are related to high profitability, although they have declined significantly in recent years as a result of rapid credit growth and increasing leverage.

In 2008, the profitability of the banking sectors was affected by the higher provisioning requirements related to the crisis, impacting the ability of banks to increase capital internally, according to the paper.

As for profits, the paper said GCC banks have stable sources of earnings from lending and other traditional banking services.

"Net interest margins represent the main source of income, ranging from 53 per cent of gross operating income in Qatar in 2008 to 80 per cent in Saudi Arabia.

Notwithstanding, losses from investments in securities and increasing provisions have weighed on banks' operating profits in 2008-2009 across the GCC."

The study noted that investment losses mostly affected Saudi and Bahraini banks, while loan loss provisioning affected Kuwaiti banks most.

Returns on equity (ROE) – hovering around 20 per cent – and returns on assets (ROA) stood at comfortable levels by international comparisons, with Bahrain and Oman being the least profitable, it said.

"Together with Saudi Arabia, the banking sector in Kuwait has been one of the most profitable within the GCC in recent years, although the latter has been affected relatively more by the current crisis."

"In the UAE, more recent data indicate that while bank profitability increased in 2008, it was negatively affected by global and domestic developments in 2009."

The paper gave no figures on profits but according to the Kuwait-based Global Investment House (GIH), the combined net earnings of the GCC's nearly 150 commercial banks dropped by about 8.5 per cent to $15.74 billion (Dh57.81bn) in 2009 from about $14.39bn in 2008.

The largest fall of around 19 per cent was recorded in the UAE, while Kuwaiti banks reported a surge of 70 per cent in net income.

GCC banks exposure

Bahrain: The retail banking portfolio in Bahrain is highly exposed to construction and real estate (33 percent of total loans) and the household sectors (23 per cent). However, household loans are mainly secured by salary which mitigates the risk of default.

- Kuwait: The banking portfolio is highly exposed to the real estate and construction sectors, which constitute close to 50 per cent of total loans. Household loans (excluding mortgages) and non-bank financial institutions (mainly to investment companies) are also important in banks' loans portfolios accounting for 16 and 12 percent of total loans, respectively.

Oman: Oman's banking sector is highly exposed to the household sector, which accounts for about 40 per cent of total loans. Rising consumer indebtedness raises concerns as Omani households are highly leveraged with household loans accounting for 17 per cent of GDP. Additionally, a high proportion of the corporate loan portfolio is in a handful of large exposures.

Qatar: The banking sector is mostly concentrated in the household, construction and real estate and government sectors, which account for 26, 20, and 27 per cent of total loans, respectively. As regards the household sector, although data is not readily available on the uses of these loans, an important share of these loans might be for securities investments. This could be a potential risk due to risk concentration and the difficulty arising from monitoring margin lending.

Saudi Arabia: The loan portfolio appears well diversified with respect to the corporate sector with trade being the main sector at 25 per cent of total loans (mirroring the structure of the economy). However, concentration of credit to high net worth individuals could pose risks, similar to other GCC countries. Household loans in turn are well diversified with no dominating sub-sector. Real estate loans in Saudi Arabia are marginal compared to the rest of the GCC at less than 10 per cent of total loans. However, similar to the rest of the GCC countries, some margin lending for equities could be a source of risk.

UAE: The banking sector is highly exposed to the construction sector and the highly speculative real estate sector (25 per cent of total loans, including household mortgages), and to the household sector (20 per cent, excluding household mortgages). Trade is also an important sector in bank loans accounting for 13 per cent of total loans. The banking portfolio is concentrated in the corporate sector, which accounts for two-thirds of total loans. Financing, however, is mainly directed to large private business groups or government-owned related enterprises and there is currently a high level of concentration of credit risk due to large financings of a few family-owned businesses and sizeable government-related entities.


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