Gulf oil producers need to create an early warning system for their banking sector as part of a post-crisis strategy involving stronger supervision of their banks, a key Western financial institution said yesterday.

The Washington-based Institute for International Finance (IIF) said the six Gulf Cooperation Council (GCC) nations had made substantial progress in prudential regulation and banking supervision since the eruption of the global financial turbulence but added that there is still scope for further improvement.

In a report sent to Emirates Business, IIF said it believed the more than 150 banks in the GCC are strong enough to deal with the repercussions of the crisis although heavy provisioning against bad debt was weighing on their profits.

"More robust management systems, 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 against the backdrop of the prevalence of large family-affiliated conglomerates, offshore and regional banking," said IIF, which comprises several major banks from the Organisation of Economic Cooperation and Development.

"This requires enlarging the information set available to supervisors, including off-balance-sheet operations of banks, household indebtedness, real estate prices and gathering information on the health of corporates. Besides regular on-site inspections, stress tests can provide early warning signals."

At recent talks in Abu Dhabi, GCC central bank governors discussed the idea for an early warning system and said they would hold more meetings on the issue.

Oman's Central Bank Chief Executive Hamoud bin Senjour Al Zedjali said they had not reached any agreement regarding the Saudi family debt default problem but added the discussions covered coordination between GCC monetary authorities regarding their banking sector in the coming stage.

"The GCC central banks are working on an early warning system to ensure better supervision of their banks… but I have to tell you that banks have to bear the responsibility of their decisions regarding extending credit to their customers whether they are nationals or foreigners," he said.

"But as far as we are concerned, the central banks are very strict in asking the banks to make provisions for non-performing loans. We want to ensure banks are well protected and immune and there is continuous discipline in this sector."

IIF said financial soundness indicators gathered from aggregate country data suggest that GCC banks remain solvent and profitable with system-wide capital and liquidity cushions that are helping them weather financial turmoil.

It attributed this to what it described as the solid economic performance over recent years, that helped strengthen balance sheets, stronger regulation in some members and high government participation in banks, especially the UAE.

The report noted that while GCC banks remained profitable in the first half of 2009, consolidated net earnings have declined notably in stark contrast to the strong growth in profits over recent years. "Although reassuring, financial soundness indicators have limitations, including that they often are backward looking. In addition, system data can mask the deterioration in financial conditions of individual banks," the report said.

"Overexposure to real estate and highly leveraged companies has eroded asset quality. Uncertainty over the true state of balance sheets, especially in light of revealed exposures of two large Saudi conglomerates compounded by inadequate transparency, will likely persist over coming months, restraining bank funding and credit growth, although we judge the risks to be manageable."

IIF said some observers had voiced concerns regarding the overall asset quality of GCC banks due to their high exposure, directly or indirectly, to the real estate sector. But it added that the high shares of public sector ownership of property developers may provide comfort to banks with exposure to the residential sector.

It said the indirect effects of global crisis had proved unexpectedly strong on the grounds the GCC's financial ties with the rest of the world have deepened over the past five years, exposing the region to the forces of global deleveraging.

Owing to worries about family business and their own exposure and the process of deleveraging, most banks in the region have become more cautious in extending credit to the private sector, it said. Its figures showed credit by GCC banks to the private sector broadly stagnated from the end of November 2008 to the end of August 2009.

"First, banks were cautious about corporate growth prospects in an environment of weak domestic demand. Second, the crisis has generally encouraged most banks around the world to refocus on risk management. Third, new private sector projects coming to the market dwindled this year, as a number of projects were put on hold or cancelled," said IIF.

 

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