Islamic banks in the GCC to face tough year: S&P

Business Tuesday 20/June/2017 15:00 PM
By: Times News Service
Islamic banks in the GCC to face tough year: S&P

Muscat: The slowdown at Islamic banks in the Gulf Cooperation Council (GCC) will persist in 2017 after asset growth declined to 5.3 per cent in 2016 from 10.7 per cent in 2014, according to S&P Global Ratings’ new report.
In the base-case scenario, S&P assumes that asset growth will stabilise at about 5 per cent as governments' spending cuts and revenue-boosting initiatives, such as new taxes, reduce Islamic banks' growth opportunities in the corporate and retail sectors.
Banks are becoming more cautious and selective in their lending activities and this would trigger stiffer competition. Yet, S&P does not expect this will happen uniformly in all GCC countries.
Although the economic slowdown will likely remain pronounced in Saudi Arabia, Islamic banks' growth accelerated there in 2016, thanks to their strategy of increasing business among corporates and small and medium enterprises (SMEs).
By contrast, the decline in economic activity was steeper in Qatar, where a mix of lower liquidity and government spending cuts prompted banks to curtail their expansion plans.
Asset growth was about nil in Kuwait over the past year, hit by the depreciation of certain foreign currencies and the ensuing impact on the financials of some leading Kuwaiti Islamic banks.
Despite the United Arab Emirates (UAE)'s tepid economic performance and the drop in real-estate prices, Islamic banks continued to expand by high single digits.
As the economic cycle turns, S&P thinks GCC Islamic banks' asset quality indicators will deteriorate in the second half of this year and in 2018. Such weakening was not noticeable in 2016 because—as is typical—banks had started to restructure their exposures to adapt to the shift in the economic environment.
Therefore, S&P saw an increase in restructured loans in the GCC last year, but not a marked increase in banks' nonperforming loans (NPLs) or cost of risk. The rating agency thinks the deterioration will be more visible in 2017 and 2018.
Overall, the rating agency believes that subcontractors, SMEs, and expatriate retail exposures will bear the brunt of the turning economic cycle and contribute prominently to the formation of new NPLs over that period.
GCC Islamic banks' profitability will therefore deteriorate again in 2017 and 2018, and S&P foresees several factors coming into play:
The cost of funding has increased, and this squeezed banks' intermediation margins in 2016.
Although the pressure eased a bit after some governments issued international bonds and unlocked payments to contractors, the agency thinks the cost of funding will remain inflated in 2017-2018.
The US Federal Reserve (Fed)'s recent rate hike, which some GCC central banks have emulated, could result in deposits shifting to profit-sharing investment accounts (PSIAs) from unremunerated current accounts. If this happens, it would raise the cost of funding even further.
Very few Islamic banks have set aside significant amounts of profit-equalization reserves, which they built in good years and use to smooth returns to PSIA holders if needed.
Cost of risk is on the rise and S&P also foresees higher credit losses in the coming two years, due to relatively weak economic conditions. Exposure to subcontractors, SMEs, and retail customers (especially expatriates) will likely fuel the upward trend for credit losses.
In general therefore, the rating agency expects Islamic banks' revenue growth to decelerate, and that they will focus on their cost bases to mitigate the impact (for example, by pruning branches). Like their conventional counterparts, GCC Islamic banks, through their relatively low cost bases, should be able to protect their profitability somewhat over the next two years, however. Although consolidation might be a way forward in some GCC markets, we expect mergers will remain an exception in 2017-2018 rather than the norm.
Capitalisation is generally a positive factor for GCC Islamic banks and S&P notes; however, that it has reduced because previous rapid financing growth was not matched by additional capital. Few GCC banks have issued capital-boosting sukuk and those that have, are primarily in the United Arab Emirates, Qatar, and Saudi Arabia.