American credit rating agency, S&P Global Ratings has observed that banks in the GCC region face an uphill battle in the next 18 months due to the slow economic turnaround and gradual withdrawal of financial constraints across the global economies.
S&P Global Ratings expects the performance of the banking industry to be at a decline with few banks reporting losses due to their exposure to high-risk asset classes or under-provisioning.
S&P’s primary credit analyst Mohamed Damak remarked that “This will push banks’ management teams to look more carefully at costs, try to leverage opportunities related to fintech and reduce the number of physical branches. Without additional support measures, we expect the deterioration in GCC banks’ asset quality to accelerate as regulatory forbearance measures end.”
Mr. Damak observed that good funding profiles and strong capitalization should allow GCC banks to support their creditworthiness in 2020-21 adding that GCC banks continue to display strong capitalization by international standards, with an unweighted average Tier 1 ratio of 17.2 percent on June 30, 2020.
“Yet we believe that GCC banks’ reduced profitability is long lasting due to the domination of non-interest-bearing deposits in their funding structures and lower revenues on the asset side. In addition, we think that, in the next few years, GCC banks might start to import capital more aggressively as local funding sources prove insufficient. This would add to the pressure on banks’ profitability. It remains to be seen to what extent banks could compensate for that pressure by consolidating or leveraging fintech solutions to cut costs,” said Damak.
Positive outlook for the future
The rating agency sees GCC economies expanding by an average of 2.4 percent in 2021, compared with a contraction of 5.6 percent in 2020.
In the report, S&P observed that “Without these glimmers of light, things could be even worse for GCC banks. We expect that lending growth will remain muted, with the exception of Saudi Arabia, where mortgages have been expanding rapidly on the back of a government initiative to increase homeownership in the country.”
The report observed that GCC banks’ lending growth slowed to an annualized rate of 6.6 percent in the first half of 2020 compared with 9.4 percent in 2019.
After analyzing 16 largest Islamic banks and 30 largest conventional banks in the GCC for their credit fundamentals, the credit rating agency believes that Islamic banks might prove less resilient to a protracted downturn than their conventional peers.
“This is because of Islamic banks’ strong entrenchment in the real estate sector and the absence of late payment fees; under Islamic law, banks must give such fees to charity. Moreover, the exposure of some Islamic and conventional GCC banks to weaker markets will probably add to their asset-quality problems,” the report said.