GCC banks face rating pressure from COVID-19 impact

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Aden - Yasmin Abdel Azim - Customers use ATMs inside a bank in Saudi Arabia. Downward pressure on profitability and loan quality due to deteriorating operating conditions resulting from low oil prices and the impact of coronavirus (COVID-19) outbreak is likely to result in more credit rating downgrades of banks in the region, according to rating agencies. Image Credit: Bloomberg

: Downward pressure on profitability and loan quality due to deteriorating operating conditions resulting from low oil prices and the impact of coronavirus (COVID-19) outbreak is likely to result in more credit rating downgrades of banks in the region, according to rating agencies.

Leading rating agencies have warned that economic impact of coronavirus and the low oil prices are likely to result in margin erosion and loan impairments for banks resulting in rating action.

Earlier this week Standard and Poor’s (S&P) revised its outlooks of a few UAE banks such as First Abu Dhabi Bank, Abu Dhabi Commercial Bank, Mashreqbank, Sharjah Islamic Bank and National Bank of Fujairah to negative, while affirming long- and short-term issuer credit ratings on these entities.

“The rating actions stem from our view that, in 2020, the sharp drop in oil prices and reduced activity due to COVID-19 will exert significant pressure on the UAE economy, especially the real estate, trade, retail, transportation, and hospitality sectors,” S&P said in a note.

The rating agency expects loan quality will be tested and cost of risk will increase, weighing on banks’ profitability in the next 12-24 months. In 2019, banks’ asset quality indicators had already started to show signs of weakness.

Rating agency Moody’s said the sizable cut in interest rate will reduce UAE banks’ net interest margins (NIMs) because gross yields earned on loans will decline more than the funding cost paid on deposits, and because the rate cut is unlikely to materially increase credit volumes in the current difficult operating environment.

In early March Moody’s had downgraded the long-term local and foreign currency deposit ratings of five Omani banks: Bank Muscat, Bank Dhofar, National Bank of Oman, Sohar International Bank and Oman Arab Bank . At the same time, Moody’s affirmed the long-term local currency deposit ratings and downgraded the long-term foreign currency deposit rating of HSBC Bank Oman SAOG and Bank Nizwa. Moody’s has changed the outlook to stable from negative on the long-term deposit ratings of all seven banks.

Rise in cost of funds

According to Moody’s, the immediate effect of a sustained period of lower oil prices would be on the liability side of the balance sheets due to reduced deposit inflows from government and government-related entities.

Bank deposits
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“We estimate that government deposits range between 15 per cent and 34 per cent of the deposits of the GCC banking systems,” said Bhojnagarwala.

S&P analysts said combination of factors such as lower oil prices, economic impact of coronavirus on regional economies and a deterioration in asset quality could weaken bank profitability in the region.

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Mohamed Damak

“The knock-on effects of lower economic growth and oil prices will further slow lending growth and increase the overall stock of problem assets at GCC banks. As a result, we anticipate that cost of risk will edge up. At the same time, interest margins will decline because the US Federal Reserve Board and other local central banks have cut interest rates. Combined, these shifts will weaken banks’ profitability,” said Mohamed Damak, Director of Research at S&P.

Strong capital and liquidity buffers

While GCC banks mostly have robust capital and liquidity buffers, S&P believes all the region’s banking systems credit quality exhibit vulnerabilities that are broadly in line with the relative creditworthiness of their sovereigns. Banks in Bahrain and Oman are the most vulnerable in this respect.

Bahraini banks will face growth, profitability and potential asset-quality challenges, as well as declining liquidity levels. Omani banks, meanwhile, will experience further strain on their asset quality and profitability, exacerbating difficulties stemming from extended payment cycles. Although government deposits will remain stable, we expect Oman’s government to increase its borrowing from the banking system.

For their part, banks in Saudi Arabia and the UAE are facing some existing pressures, but are likely to be moderately affected specifically as a result of the decline in oil prices because of the countries’ relatively large reserve buffers. “Both [UAE and Saudi] governments can in principle sustain public spending to support economic growth, but low oil prices are likely to constrain governments existing spending plans especially in Saudi Arabia, weakening operating conditions. As such, we expect credit growth to remain subdued, while profitability will decline and asset-quality is expected to weaken for the banks in these systems,” said Damak.

Kuwaiti banks more resilient among GCC peers

Fitch Ratings believes Kuwaiti banks are in a better position than most peers in the GCC to weather pressures in the current crisis of declining oil prices and coronavirus fallout.
We expect banks' Viability Ratings to remain stable in the short-to-medium term. However, if the impact on the economy and on banks deepens, rating actions on ratings cannot be ruled out,” Fitch said in a recent note.
The Central Bank of Kuwait (CBK) has acted swiftly to weather the negative impact of the current crisis on the economy. It cut its discount rate (benchmark rate for Kuwaiti dinar lending) twice in March by a cumulative 125bp to a historical low of 1.5 per cent in order to reduce the cost of lending and support domestic growth. The CBK does not automatically follow the Fed's rates changes: in 2017 and 2018, the CBK increased its discount rate only twice (by 25bp each time) out of the seven Fed-rate increases. The current CBK measures, therefore, reflect the severity of the current crisis and the authorities' high willingness to support the economy.
“The recent sharp decline in oil prices will have adverse effects on Kuwait's public finances and debt dynamics, external balances and economic growth and will add to the pressure on the banks from the coronavirus fallout,” Fitch said
Real estate and construction sectors are likely to soften because of a slowdown in cash flow owing to delay in payments and project postponement, including from the government due to an expected tighter budget, as well as weaker demand for commercial and residential properties.

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