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Geopolitical uncertainty, shaky investor confidence, problematic assets plague MENAT Banks

Increased geopolitical uncertainty weighs on the economic prospects of the Middle East, North Africa, and Turkey, potentially undermining their banking systems' creditworthiness

As investor confidence remains fragile, some countries' high dependence on foreign funding and non-resident deposits represents a key risk The adoption of International Financial Reporting Standard 9 and sluggish economic environments are increasing problematic assets, particularly in Tunisia, Lebanon, and Turkey Ratings in low 'B' territory will remain dominant in 2020, with the exception of Moroccan banks, which we expect will maintain stable asset quality and financial performance indicators

This year looks eventful for banking sectors in the Middle East, North Africa, and Turkey (MENAT). Geopolitical uncertainty, tensions with Turkey’s western allies, and domestic political turbulence in Lebanon and Tunisia are likely to weigh on banking systems’ creditworthiness. Risks relating to banking systems’ dependence on external funding are particularly high for Turkey and Lebanon, at a time when more than $15 trillion of assets have negative yields and investors are actively chasing returns. Our ratings in the MENAT region have also been on a downward trajectory over the past 12 months. The ratings are now concentrated in the ‘B’ category, with the exception of those on Lebanese banks. We placed Lebanese banks on CreditWatch with negative implications in October 2019 and downgraded them to selective default (‘SD’) in December 2019 due to higher pressure on liquidity and limits on depositors’ access to funds. The outlook distribution among banks in the MENAT region indicates that the bias toward negative rating actions will continue in 2020. Morocco remains the one bright spot, where we expect banks will maintain stable asset quality and financial performance indicators in 2020.

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Real GDP growth is low Average real GDP growth in MENAT countries was weaker than we expected in 2019 and at its lowest level for 10 years. The Turkish and Lebanese economies entered into recession. Egypt was the only economy to expand at a relatively rapid pace, supported by domestic reforms on exchange rates, the fiscal front, and energy sector. In 2020, we expect a slight acceleration in average real GDP growth, even if the economic prospects vary widely within the MENAT region due to challenges and factors specific to individual countries.

Loan growth is weak Average loan growth in MENAT countries was also weaker than we expected in 2019. This was mainly due to Lebanese banks’ significant deleveraging. Soaring lending rates, combined with the challenging economic environment, led to an about 10% decline in outstanding loans in Lebanon over the year. In 2020, we expect loan growth to accelerate to average 6%-7% in the MENAT region (excluding Lebanon), although this rate remains insufficient to finance the region’s development needs when we adjust it for inflation. Lending activity is highly correlated with economic prospects. We expect Egypt’s solid GDP growth to translate into annual loan growth of above 12% in the next two years. Additional drivers include large infrastructure projects and improved financial inclusion provision of affordable financial products and services to vulnerable groups in society. Another key spur is the Central Bank of Egypt’s (CBE’s) instruction to banks to increase lending to small and midsize enterprises (SMEs) to at least 20% of their loan books by year-end 2020, thereby pushing banks to onboard higher risks and helping them to diversify away from government securities. The idiosyncrasies of each banking system are clearly apparent when comparing their loan-to-domestic deposit ratios. Tunisia’s ratio will remain the highest in the MENAT region, and will move only slowly toward the 120% limit the regulator has imposed. On the other hand, we expect Lebanon’s ratio to remain below 30%, because Lebanese banks continue to invest the majority of their assets, either directly or indirectly, in government securities. Moreover, we expect Lebanese deposits to continue shrinking, with potentially high volatility in the short-to-medium term due to recent domestic political turbulence and a significant proportion of non-resident deposits from confidence-sensitive middle-to-high-income international customers in total funding.

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Asset quality is under pressure Asset quality remains a major issue for banks in the MENAT region. Although nonperforming loans (NPLs) have declined on average in the past 10 years, the trend reversed in 2019. Following most countries’ implementation of International Financial Reporting Standard (IFRS) 9, we expect average NPL ratios to keep increasing in 2020 and 2021. This is especially true in Lebanon and Turkey, where we anticipate that banks’ portion of problematic loans (including restructured exposures) will reach almost 20% of all loans in 2020 in Turkey and even more in Lebanon. Tunisia will also remain a negative outlier in terms of deteriorating asset quality, penalized by a legacy of high lending activity and the poor economic recovery. We expect that the Tunisian banking system’s NPL ratio, excluding restructured/rescheduled loans, will remain above 14%, and believe that its asset-quality indicators could worsen further if banks were to adopt IFRS 9. Egypt is the only country in which we expect an improvement from 2021, while at the same time its banks’ coverage of NPLs remains the highest in the MENAT region.

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Attracting foreign funding is challenging The capacity to attract foreign funding represents one of the main challenges for MENAT banks, since the need for external financing will remain high due to the weak state of some local economies and the overall slow pace of fiscal consolidation. In Lebanon, Morocco, and Jordan, banks largely rely on nonresident transfers, while Turkey’s banking system is more dependent on wholesale funding, which became highly volatile as geopolitical tension increased. In fact, Turkish banks’ external debt has started to decline, pointing to a continued drop in debt rollover rates, higher funding costs, and investors’ rising concerns about the country’s policy direction. As of Sept. 30, 2019, the total stock of external debt of Turkish private-sector banks stood at $141.0 billion. This comprised $64.5 billion of short-term debt and $76.6 billion of long-term debt, including $29.8 billion of private-sector banks’ debt maturing in the next 12 months. This stock was $13.3 billion lower than at year-end 2018. Lebanese banks’ capacity to retain nonresident deposits is fundamental to guarantee the sustainability of the banking system and the government’s finances. However, deposit erosion that started in first-half 2019 intensified in the second half. This was because of domestic political developments, protracted social unrest, prolonged bank shutdowns, and individual banks’ restrictions on specific transfers and operations. From August 2019, declining investor confidence accelerated withdrawals and deposit outflows outside the country, notwithstanding increased interest rates, the imposed longer tenor of those deposits, and restrictions on transfers abroad. This trend raised concerns about the stability of the Lebanese pound peg with the U.S. dollar, thereby putting additional pressure on the Lebanese government to implement decisive reforms, which we think will be difficult in the current environment.