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S&P Report says GCC Banks face an earnings shock: Oil and Corona culprits

Conventional and Islamic banks in the Gulf Cooperation Council (GCC) countries will see significantly reduced revenue and credit growth in 2020, S&P Global Ratings said

The severe shock could cause irreparable damage to some parts of the non-oil economy We also expect banks to focus more on asset-quality indicator preservation than generating new business In our view, Islamic banks are somewhat more vulnerable than their conventional peers

By: S&P Global Ratings

Conventional and Islamic banks in the Gulf Cooperation Council (GCC) countries will see significantly reduced revenue and credit growth in 2020, S&P Global Ratings said March 6 in the “GCC Banks Face An Earnings Shock From The Oil Price Drop And COVID-19 Pandemic,” report published on RatingsDirect

“The sharp drop in oil prices and measures implemented by regional governments to contain transmission of the coronavirus (COVID-19) will take a toll on important sectors such as real estate, hospitality, and consumer-related. Under our base-case scenario, we assume that these measures will be relatively short lived and forecast a gradual recovery in non-oil activity from third-quarter 2020,” said S&P Global Ratings credit analyst Mohamed Damak.

“However, the severe shock could cause irreparable damage to some parts of the non-oil economy. Furthermore, if the recovery takes longer than we expect, GCC banks could feel greater pressure,” Mr. Damak concluded.

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the COVID-19 outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. As the situation evolves, we will update our assumptions and estimates accordingly.

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We Expect A Significant Slowdown In Lending Growth In 2020 

Although growth rates last year were almost the same as 2018, GCC conventional banks saw faster increases than Islamic banks. This was mainly explained by acquisitions. Emirates NBD, for example, acquired DenizBank in Turkey, increasing its total assets by almost one-quarter. Other transactions were mainly local or regional with Abu Dhabi Commercial Bank absorbing two other local banks (including one Islamic) and Saudi British Bank taking over another local bank. 

In 2020, we expect slower organic and non-organic growth, with Islamic and conventional banks seeing similar rates of 2%-3%. We project average real GDP growth for the six GCC countries will slightly accelerate in 2020 compared with 2019, but this will be primarily spurred by higher oil production (see chart 1). With the significant decline in oil prices–our assumption for 2020 is now an average of $30 per barrel, down from $60 at the start of the year–and government measures to contain the spread of COVID-19, we think that non-oil growth will decline. 

This will result in fewer growth opportunities for banks. We also expect banks to focus more on asset-quality indicator preservation than generating new business. The delay of Expo 2020 for Dubai and cancellation of the pilgrimage season for Saudi Arabia, for example, now depend on the spread and containment of COVID-19. If either event is cancelled, the impact on regional economies could be stronger than we currently expect and further increase risks for banks. 

Chart 1

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At year-end 2019, the average nonperforming financing (NPF) ratio reached 2.8% for Islamic banks compared with 3.0% for conventional banks in our sample (we don’t see much significance in the slight difference). The coverage ratios were also comparable at 155.5% for Islamic banks and 154.6% for conventional banks at the same date. For 2020, we think that NPF ratios could easily double, and cost of risk could reach 1.5%-2.0% of total loans. Moreover, we believe that most of the deterioration would come from small and midsize enterprises (SMEs) and companies operating in the real estate, hospitality, and consumer-related sectors. 

In our view, Islamic banks are somewhat more vulnerable than their conventional peers. This is because they tend to have higher exposure to the real estate sector due to the asset backing principle inherent to Islamic finance. Furthermore, they cannot charge late payment fees (unless these are donated to charities at the end of the exercise) meaning that clients tend to prioritize payments on conventional exposures versus Islamic. However, GCC governments’ requests for all banks not to charge late payment fees when they reschedule financings to affected companies partially mitigates this distinction. 

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Funding And Liquidity Remains Good

 Growth in customer deposits was strong in 2019 for both types of banks thanks to the recovery in oil prices. The funding profile of Islamic and conventional banks also remained stable, with total financing to total deposits of about 93% at year-end 2019. We see two main risks in 2020. These include the concentration of the deposits base on government and government-related entity (GRE) deposits, which account for 10%-35% of total deposits. These entities might burn cash as the drop in oil prices and less supportive economic environment affect their activities. Furthermore, we note risks related to deposits outflows once the COVID-19 pandemic is contained and the full effect on employment is known. Some expatriates might increase remittances to their home countries. 

Despite this pressure, we continue to take comfort from GCC banks’ good liquidity indicators. Banks’ funding profiles remain a strength in most GCC countries.