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GCC banks eye a brighter future

28 July 2023

 

Against a backdrop of booming profits, robust liquidity and healthy loan books, GCC banks remain in generally strong fettle in 2023.

Even if performance levels this year are unlikely to match the surging metrics witnessed last year, when the post-pandemic revival drove exceptional growth stats, most regional lenders have little to fear and much to gain from regional and global conditions.

The global interest rate climate remains a source of valuable support for Gulf banks. Even if this year does not see the fat net interest margins (NIMs) that led to much of the profit generated in 2022, the first-quarter 2023 results for listed Gulf banks still show healthy earnings.  

Banks in the largest markets, such as Saudi Arabia, the UAE and Kuwait, have been riding the yield curve and, while the cost of funds has increased, asset yields have widened further. Analysts say the growth in loan portfolios and asset volumes has continued this year. 

“We are seeing profitability metrics improving, and that’s due to the higher rates following the dollar,” says Redmond Ramsdale, head of Middle East Bank Ratings at Fitch Ratings.

“And we’ve seen loan impairment charges coming down as banks have been building up their provisions and dealing with the pandemic. Certainly on profitability, we’re back to pre-pandemic levels, if not slightly above them.”

Broad-based growth

Bank performances reflect a confluence of factors. In the UAE, according to analysis from CI Ratings, profit growth is largely due to higher margins and net interest income, but also because provisioning expenses have come down significantly as banks see lower levels of new non-performing loan (NPL) classification and good recoveries. This is also related to the improving real estate environment.    

Kamco Invest research shows net profit for listed banks in the GCC in the first quarter of this year benefitted from a steep quarterly increase in non-interest income that more than offset a sequential decline in interest income in Qatar and Kuwait.

In addition, lower provisions booked by banks in the region also supported bottom-line performance. As a result, aggregate net profits saw the biggest quarterly growth since the pandemic at 17 per cent to reach $13.4bn. The sequential increase in net profit was broad-based across the GCC.  

There are some causes for concern. For one thing, GCC banks now have to grapple with an increased cost of funds. According to the Kamco figures, these have gone from 1.9 per cent in the previous quarter to a multi-quarter high of 2.5 per cent during the first three months of 2023.

But overall, GCC banks have enjoyed success in containing costs, as reflected in total operating expenses registering a decline of 3.1 per cent to $11.2bn during the first quarter of 2023, after consistent growth during the three previous quarters, according to Kamco figures.

The downturn in loan loss provisions – which increased in the 2020-22 period, driven by the pandemic impact – has proved a boon. Figures show these provisions stood at $3.1bn in the first quarter of this year, down from $3.3bn in the previous quarter.

Macro conditions

Analysts see the macroeconomic environment as playing a decisive role in supporting GCC bank performances. 

“Reasonable oil prices are supporting liquidity in the system and the level of government and government-related deposits,” says Ramsdale.

“Government and government-related entity (GRE) deposits make up about 25 to 30 per cent of sector deposits, and with the increase in oil prices, we’ve seen a slight increase in these levels.”

According to CI Ratings, the largest banks in the region have distinct competitive advantages in terms of franchise, margins, cost efficiency, generally well-performing loan books and diversified earnings.  

GCC banks were well placed for rising interest rates because they have quite a high base of current account and savings accounts (CASA) and a high proportion of short-term loans, says Ramsdale.

“The asset side has been repricing quickly. We have seen some migration from these low-cost CASA to term, but there is still a big proportion that’s very low cost, and that supports profitability metrics,” he says.

There has been no sign of significant deterioration in asset quality. “The end of forbearance didn’t really impact ratios too much, but interest rates have gone up a lot, and we expect some pressure on affordability. We, therefore, do expect stage three loans to start ticking up,” says Ramsdale.

Loan outlook

Lending has risen overall, although not as strongly as customer deposits, which resulted in a loan-to-deposit ratio for the GCC banking sector of 78.5 per cent in the first quarter of 2023.

Saudi Arabia stands out here, with more sector liquidity tightening reflecting stronger loan growth. Last year it was 15 per cent, significantly outpacing deposit growth of 9 per cent, says Fitch.

“The Saudi loan-to-deposit ratio of around 100 per cent is the highest it’s been in about 15 years, and it’s the opposite of what we’ve seen in other GCC markets,” says Ramsdale. “The UAE loan-to-deposit ratio hasn’t been this low for 10 years, reflecting the ample liquidity going into the UAE.”

In the kingdom, the government has been supplying additional liquidity from oil revenues that has gone into government agencies, such as the Public Investment Fund. That represented a change from the past, when that liquidity was largely channelled through the banking system.

Fitch is expecting the kingdom’s explosive recent loan growth to come down to about 12 per cent this year with a tightening of state subsidies putting pressure on housing affordability.

External funding

In Qatar, the big story is the composition of the funding base. Although there has been an improving trend in 2022 and the first quarter of 2023, CI Ratings notes that there is still a heavy dependence on wholesale funding, particularly offshore wholesale funding. 

Ratings agency S&P says Qatari banks have the highest recourse to external funding among the GCC, with the system’s loan-to-deposit ratio reaching 124 per cent at the end of March 2023.

This resulted in an overall funding gap (total domestic loans minus total resident deposits) of $112bn, equivalent to almost two times the public sector deposits.  

The high reliance on external funding is still a credit weakness for Qatari banks, says Amin Sakhr, director of financial institutions at Fitch Ratings.

“There’s some positivity that’s been observed since last year on the back of higher hydrocarbon revenues, which means domestic liquidity is improving, so banks are becoming less and less reliant on external funding. In the UAE and Saudi Arabia, this has traditionally been about 5-10 per cent of system deposits.”

The GCC will experience solid operating environment conditions, given that healthy oil prices will underwrite government spending

Performance prospects

In the UAE, credit demand will drive loan growth, but margins will moderate in line with interest rates. For some banks, their continuing strong NPL recovery will boost earnings performance. 

The UAE’s largest banks, such as Fab and Emirates NBD, also entertain growth ambitions beyond the country's borders that will help them grow their balance sheets. 

According to S&P, UAE banks are in a comfortable net external asset position and their loan-to-deposit ratios are among the strongest in the region. Banks have accumulated local deposits over the past 15 months amid muted lending growth. The ratings agency does not expect an acceleration of lending, so UAE banks’ funding profiles should continue to strengthen. 

In Oman, customer deposits grew to $67bn in the first quarter of 2023, compared to $63.4bn in the same quarter of 2022.

While Omani banks are benefitting from rising interest rates, higher competition for deposits could translate into a higher cost of funds, which could impact margins. Analysts say that the benefits to banks of a rise in interest rates may be lower in Oman than in the other markets.  

In Bahrain, banks will likely continue benefiting from the prevailing high-interest rate environment for the remainder of 2023.

The country’s retail banks’ loan-to-deposit ratios have been consistently below 80 per cent for the past five years, suggesting that local deposits and a significant portion of external liabilities are being recycled into government and local central bank exposures. 

In contrast, Kuwait has a funding profile dominated by customer deposits, which have proved stable. Only 20 per cent of Kuwait’s deposits are from the government or GREs. 

Like their Saudi counterparts, Kuwaiti banks have room to attract foreign funding. Moreover, notes S&P, the Saudi riyal’s peg to the dollar and the relative stability of the Kuwaiti dinar exchange rate – thanks to its peg to a basket of currencies – mean that even if this flow is recycled locally, foreign currency risks are likely to remain in check.

Looking ahead, the GCC will experience solid operating environment conditions, given that healthy oil prices will underwrite government spending. This should underpin lending growth and maintain the region’s top lenders’ buoyant state into 2024.

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James Gavin

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    When the first missiles and drones were fired at the GCC on 28 February, the region’s economic story pivoted abruptly, from long-term vision-building to near-term resilience.

    The conflict is now the Gulf’s most consequential economic stress test in a generation. It is challenging the safe haven premium that underpins capital inflows, while disrupting the physical networks that keep the region’s economies running, from energy exports and shipping lanes to airports and tourism.

    Over the past two decades, GCC governments have worked to pair diversification with an image of stability: open economies, predictable regulation and security that felt, to many investors, close to non-negotiable.

    This crisis has reopened an older question last asked during the 1990 to 1991 Gulf War: not simply how fast the Gulf can grow, but whether it can remain investable and operational under sustained security risk. The early evidence is mixed and still emerging.

    Energy infrastructure has been damaged and supply chains have been paralysed, but other parts of the economy, such as retail and construction, have continued to operate largely as normal.

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    The clearest and most quantifiable example of the economic toll came when Iranian strikes targeted Ras Laffan Industrial City in Qatar. The damage reported by QatarEnergy is significant. Liquefied natural gas (LNG)-producing trains 4 and 6, which account for about 17% of Qatar’s total LNG exports, need repairing. The expected revenue loss is $20bn a year.

    In a statement, QatarEnergy president and CEO Saad Sherida Al-Kaabi said the repairs will take three to five years to complete, underlining the long-term impact on the Qatari economy. JP Morgan estimates that Qatar’s GDP could contract by 9% this year.

    Qatar is not the only GCC state to have suffered damage to its energy infrastructure. Bahrain, Kuwait, Oman, Saudi Arabia and the UAE have all had energy assets targeted.

    In addition to damage caused by missiles or drones, logistics problems triggered by the closure of the Strait of Hormuz are having a material impact. Aluminium Bahrain (Alba) has implemented a controlled shutdown of reduction lines 1, 2 and 3, one example of how supply chain paralysis is spreading into industry.

    By idling 19% of its production capacity, approximately 308,000 tonnes a year, Alba is attempting to preserve raw material inventory and prioritise the operational stability of its newer, more efficient lines 4, 5 and 6. However, the macro implications for Manama are severe. Alba contributes 12% to Bahrain’s GDP, with the broader aluminium sector, a vital driver of the kingdom’s Economic Vision 2030, accounting for over 15%.

    The conflict is now the Gulf’s most consequential economic stress test in a generation

    Dubai disruption

    In Dubai, where the economy has made great strides in diversifying away from oil and gas and into sectors including tourism, aviation and real estate, the disruption caused by the war is also taking a toll. Despite a few high-profile attacks, the city’s infrastructure remains almost entirely intact. The problem is that its accessibility has been halved. As of late March, data shows flight capacity hovering at 50% across 70% of destinations. Hotels in the emirate are operating at single-digit occupancy levels.

    In response, Dubai has begun reviewing support packages for the sector, including fee relief and the removal of penalties for delayed payments. This stance mirrors Dubai’s response to the Covid-19 pandemic, a crisis the emirate ultimately navigated well. The plan is that an initial focus on resilient source markets, such as Russia and Africa, will allow the tourism sector to move onto the road to recovery.

    The Dubai property market is perhaps the most sensitive barometer of international confidence. For three weeks, the market has lived in a state of suspended animation. While AED11.9bn in real estate sales were recorded in early March, analysts warn of a significant time lag. These figures represent registrations of sales agreed weeks or months ago, and the true impact of the 28 February escalation may not be reflected in official data until late March or April.

    Early indicators from brokers and market analysts point to falling transaction volumes. The narrative of safety and guaranteed returns that fuelled the post-pandemic boom, and attracted billions in overseas wealth, has been dented. Investors are increasingly seeking reassurance that their capital is not anchored in a conflict zone.

    Rather than cutting headline prices, which would damage long-term community values, some developers are offering registration waivers, 0.5% monthly payment plans and extended grace periods.

    More than 15,000 flights were cancelled at seven major regional airports in the first week of March

    Aviation strain

    With airports in Bahrain, Riyadh, Kuwait, Dubai and Abu Dhabi all targeted during the conflict, the Middle East’s aviation sector is grappling with unprecedented operational friction. According to Fitch Ratings, more than 15,000 flights were cancelled at seven major regional airports in the first week of March alone.

    The main international hubs, Dubai, Abu Dhabi and Doha, are facing a sharp spike in operating costs. Rerouting around restricted airspace requires longer flight paths, additional technical stops and increased expenses for crew overtime. While carriers have buffers through fuel hedging, ranging from 50% to 80%, the sheer volume of refunds, vouchers, and accommodation for 1.5 million displaced passengers is weighing on balance sheets.

    The aviation insurance market is also shifting. With insurers holding the right to cancel war cover during active conflict, the risk profile of regional fleets is being repriced in real time. 

    If the conflict remains short-lived, the impact on annual profitability may be temporary. But a prolonged period of airspace instability would test the flexibility of the region’s transport infrastructure at a time when aviation is meant to be a central pillar of growth.

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    Underpinning all sectors is the banking system, and the response from regional regulators has been swift. The Central Bank of the UAE (CBUAE) has approved a Financial Institution Resilience Package that aims to both reassure and protect the economy.

    The UAE’s banking sector entered the conflict from a position of strength, with foreign exchange reserves exceeding AED1tn ($272bn) and a capital adequacy ratio of 17%. By allowing banks to tap reserve balances up to 30%, and providing term liquidity facilities in both dirhams and dollars, the CBUAE is signalling that the system remains liquid, capitalised, and ready to support corporate and individual borrowers through temporary classification flexibility.

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    The risk of non-performing loans also looms. S&P suggests that, in a high-stress scenario, total losses across the GCC’s 45 largest banks could reach $37bn, with the logistics, tourism and real estate sectors bearing the brunt. The banking sector is the ultimate backstop. While it is well-placed to navigate the conflict, much will depend on how long the economic impact lasts.

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    For decades, the GCC has positioned itself as a place where capital is safe, taxes are low and the lifestyle is aspirational. The conflict that began on 28 February has undermined that perception of safety. Restoring it will be the key challenge for the coming years.

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