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.