Outlook 2021: Challenging outlook offers varied picture for GCC banks

As we are heading towards the end of a whirlwind year, GCC banks still have a long way to go to recover from the shockwaves of the Covid-19 pandemic.

Our base case scenario is that a Covid-19 vaccine will be widely available by around mid-2021 and that the oil price will stabilise at an average of $50 per barrel. We also foresee that the GCC economies will expand by an average of 2.4 per cent in 2021, compared with a contraction of 5.6 per cent in 2020.

However, despite these glimmers of light, we anticipate that a few banks will suffer losses this year and the next, and that the overall GCC banks’ profitability will take a hit in 2020 and 2021.

Rated banks in the GCC face an uphill struggle in the next 18 months due to the protracted nature of the economic recovery and the expected gradual withdrawal of regulatory forbearance measures. We expect that lending growth will remain muted, except for Saudi Arabia, where mortgages have been expanding rapidly on the back of a government initiative to increase home ownership in the country. The cost of risk will continue increasing as problematic asset recognition accelerates in the absence of additional support measures.

We also expect interest revenues will remain below their historical levels due to the US Federal Reserve’s policy of lower-for-longer interest rates. This will affect GCC banks’ profitability and will continue declining, with a few reporting losses because of their exposure to high-risk asset classes – such as small-to-midsize enterprises (SMEs) and credit cards – or in few instances, because of under-provisioning. This will push banks’ management teams to look more carefully at costs, try to leverage opportunities related to fintech, and reduce the number of physical branches.

In this environment, GCC banks’ funding profiles and capitalisation provide some support for their creditworthiness. Funding remains dominated by core and stable deposits, with a limited contribution from external funding. Capital is also strong, both quantitatively and qualitatively, and protects the banks from stronger-than-expected shocks.

As of today, 65 per cent of S&P Global Ratings’ outlooks on GCC bank ratings are stable and 30 per cent are negative. Only one rated GCC bank has a positive outlook on the back of an upcoming merger.

A second wave of mergers and acquisitions (M&A) could start when the full impact of the weaker operating environment on banks becomes apparent. In the first wave, we have seen that M&A was mainly driven by shareholders’ desire to reorganise their assets. The second wave, however, will be more opportunistic and driven mainly by economic rationale. The operating environment might push some banks to find a stronger shareholder or to join forces with other banks to enhance their resilience. For example, this might involve consolidation across the different GCC countries or the different emirates in the UAE.

The GCC governments’ measures to help corporates and individuals navigate the challenging environment have taken various forms. Some governments have opted to reduce taxes and levies. Others have asked the banks to extend additional subsidised loans to their clients to maintain employment and avoid the destruction of productive capacity.

In terms of the different GCC banking systems, we think that the UAE, Oman, and Bahrain will take longer to recover than the rest. We expect the fiscally constrained Omani and Bahraini governments’ to be less able to support their economies than elsewhere in the region.

In the UAE, particularly Dubai, the simultaneous shocks to several sectors of the economy and the federal structure of the country are likely to have a greater impact on banks’ asset quality, and potentially, make them selective in extending support. The question of how to allocate resources among the smaller and richer emirates might arise at some stage. That said, we continue to believe that in case of need, the federal authorities will intervene and support systemically important banks in the UAE.

In Saudi Arabia, we expect the cost of risk to normalise gradually from 2022, but we expect that Saudi banks’ profitability will remain lower than before the pandemic due to lower-for-longer interest rates.

For Kuwait, we think that the provisions banks have accumulated over the past few years will help them navigate this challenging time. However, given the government’s current liquidity constraints, support to the economy is likely to be relatively muted, which could exacerbate pressure on the banking system.

The Covid-19 pandemic and lower oil price could mark the start of a new era for banks in the GCC. Beyond our two-year outlook horizon, we expect banks’ reduced profitability to be structural due to lower-for-longer interest rates, weaker lending growth, and the significant proportion of noninterest-bearing deposits in banks’ funding profiles.

We also think that, in the next few years, GCC banks might start to import capital more aggressively as local funding sources prove insufficient, which is already the case for Qatar. This would add to the pressure on banks’ profitability. It remains to be seen to what extent banks could compensate for that pressure by consolidating or leveraging fintech solutions to cut costs.

Dr. Mohamed Damak is the senior director and global head of Islamic Finance at S&P Global Ratings