Tight monetary policy and liquidity squeeze to weigh on Gulf banks: Study

Muscat: Headwinds from significant fiscal consolidation coupled with the repercussions of a tighter monetary policy and liquidity squeeze are two of the main challenges that banks in the Middle East and North Africa (Mena) region will have to grapple with going forward, according to a new research report entitled ‘Mena Financials-Selective Opportunities’ released by Arqaam Capital.
The report expects revenue growth for Gulf banks to be fairly limited as higher assets yields are being offset by a substantial increase in the cost of liquidity, with banks and governments having to source funding outside their home markets at wider spreads.
Additionally, some Gulf banks, particularly in Qatar, have to bring back substantial negative dollar positions to below 25 per cent of shareholders’ equity, protecting the banks from a potential depeg.
“With credit growth slowing down, limited possibilities to boost net interest margins and a market reduction in loan origination fees, banks are focusing on costs, though this is unlikely to provide a substantial cushion if the downturn were to worsen. Having said that, most banks have reported excellent quality of earnings with very rich build-up in general provisions. We estimate understatements in reported earnings of 10-25 per centover the last few years,” said Jaap Meijer, managing director, research.
“Under the stress scenario where we model for a 50 basis points increase in additions to loan loss reserves, commercial banks will continue to report double digit return on equity (RoE), thanks to solid pre-provision profits, mainly reflecting fairly high NIMs by international standards and low operating costs. Encouragingly, most valuations have started to reflect this, despite the relief rally year- to-date of about 30 per cent,” Jaap added
The report also highlights that the reported non-performing loans (NPL) evolution is understating the underlying deterioration in asset quality. This is due to NPL write-offs and using some of the over-provisioning. As economies further slowdown and lending standards further tighten, NPL formation should further accelerate.
“We see only limited possibilities to cushion profits and loss statement from the worsening asset quality due to three reasons, namely the implementation of IFRS 9 rules, which forces banks to provision on expected losses rather than incurred losses, the relatively limited over-provisioning of existing NPLs given overall low NPL levels and the stress in the SME sector which is likely to start affecting larger corporates.”
“We see ample opportunities for banks in the region with strong and sustainable growth in economic profit and risk adjusted return on capital generation. These banks will be better positioned to tap liquidity and to some extent capital, which should allow them to capture more market share as other banks may slam on the brakes. We also see deep value in some stocks with price dislocation and in certain banks where restructuring could unlock substantial shareholder value. In addition, regulatory reforms can also present great opportunities as is the case for certain insurance companies in Saudi Arabia helped by a huge privatisation drive and crackdown on poor underwriting and pricing practices,” Jaap concluded.