The Covid-19 pandemic and the collapse of oil prices will test the earnings of Gulf-based lenders but overall they could absorb up to a $36bn shock (in normalised losses) before starting to deplete their capital base, according to Standard and Poor’s (S&P), an international credit rating agency.
“The rated banks’ profitability and provision cushions built over past years will help them navigate the current rough waters,” S&P said in its report.
On average and factoring in the additional cushion, the GCC (gulf Cooperation Council) rated banks can absorb 2.7 times the normalised losses level without touching their capital base, which would correspond to a substantial level of stress, it said, referring to the absolute level of $36bn shock absorbing capacity.
Most rated GCC banks have relatively strong profitability and a conservative approach to calculating and setting aside loan-loss provisions, it said, adding some Kuwaiti banks take a conservative approach as part of local regulatory requirements to set aside general provisions for all their lending portfolios.
The rating agency acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak with some government authorities estimating the pandemic will peak about midyear.
“Our current assumption is that Covid-19 containment and the resumption of nonoil activity will occur by third-quarter 2020,” it said.
The strong structural profitability of the rated Gulf banks was owing to a large proportion of non-interest bearing deposits, which ensures hefty margins; higher non-interest earnings due to sustainable fee income as fees and commissions; and “very strong” efficiency in terms of average cost-to-income ratio.
Although anticipating banks’ profitability to deteriorate in 2020, due to the dual shock of pandemic and the decline in oil prices; S&P said “however, we believe banks will continue to benefit from their relatively low cost base and potential additional cost-saving initiatives from 2021.”
On sufficient capacity to absorb normalised losses; it said at year-end 2019, all rated GCC banks had the capacity to cover normalised losses using their net operating income.
“This remains valid even if we factor in the impact of a 100 basis point (bps) drop in interest rates as reported by banks,” it added.
The US Federal Reserve reduced interest rates by 150 bps and this cut was fully or partially mirrored by central banks in the GCC region as for most of them, there is a peg between their currencies and the US dollar, it said, reasoning for the capture of the potential impact of a 100-bps decline in interest rates.
Investment revenue is also likely to support the bottom line of some banks this year as the drop in interest rates increases the market value of these instruments and banks decide to offload them, thereby realising gains, S&P said.
