The Gulf Co-operation Council (GCC) banking sector requires close monitoring to contain financial vulnerabilities once the Covid-19 policy support measures are withdrawn, according to an International Monetary Fund (IMF) working paper.
The GCC banking sector has been resilient so far, entering the crisis with strength and supplemented by ongoing Covid-19 policy support, but financial vulnerabilities may emerge, the IMF said in a working paper. The GCC banking systems still appear well-capitalised and resilient against further shocks with generally low-reported NPLs or non-performing loans; although the profitability declined, it said.
However, the Covid-19 policy support, especially loan moratoria and associated risk classification, could obscure deterioration in asset quality, it cautioned. “Given the gradual and uncertain recovery, credit risk is a concern going forward, requiring close monitoring to contain financial vulnerabilities once policy support measures are withdrawn,” the IMF working paper said.
While monetary and financial supporting policies continue to be essential to strengthen the ongoing recovery, it said these policies should be calibrated to the stage of the pandemic.
“The emergence of virus mutations and greater uncertainty about the recovery point to the need for continued policy support measures to maintain the flow of credit to borrowers and contain financial stability risks,” the paper said.
Substantial downside risks to the outlook remain, suggesting that the eventual removal of unprecedented policy support will have to be gradual, tailored to country-specific circumstances, and recalibrated along the way as dictated by the evolution of the recovery, the paper suggested.
The central banks should analyse the use of liquidity lines provided during the pandemic gradually targeting them during the opening phase and winding down liquidity facilities once the recovery is well under way.
“Extending loan moratoria should be data-dependent and increasingly targeted to distressed but viable borrowers, considering the availability of other policy tools to support households and businesses,” it said.
Policymakers need to continue to strike a balance between supporting recovery and mitigating risks to financial stability, it said; adding policymakers should be vigilant of the financial stability risks stemming from high leverage in the post Covid-19 environment and potential challenges to the public finances.
Given the still elevated uncertainty about the path of the pandemic, the scope of support measures could be amended and progressively narrowed to target those who need it most — distressed but viable corporates — such as small and medium enterprises or SMEs and those in high contact-intensive sectors.
The paper said monitoring balance sheet linkages and related vulnerabilities could help avoid financial shocks amplification.
Policymakers should enhance monitoring the evolution of balance sheet exposures over time and, where risks emerge, address underlying imbalances that may cause excessive buildup of debt, it said. “Given banks’ pivotal role in credit intermediation, ensuring the soundness of the domestic banking systems will be crucial for a smooth post crisis recovery,” it said.
In this context, policies would include ensuring sufficient buffers to withstand possible losses and promptly recognising asset impairment related to sectoral reallocations.
Furthermore, ensuring fiscal and external sustainability in the medium term would contain any excessive accumulation of external debt and capital inflows, which in turn could help limiting the build-up of domestic leverage in foreign exchange, the paper said.
Strengthening the borrowers’ insolvency resolution frameworks will facilitate the recovery, the IMF suggested.