In the first half of 2013, the profitability of Qatar’s banks rose by 8.9 per cent to $2.4bn. Income has accelerated so rapidly in the tiny peninsula that profit in the six months to July 2013 is almost equal to the full-year amount in 2009, when the lenders collectively earned $2.7bn.

The continued growth and strength of the banks has made the country home to the region’s largest lender by assets, Qatar National Bank (QNB), as well as the third-largest banking system in the GCC, behind Saudi Arabia and the UAE. By the end of 2012, the combined assets of the locally listed banks totalled $197.7bn, up more than 18 per cent compared with the end of 2011.

Asset quality

The challenge for the Qatari banking system and regulators is not where growth will come from, but managing that growth and ensuring rapid asset booking does not lead to a drop in asset quality. So far, asset quality has remained good. Non-performing loans are expected to remain at about 1.7 per cent of total loans during 2013. There are no indications that this is about to change.

Although there are 18 licensed banks in Qatar, the financial sector is extremely concentrated. The top five lenders account for almost 80 per cent of assets and QNB alone accounts for 45.2 per cent of total assets. Of the eight banks listed on the Qatar Exchange, QNB makes up 51 per cent of total assets, a proportion that has been increasing in recent years. In 2008, its market share was 44 per cent.

In terms of profit, QNB’s market share has grown even further. In 2008, it accounted for 37 per cent of the profit made by listed banks in Qatar. By 2012, that figure had risen to 52 per cent. Foreign banks with licences to operate in Qatar, including the likes of the UK’s HSBC and Standard Chartered, France’s BNP Paribas, and the UAE’s Mashreq Bank, make up only about 5 per cent of total bank assets.

QNB’s status as a state-controlled entity enables it to capitalise on government-related deals, while its size and financial resources have given it the ability to embark on an aggressive international expansion plan. Most recently that involved the acquisition of Egypt’s National Societe Generale Bank from France’s Societe Generale. The $2.6bn deal gives QNB a significant foothold in Egypt, which, despite the current political turmoil, is considered one of the region’s most attractive markets to enter due to its large under-banked population.

QNB is aiming to raise the contribution of its international operations to 40 per cent of profits and 45 per cent of assets by the end of 2017, from less than 25 per cent currently. As part of this plan, it has acquired 49 per cent of Bank of Commerce & Development in Libya, and has increased its stake in Mansour Bank in Iraq to 51 per cent. QNB also has a significant stake in Commercial Bank International in the UAE.

Other local lenders such as Commercial Bank of Qatar and Doha Bank are also pursuing international expansion strategies. Newer entrants such as Barwa Bank are carving out niches for themselves in Islamic finance and structuring sharia-compliant products, helping them to do business beyond their domestic markets.

There are now signs that the composition of banking growth in the country is changing. A year ago the government was driving loan growth. In August 2012, state lending had more than doubled compared with a year earlier. By September 2013, that growth had dropped to just 10 per cent. At the same time, private sector credit growth has picked up, rising to 20 per cent in September, compared with 16 per cent at the same time last year.

Bankers in the country say this is reflective of the government increasingly funding new infrastructure projects from its own balance sheet, as it looks to accelerate the pace of project delivery. Several large schemes, including the award of about $8.5bn of contracts for the $21bn Doha Metro, are being directly funded by the state.

Regulating spending

With so much development work planned, Doha has become increasingly concerned about borrowing by government-related entities getting out of control. In late 2013, the Finance Ministry told state-owned firms that any new borrowing had to be approved by the government. State energy firm Qatar Petroleum (QP) and its subsidiaries are excluded from this ruling.

Qatar plans to spend more than $125bn between 2011 and 2016 on construction and energy projects. The Qatar National Development Strategy outlines spending of QR130bn ($35.7bn) through its state-linked companies, mostly through Barwa Bank and Qatari Diar. QP and its subsidiaries are expected to spend about QR88bn, with the government investing an additional $67bn on transport and infrastructure schemes.

By ensuring the Finance Ministry is aware of any borrowing at state-related firms, Doha is trying to ensure a debt problem does not result from the rapid development and investment spending in the country.

In July 2013, the central bank issued a consultation paper to local lenders on the implementation of new international banking regulations known as Basel III. The rules were drawn up in the wake of the 2009 financial crisis and are intended to strengthen banks by making them maintain bigger financial buffers to cover potential losses.

One upshot of this is that lending is expected to slow as banks prepare to comply with the new regulations. Increasingly, longer-term lending will be pushed into the bond and sukuk (Islamic bond) markets, away from banks. Developing the debt market has become a key policy objective of the Qatari authorities, who want to see more international bond issuance and the development of a local currency bond market, with a liquid secondary market traded through the Qatar Exchange.

Many opportunities

Lending is hardly expected to dry up, however. Moody’s Investors Service of the US says it expects credit growth to be about 20-25 per cent during 2013 and into 2014. According to the ratings agency, the government’s infrastructure investment programme will continue to provide a lot of lending opportunities. This will mainly be based around the bonding and working capital required by contractors.

One area where growth remains strong is for Qatar’s Islamic banks. After a directive from the central bank banning conventional lenders from offering sharia-compliant products from the end of 2011, the Islamic banks have managed to capitalise on having the sector to themselves.

“Assuming that [Qatar’s] Islamic banks grow by an average of 15 per cent over the next five years, which is significantly lower than the previous five-year average of 35 per cent, we could see [their] asset base exceeding $100bn by 2017,” says Timucin Engin, credit analyst at the US’ Standard & Poor’s. At the end of 2012, the combined assets of the country’s sharia-compliant lenders was $54bn.

The challenge for Qatar’s banks is ensuring the rapid international expansion is properly managed and that domestic lending, which in the past has been focused on the cyclical real estate and construction sectors, does not spiral out of control.

Government support

Doha has shown it is highly supportive of domestic banks, previously injecting equity and buying the real estate and securities portfolios of local lenders in the wake of the financial crisis, allowing them to avoid accounting for the fall in the value of those assets. The government is already looking at prudential measures to ensure banks are protected as it looks at a massive investment programme, and is encouraging the private sector to take on a larger role in the economy.

With ample opportunity for credit growth, mostly on the back of government-related contracts, the outlook for Qatar’s banks is positive. Competition among lenders leading to margin compression is one key area of concern, however. The imposition of interest rate caps on retail loans could exacerbate this trend. The ability of banks to handle the rapid expansion in their asset books is another potential issue, but as the government has shown itself to be interventionist in the past with previous lender bailouts, it is not yet too much of a worry.

Despite having such a small domestic market, Qatar’s banks are poised to continue growing strongly.