The region’s banks were on the brink of the worst financial crisis in decades in late 2008. With meltdown a very real possibility, the region’s governments had to act fast and inject billions of dollars into its banks to ensure that the financial system weathered the global economic crisis.

The boldest action was taken by the UAE, which so far has put a total of AED140bn ($38bn) into the banking system. In Qatar the government has provided banks with more than QR30bn ($8.7bn) of financial support. Saudi Arabia has provided SR37.5bn ($10bn) in direct liquidity to the banking sector through the Saudi Arabian Monetary Agency (Sama), the central bank, and additional deposits have also come from government ministries.

The massive injection of liquidity may have averted a crisis, but economic problems remain. Now that the money has been put into the banking system, the focus has shifted to getting the banks to start lending that money and stimulate growth. Today, central banks throughout the region are aware of the problem and are putting pressure on finance houses to start making new loans, telling them that the money they have received in bailouts should not be kept to themselves.

Conservative attitudes

“The central bank [of Qatar] has made it clear in discussions with all the banks that it was not just handing out money for them to hold on to. They need to go out and start lending it because the national economy desperately needs it,” says one banker in Doha.

Qatar is not alone. Industry sources across the GCC tell similar stories of policymakers trying to apply pressure to finance houses to get money out of the banks and into the economy.

Despite their efforts, they have made little progress so far. “Right now, lending new money is not something any bank is considering,” says a head of syndications at a UAE-based bank.

Banks remain wary of making new loans to the private sector, and instead are parking billions of dollars in the safest place they can find – back with the central banks. The problem is most acute in Saudi Arabia where 11 local banks had SR149bn on deposit with Sama at the end of 2009, compared with SR55.4bn at the end of October 2008.

“There are two sides to this issue,” says Giyas Gokkent, economist at  National Bank of Abu Dhabi. “Loan demand has dried up because the slower economy is holding businesses back from investment spending, but there is also a very conservative attitude in the banking sector now.”

Bankers say it is not just the drop in demand that has led to fewer cheques being written by banks. They say that internal credit committees have become increasingly sceptical of making new loans in the region.

Banks don’t want further exposure to a market where there have been defaults at two of Saudi Arabia’s biggest family conglomerates – Saad Group and AH al-Gosaibi & Brothers Company – and several Islamic bonds (sukuk) issued from the region. Adding to their caution is the situation in Dubai, where government-owned conglomerate Dubai World is trying to restructure about $22bn of debt.

“There is very little appetite to lend to anyone but the strongest businesses with a proven track record, or where there is guaranteed government support,” says one Dubai-based banker.

The scepticism is so strong there are now sectors of the economy banks will not make new loans to.

“Sectors such as real estate, hospitality, tourism and manufacturing are just off limits now,” says one head of corporate banking. “I would only look at making short-term loans to already cash-generative businesses.”

The banks’ conservatism is a radical change to the exuberant credit growth of the past few years. Between 2005 and 2009, the total loans and advances from the Gulf banking sector more than doubled. Annual credit growth was frequently in double digits, and peaked at nearly 40 per cent in the UAE in 2008. It has since dropped dramatically in 2009, falling to a growth of 2.4 per cent in the UAE, 6.1 per cent in Kuwait, and shrinking by 0.3 per cent in Saudi Arabia.

The downward trend is expected to continue. “The region’s private sector will remain subdued as it restructures and deleverages,” says Henry Azzam, chief executive officer for the Middle East and North Africa at Deutsche Bank. “Tighter lending will continue to effect the retail and corporate sectors.”

In an effort to get banks lending to the private sector again, the Central Bank of Kuwait cut interest rates in February, echoing moves taken by Sama in June 2009 in a bid to mobilise the huge deposits placed with it by local banks.

But when compared with the years of virtually unregulated credit growth, the central bank’s efforts are destined to failure, because anything less than the previous loose credit conditions will feel like the banks are not releasing enough funds.

Conservative attitudes

Regulators are also wary. They fear the quality of asset held by banks will deteriorate if they go back to loan growth of the levels seen in previous years. They are also aware that, after cutting rates and trying to put pressure on banks to start lending again, there is little more they can do.

“As the economy starts to recover then banks will start lending again,” says Gokkent. “The problem at the moment is that there is too much uncertainty weighing on the banks and deterring them from lending.”

Saudi Arabia has been able to mitigate the drop in the banks’ risk appetite through actions by the Public Investment Fund (PIF), which is essentially an arm of the Finance Ministry. Several measures were announced in January 2009 to allow the PIF to make a greater contribution to financing projects in the kingdom, and take up some of the slack left by local and international banks.

“Without state funds, many crucial expansion projects would be held up for months waiting for lenders to slacken strict lending policy,” says John Sfakianakis, chief economist at Banque Saudi Fransi. “Despite very low interest rates in Saudi Arabia and elsewhere, a pick-up in lending has not happened with as much strength as many policymakers had hoped.”

Sfakianakis adds that the problem could get worse as a continued reluctance in the private sector to offer new funding to businesses could hit the pace of the economic recovery this year. He says he expects credit growth to pick up in Saudi Arabia in the second half of the year. However, if it does not reach the 8 per cent growth he is forecasting he will have to revise down his 3.9 per cent gross domestic product (GDP) growth forecast.

Disappointing growth could be a real prospect as the debt problems in the region continue to weigh on sentiment in banks. Qatari banks are being forced to reschedule loans to the troubled local real estate sector, Dubai also faces a long challenge dealing with the debts of government-owned companies, and the $20bn defaults at two Saudi firms means almost every bank in the region will be busy addressing problem loans for years to come.

Limited growth could force more governments to follow Saudi Arabia’s move to give the government a more prominent role in providing financing to private sector projects.

As governments and regulators face up to their mistakes, analysts hope credit growth will not be allowed to get out of control again in the future. “There was a belief that credit growth of such high levels was justified after years of very little credit expansion,” says Gokkent. He adds policymakers now realise that those rates where unsustainable, but they still face the difficulty of knowing when to intervene in the markets to cool their economies.

If that lesson is not learned, the region faces the worrying prospect of another bubble developing when banks do finally begin to unlock the huge liquidity they are sitting on.

CAPTION - Liquidity: Finance ministries and central banks across the GCC face a challenge in pursuading banks to overcome their caution and lend money to local firms