MEED's annual survey of the top 20 banks in the GCC by asset size reveals that despite the difficulties caused by the global financial turmoil, their combined assets grew by 15 per cent last year to $752.6bn, from $654.6bn in 2007.

With three exceptions - Arab Banking Corporation, Gulf International Bank and Gulf Bank - all banks on the list increased their assets in 2008. And in a sign of the underlying strength of the region's 20 largest banks, the same institutions that featured in the list in 2007 are also present this year.

The UAE's Emirates NBD retains its number one spot as the region's largest lender, with its assets (including loans) growing by 11.3 per cent to $76.8bn in 2008. The bank overtook Saudi Arabia's National Commercial Bank in 2007 to become the biggest GCC bank by asset size, following its creation in October 2007 through the merger of National Bank of Dubai and Emirates Bank International.

The 2008 results show that Emirates NBD is more than twice the combined size of the 10 banks in the second half of the table. Saudi Arabia's National Commercial Bank and Samba are second and third, with assets of $59.1bn and $47.7bn respectively.

The Saudi banking sector has arguably been affected less by the global financial turmoil than those of the other GCC countries. The seven Saudi banks that feature in the list this year have either maintained their positions or climbed the rankings.

Slowing growth

While the major GCC banks' results are impressive compared with the money haemorrhaged by the top international banks, their rate of growth has slowed noticeable from recent years, reflecting the problems caused by the global financial crisis.

"Prior to 2008, asset growth of 30-40 per cent was the norm for GCC banks," says Philip Smith, a senior director at ratings agency Fitch Ratings. "Therefore, 15 per cent is quite a big decline from previous years. Early last year, the view being expressed very loudly in the GCC was that we were immune from this international crisis. Of course, that has turned out not to be true."

Indeed, while banks continued to grow their assets aggressively in the first three quarters of 2008, the full impact of the global credit crisis hit GCC financial institutions in the fourth quarter of the year and considerably weighed down their performance, with the top 20 banks reporting a combined fall of $300m in net profit in 2008.

However, the problems generated by the downturn were compounded by what many regard as the GCC's homegrown credit crunch.

"The region's relatively high level of asset growth against the backdrop of global events is less a measure of how little the region was touched by the downturn and more a reflection of excessive asset growth last year, fuelled by 'hot money' [money invested in the Gulf to take advantage of favourable exchange rates]," says Marios Maratheftis, regional head of research at the UK's Standard Chartered Bank in Dubai. "Many banks used capital inflows that were coming into the region for the anticipated GCC currency revaluation to fund their asset growth."

The top 20 banks in the GCC added more than $46bn in new loans in 2008, bringing their total loans outstanding to $359.3bn, up from $312.8bn a year earlier.

"A lot of the banks took the money and lent it out [over the] longer term," says Maratheftis. "So when it left the region, they found themselves with a funding gap, and that is partly why credit growth came to a standstill towards the end of last year."

Indeed, the departure of the 'hot money' in September and October 2008, combined with the full impact of the financial downturn hitting the region in the fourth quarter, resulted in a sharp reduction in loan and asset growth. As a result, banks have been competing for deposits ever since.

Consequently, central banks have implemented a raft of measures such as raising interest rates to attract more deposits into banks so they can resume lending. The latest data from the region's central banks shows that their efforts have been rewarded. The funding gap between loans and deposits for the top 20 GCC banks stood at $31.6bn at the beginning of the year but has now closed to $8.7bn, firm evidence that deposits are growing faster than loans.

Indeed, total UAE bank deposits have increased from $237.3bn in September 2008 to $264.8bn in May 2009. Meanwhile, loan growth has decreased from 52 per cent year-on-year in September 2007 to 21 per cent year-on-year for the same period last year.

The mismatch between the GCC bank's loans and deposits has been improved by the fact that demand for loans has slowed down considerably because activity in the GCC economies has slowed.

According to the Shelter in a Storm report published by Kuwait Financial Centre in March this year, a total of $25.4bn worth of projects were cancelled or postponed in the GCC region in 2008. With projects being cancelled, their sponsors are no longer in need of bank funding.

However, despite this trend, the loan-to-deposit mismatch in the market remains. Banks are reluctant to lend, especially given the uncertainty over the credit quality of borrowers. This was best exemplified in May this year when the Saudi Arabian Monetary Agency (Sama), the central bank, reported that deposits had risen to $36.6bn from $31.5bn in January.

Sama has taken a series of measures since October 2008 to encourage lending, including cutting interest rates five times to 2 per cent and cutting the reverse repo rate - the rate it pays banks to keep their deposits - from 50 basis points to 25. Cutting the reverse repo rate usually encourages banks to reduce deposits with the central bank and so increases the incentive for commercial lending, but banks preferred to place the money with Sama.

However, monetary easing measures introduced by the respective GCC governments have helped to improve short-term funding. For example, in January the UAE central bank lowered its interest rate by 50 basis points to 1 per cent. "Given that the funding gap has narrowed so quickly, I think we will see better liquidity conditions from the fourth quarter onwards," says Maratheftis. "Credit is still tight but it has definitely improved."

Funding scarcity

Meanwhile, international capital markets have shown little sign of recovery, resulting in the ongoing scarcity of mid-to-long-term funding. Any longer-term funding that can be found is still expensive, and with banks bidding for deposits at rates as high as 7.5 per cent, they are not prepared to pay for it.

Industry insiders have also voiced concern over the threat of asset quality deterioration.

"The crucial issue is the extent to which retail and corporate customers get into diffic-ulties this year as a result of the downturn," says Smith. "This could result in higher impairment charges, which not only damages asset quality but could also feed through into banks' profitability and their ability to retain earnings to support their capital."

Typically, asset quality suffers about one year on from when the business cycle turns, which means any such deterioration would be likely to surface in October.

Banks have already reported a 2 per cent decline in their 2008 net profits, from a combined $13.1bn in 2007 to $12.8bn in 2008.

Even Emirates NBD's net profits for 2008 are down about 7 per cent from 2007, at $1.03bn.

"Banks have repriced credit, and deposit rates have come down, which has so far counter-acted the impact of asset deterioration on profitability," says Giyas Gokkent, chief economist and co-head of asset management at National Bank of Abu Dhabi (NBAD). "Obviously, lower asset growth also reflects in profitability, so I am expecting flat profits this year."

Indeed, according to data from the Central Bank of the UAE, asset growth has rapidly slowed since September 2008, when UAE assets totalled $397.6bn, a 37 per cent increase on the same period in 2006. In May they stood at $416.1bn, a 10 per cent increase year on year.

"Similarly, data for various GCC banking systems shows that asset growth has slowed down," says Gokkent. "So I think that single-digit asset growth is realistic for 2009."

Indeed, there is a consensus among analysts that Gulf banks' asset growth will pick up in the second half of the year as the GCC governments' monetary easing and fiscal stimulus packages boost the flow of credit through the banking system.

However, concerns remain that there is insufficient liquidity to spark recovery among GCC banks. Since they rely heavily on lending in the absence of other major investment tools such as trading in securities and bonds, it is expected that the banks' difficulty in attracting deposits, along with a more cautious approach towards credit provision, will combine to stifle growth in lending activity.

With growth of both loans and deposits lower this year because of the global financial turmoil, coupled with the increasing cost of deposits due to tight liquidity, the expected contraction of net money earned from interest paid on loans will be worsened by further losses on bad loans.

Consequently, banks are adopting a prudent strategy for the year ahead. "2009 is the year of good housekeeping for NBAD," says Gokkent. "In practical terms, this means that emphasis on cost consciousness increases, but expansion in business areas of potential is also pursued."

After enjoying seven years of high earnings on the back of the oil boom, the GCC's largest banks will have to temper their expectations for the year ahead.

"Assets will continue to grow this year but at a considerably slower pace than in 2008, which was not a healthy growth rate," says Maratheftis. "2009 will be a year for correcting the excesses of 2008, and a problematic year on the whole."

Amid all the financial uncertainty, what is clear is that GCC banks will be subjected to much more turbulence before their economies settle down for a renewed period of sustained growth.