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After an epoch-changing 2020, it may be rash to make predictions about the year ahead. Middle Eastern lenders that were looking ahead to a period of stability this time last year soon found themselves at the centre of an economic crisis that continues to work its way through the system.
There may be light at the end of the tunnel, with Covid-19 vaccine optimism fuelling markets across the globe. And yet, banks are still facing a day of reckoning when various monetary support measures are eased and the full impact of the pandemic reveals itself on balance sheets and income statements.
What is clear is that the twin challenges of the pandemic and protracted low oil prices have corroded banks’ profitability through a mixture of slower credit growth, lower net interest margins (NIMs) and higher provisioning to account for non-performing loans (NPLs).
The Covid-induced gloom should not distract from the positives revealed in the past 12 months. In general, most banks have proved they had sufficient firepower to withstand the sizeable drop in economic activity. This is not to suggest the pain was felt equally across the region.
As Junaid Ansari, vice-president of investment strategy and research at Kuwait-based Kamco Invest says, the GCC has not seen business failures to the extent seen in some of the other emerging markets – a situation that largely reflects the active and very strong support from the government to local businesses.
The stronger banks in the region – those from Saudi Arabia, the UAE and Kuwait – enjoyed much more active support from their governments, as they were better placed to do so.
“Taking elements like the loan moratorium and the reduced interest rates, that was much more elaborate for the stronger countries as compared to countries that were already under pressure due to economic woes,” says Ansari.
In the Gulf at least, most lenders boast solid funding profiles and robust capital buffers that should keep them active in 2021. If you add in the substantial support measures governments and central banks across the region have extended, there is sufficient ballast to enable them to continue lending to private sectors that will be tentatively looking to revive.
“One of the key reasons for the extraordinary support from the government was that banks provide capital to the economically important SMEs [small and medium enterprises] and MSMEs [micro, small and medium enterprises], [which are] the biggest providers of employment in the region,” says Ansari.
“GCC governments were very clear in their strategy to deal with an already high unemployment rate as they cannot afford to let it spike to an uncontrollable level. The reforms in terms of reduced regulatory capital and continued lending to key sectors helped the economy in recovering from the Covid-19 pandemic.”
The loan-to-deposit ratios of GCC lenders are among the lowest in the world, reflecting unutilised lending capacity and underutilised funds. This could prove useful in the near term as governments look towards private sector participation in the development process.
At the same time, Middle East and North African (Mena) banks have not been able to escape the impact of the crisis on their profits. Net income contracted markedly in the second and third quarters of 2020, with lower NIMs reflecting the lower fund rate from the US Federal Reserve. According to Kamco, average NIMs for GCC banks continued to slide during the third quarter of 2020, reaching one of the lowest recorded quarterly levels at 2.98 per cent.
The hit on margins – on top of the higher provision charges for NPLs – has translated into lower net income. The profit contraction has been stark for some of the biggest banking markets.
In the UAE, the four largest UAE banks reported a combined drop in net profit of 36 per cent to $3.4bn for the first half of 2020.
Mena banks will not be expecting to engineer a speedy return to pre-crisis period lending growth levels in 2021, with risk appetites remaining generally subdued.
According to the US’ S&P, only Saudi Arabia, where mortgages have been expanding rapidly on the back of a government initiative to increase home ownership, will see a boost in lending.
Much will depend on how quickly the region’s economy revives on the back of positive vaccine news.
“If the vaccine development happens sometime early [in 2021], then we will see banking sector growth, with lending at a higher pace in the following quarters,” says Ansari.
Before banks get carried away on the vaccine optimism, however, there is a need to recognise the long road ahead.
According to Redmond Ramsdale, head of Middle East bank ratings at the US’ Fitch Ratings, the starting point for Middle East banks is that the operating environment remains challenging for 2021.
“What we’ve seen so far is a lot of pressure on profitability,” he says. “Bank metrics have been hit by lower interest rates and subdued business volumes, but most significantly by higher loan impairment charges.”
As IMF regional director Jihad Azour noted in October 2020, the pandemic may inflict deeper, more persistent economic scarring than previous recessions in the region. He said the crisis has heightened corporate default and credit risks for Mena banks, with potential losses that could amount to $190 trillion, or 5 per cent of GDP.
If unaddressed, these developments may threaten financial stability.
The shocks of low oil prices and the pandemic have put pressure on banks and that will continue, vaccine or not.
“The true asset quality picture won’t emerge until the loan deferral programmes roll off and regulatory flexibility for banks to recognise loans ceases. We have also seen an increase in loan restructuring, and this is not reflected in the stage 3 loan numbers,” says Ramsdale, referring to the classification category of a loan where the financial asset is credit-impaired – in stage 2, the credit risk is regarded to have increased significantly.
“Problem loans can be seen as a combination of stage 2 and stage 3 loans. These reflect pressures in the real estate market due to oversupply and problems in the retail, hospitality, transport and aviation sectors. Adding stage 2 and 3 loans together, you get some high ratios and that [speaks for] the potential for asset quality deterioration,” he notes.
Yet despite the doom and gloom, analysts do not expect asset quality to deteriorate materially.
“Ratios are going to deteriorate, so we might see GCC stage 3 ratios up by 150 basis points by the end of 2021. But this is still adequate so long as liquidity remains solid, and that is our expectation in the Gulf region at least,” adds Ramsdale.
Payment holidays are being extended in most countries, for instance to the end of the first half of 2021 in the UAE, effectively extending the time when problems will be recognised. Regulatory forbearance measures have been extended and that reflects both the scale of the problem and the time it will take to deal with it.
One thing that can be forecast with a relatively high degree of certainty is that Mena banks will be taking a much closer look at cost discipline in 2021.
The focus on costs could reinforce consolidation efforts. Although big-ticket mergers may be unlikely in the near term, there is scope for the better-funded banks to pick up some distressed assets.
Future merger and acquisition moves will likely be outward-looking rather than within countries. For example, the bigger Gulf players could be looking to the likes of Egypt and Lebanon for potential offerings. Some Egyptian assets held by Lebanese banks could emerge as likely candidates for acquisition – especially given the domestic pressures facing Beirut-headquartered banks.
No one could have anticipated that Mena banks would find themselves facing 2021 in this way. There is still more pain to come, but there is at least a view that better days are around the corner, even if 2020’s scarring will not heal quickly.
Help on hand for regional banks
A mixture of loan payment deferrals, liquidity injections and regulatory forbearance measures provided often life-saving support to Middle East and North African (Mena) banks in 2020, and much of this will continue through 2021.
The government response came largely in the form of monetary instruments, channelled through the commercial lenders.
The measures cushioned much of the blow dealt by the Covid-19 pandemic and low oil prices, giving banks more leeway to extend credit. Some of the help given was substantial in size. Saudi Arabia, for example, injected $13.3bn into its banking system.
According to estimates from the OECD, 3.4 per cent of liquidity – more than $47bn – was activated by central banks across the region in the first weeks of the crisis.
For example, Bank of Algeria reduced the minimum reserve ratio for banks from 8 per cent to 6 per cent alongside easing solvency and liquidity ratios.
Some central banks extracted a price for their assistance, however. Bank of Morocco requested banks to withhold dividend payments so that they would have sufficient funds to face the financial impact of the crisis.
Egypt’s central bank implemented several preferential and low-interest lending initiatives as well as loan guarantees targeting the most affected sectors. The Central Bank of Jordan injected $705m into the economy by reducing the compulsory reserves of commercial banks, allowed lenders to postpone loan repayments in affected sectors and expanded the coverage of guarantees on loans to small and medium enterprises (SMEs), including new credit facilities for the tourism sector.
Saudi Arabian Monetary Authority provided SR100bn ($27bn) to banks so that they would defer loan repayments to the end of 2020 and restructure loans without charges to support businesses and individuals affected by the crisis.
The UAE central bank provided AED256bn ($27.2bn) to enable banks to continue lending to the economy, including allowing loan repayment deferrals, while lowering the reserve requirements for banks and providing zero-interest rate collateralised loans to banks to support SMEs.
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