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Arab Banks Maintain Stability Despite Lower Energy Prices

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Powered by financial institutions in the six countries of the Gulf Cooperation Council (GCC) and Egypt, the Arab banking sector is poised for stability this year even as the drop in oil prices makes a dent in the coffers of many government treasuries.

The same insularity that helped many banks in the region weather the global financial crisis should guide them through the shift in energy prices, analysts say, as the ample sovereign wealth funds filled during flusher times help cushion any accompanying dips in government revenues. “There is implicit government support of local banks,” says Ozgur Kan, a managing director at Berkeley Research Group. He adds that Arab banks have always enjoyed the support of oil money and their countries’ ruling elite. Based in New York City, Kan is a leader in the company’s credit risk analytics practice.

The drop in energy prices could even open new lending opportunities for these financial institutions if their respective Arab governments accelerate existing plans to diversify their economies away from oil and gas and their banks follow suit. In addition to intensifying consumer banking services to tech-savvy customers with smartphones and tablets, Arab banks are eyeing expanded lending opportunities to retailers, shopping mall owners, manufacturing companies, construction firms and small- and mid-size enterprises.

Analysts agree that sustained public sector commitment to spending on infrastructure projects, along with economic growth, will help provide a stable outlook for banks in the six GCC countries: Saudi Arabia, Kuwait, the United Arab Emirates, Qatar, Bahrain and Oman.

“We expect the impact of lower oil prices on the banking industry to be indirect as a result of slower economic growth and a potential reduction in government spending,” says Munir Shahin, director, Europe, the Middle East and Africa financials equity research, at Bank of America Merrill Lynch Global Research in Dubai. “Government spending on infrastructure and economic development has been a major source of capex spending in the region, driving credit growth in the corporate banking space.”

Saudis Push Infrastructure
In Saudi Arabia, for example, the government is investing substantially in infrastructure projects, including the Riyadh metro and several new industrial complexes, which aim to diversify its economy away from oil. Last year, oil generated about 87 percent of the Saudi government’s revenues, according to Moody’s Investors Service. Yet the Saudi buffers include considerable domestic financial assets as well as foreign exchange reserves, held by the Saudi Arabian Monetary Agency, which equal about 100 percent of the country’s gross domestic product.

Analysts at Moody’s expect that an uptick in consumer and business activity, particularly in the United Arab Emirates (UAE) and Saudi Arabia, will help the Gulf banks’ expand their loans by 10 percent in 2015. Strong public spending, particularly in Abu Dhabi—the wealthiest of the seven emirates that make up the UAE—and the diversified private sector in Dubai would help the Emirates’ economy grow by about 3 percent this year.

Fitch Ratings has maintained a stable rating on all banks in the Gulf Cooperation Council nations and its analysts believe problem loans at the banks have peaked. That means impairment charges should continue to drop, which would in turn help boost profits.

More growth in Islamic finance
IsIamic finance offers another growth area for Arab banks and the six GCC countries harbor one of the world’s largest Islamic banking markets. Islamic banks have captured nearly 25 percent of the overall GCC banking system and Standard & Poor’s Ratings Services expects that portion to move closer to 30 percent over the next five to six years. The trend is supported by an emerging generation of young Muslims seeking banking services for the first time and more Muslims of every age deciding to invest their wealth in sharia-compliant instruments.

Yet the Islamic banks’ gains will be tempered by the structural advantages held by the conventional banks. Standard & Poor’s notes that the balance sheet growth of Islamic banks slowed to 12 percent in 2013. While still ahead of the 11 percent growth of conventional banks, it was a drop from the 17.4 percent growth rate posted in 2012. The assets of conventional banks increased by just 10.7 percent in 2012.

Islamic banks also are well-positioned to tap into the increasing popularity of the sukuk market, which reached $116.4 billion in 2014, up from $111.3 billion in 2013. With help from regulatory changes, these financial instruments are attracting interest from markets outside their core markets in the Gulf and Malaysia. The United Kingdom, Hong Kong and Luxembourg are among the new markets viewing sukuk financial instruments—the Islamic equivalent of bonds—as an avenue for broadening their investor bases.

Islamic finance—and the sukuk market—also could begin making inroads in North African countries such as Egypt, Tunisia and Morocco, according to Standard & Poor’s, if the Islamic banking products are priced competitively. Tunisia and Egypt began implementing new regulatory frameworks for sukuk issuance in late 2013 and in January 2014, the Moroccan cabinet approved the legal foundation for Islamic banks. Tempered by lower oil prices and upticks in U.S. Federal Reserve interest rates, the sukuk market’s total issuance may slow in 2015 but should still pass the $100 billion mark.

Strength in Egyptian banking
Outside the Gulf region, Egypt—with a diversified economy—is expected to grow by 4.5 percent in the fiscal year ending in June, and this growth will undoubtedly help the nation’s financial institutions.

After a long-term process of consolidation, privatization, greater foreign ownership and recapitalization that began in the early 2000s, Egypt’s banking sector is stronger and in better shape. Led by the Central Bank of Egypt, the process has created a stable, liquid and well-capitalized banking industry that is poised for growth, according to Hisham Ezz Al Arab, chairman and managing director of Commercial International Bank in Cairo.

Many new opportunities exist for the banking sector, including opportunities in retailing, mortgages and loans to small- and mid-size enterprises, Ezz Al Arab says. Another promising growth area is being generated by the government’s commitment to attract local and foreign investment through public-private partnership projects, he adds.

“Despite the political and economic challenges of the past few years, Egypt’s fundamentals remain solid,” says Ezz Al Arab, adding that the economy’s diversity has contributed to its resilience and produced a business growth story. “Promising investment opportunities are still to be found in Egypt.”

Commercial International Bank ‘s consolidated net income for full year 2014 was EGP 3.74 billion, up 24 percent over 2013. The bank’s gross loans grew by 17 percent during the year to reach EGP 53.1 billion while deposits increased by 26 percent to reach 122 EGP billion.

Shahin says new regulations have helped improve the banking sector’s risk profile. In the United Arab Emirates, for example, new regulation requiring minimum down payments on retail mortgages, as well as tighter caps on large exposures, means the banks are less exposed to asset quality deterioration in the event of a slowdown. Saudi consumer protection regulation in retail banking, effective late last year, aims to improve transparency and protect the Saudi consumer, he added.

Kan believes banks throughout the Arab banking region are still trying to catch up with international banking standards and regulations, whether capitalization requirements, the bank stress tests faced by banks in the United States and Europe, or the United States Foreign Corrupt Practices Act of 1977. “They’re still working to catch up with best practices,” Kan adds.

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