Gulf states should carry out regular stress testing of banks' asset quality as part of assessing the stability of the financial sector, the IMF says. Governments should periodically review assets to gauge any holes in bank balance sheets rather than pre-emptively pumping emergency funding into the banking system, as the UAE and Qatar did during the global financial crisis, said a report from the Washington-based fund.
"GCC countries should conduct periodic reviews of banks' asset quality, in addition to stress testing, to determine whether the level of capital support is sufficient," said the report by the IMF's Middle East and Central Asia department. "Stress tests could also be used to guide the authorities' decisions on bank asset purchases, if necessary." Bahrain, Qatar, Kuwait and Saudi Arabia began stress testing of banks after the financial crisis, the report noted.
Analysts view stress tests as an important tool in assessing banks' financial stability and in helping to restore confidence in the UAE's banking system. Banks have been bruised by a combination of exposure to bad loans linked to the property market and write-downs on investments. The US was one of the first countries to adopt stress tests after the financial crisis last year, with the results showing that 10 of the nation's 19 largest banks needed a total of about US$75 billion (Dh275.47bn) in additional capital to cover losses in case the recession worsened.
The tests usually assess whether a bank has enough capital to cushion against losses and to ensure lenders are paid. Kuwait's government last year asked the country's banks to conduct their own stress tests semi-annually. Sofia el Boury, an analyst at Shuaa Capital, said UAE banks probably were already conducting similar tests internally. It was important, however, that any official assessment of UAE banks be carried out by the Central Bank or an independent authority established by the Government, said Janany Vamadeva, a banking analyst at HC Securities in Dubai. "What matters is the spirit with which any tests are carried out, otherwise there is no point in just doing the tests and coming up with a conclusion that everything is perfect," Ms Vamadeva said.
Any recapitalisation of banks should involve private sector money as far as possible, said the IMF report. Injections of government capital should be carried out with transparency and reversed as soon as market conditions allow, it said. Starting in late 2008, the UAE made available a total of Dh120bn to shore up its banks after the financial crisis. The report also recommended improving the supervisory and monitoring framework of the financial system, especially for larger banks with exposure to similar risks, such as property.
Although the Central Bank has limited banks' exposure to property, analysts say this has not been very effective. The existing 20 per cent limit applies only to commercial loans and does not include mortgages or personal loans that may have been used to buy property. Governments needed to establish mandatory procedures for banks to follow in financial emergencies, the report said. Such procedures would ensure that banks addressed emerging problems promptly, it said.
"If banks fail to comply with these measures, a quick resolution would be important to avoid disruption to the rest of the banking system." No GCC state had yet developed a so-called prompt corrective action framework, the report said. The UAE plans to amend its banking law to increase Central Bank powers, while Kuwait has passed a financial stability law. In the first major test of that law, The Investment Dar, a Kuwaiti finance house that owns the car maker Aston Martin, announced on Saturday it was using the regulations to protect itself from creditors who had declined to back its debt restructuring.