Nationalisation may haunt global banks in 2009

There might still be further bad news for banks this year as worsening global economic prospects cause uncertainty over their credit write-offs. Gulf banks might not go unscathed, as rating agencies have decided to cut ratings for a range of regional banks and other public-sector institutions. Moody's Investors Service has revised its outlook for four UAE banks, lowering its view from stable to negative for Abu Dhabi Commercial Bank, First Gulf Bank and Dubai Islamic Bank, and from positive to stable for Dubai Bank. Not to be outdone, Fitch Ratings lowered its ratings on 15 banks in the GCC, which surprisingly included seven banks in Saudi Arabia. Saudi banks had seemed to escape relatively unscathed during the global financial turmoil, underpinned by massive government spending commitments. According to Fitch, however, the outlook for GCC banks has become less favourable as regional financial institutions will not be able to fully insulate themselves from the global credit crises. It is not only financial institutions that are being downgraded, but also seemingly solid public-sector entities as Fitch also reduced its long-term debt rating to "A plus" from "AA minus" for Dubai Holdings and Dubai Electricity and Water. The key factor, whether for Gulf or other financial markets, lies in the speed of economic recovery and whether banks can overcome tighter credit markets. Some analysts are predicting that this year will witness another round of capital raising by major banks, whether from private or government sources. The reason is obvious. After rebuilding their balance sheets last year following hefty bad-debt write-downs, some banks, especially in the UK and Europe, face worsening domestic economic outlooks that might force unanticipated loan impairments from businesses and consumers. Companies short of cash due to lower consumer spending and unable to meet debt obligations, and individuals out of jobs unable to meet personal loan and mortgage payments, are both a disastrous recipe for balance-sheet impairment. According to Credit Suisse analysts, another £60 billion (Dh324.77bn) might be needed to contain balance-sheet impairment by major UK banks such as Royal Bank of Scotland (RBS), the combined Lloyds Banking Group, and even Barclays. Such a possibility happening was underlined by a trading update from the Halifax Bank of Scotland (HBOS) which became part of Lloyds Banking Group. According to the HBOS report, impairments from both commercial and residential property rose significantly, with even grimmer news due to rising UK unemployment. Independent economic analysts predict that the British economy might shrink between 2.4 per cent and 2.6 per cent this year, the first such reduction in GDP since 1946. Such a dire economic situation might call for drastic action to ensure bank solvency and lending. The governor of the Bank of England has publicly stated that getting UK bank lending moving was the most important task for fighting recession and, ominously, has not ruled out full nationalisation of the UK banking sector. A worsening of banks' balance sheets could pressure the UK and other continental European governments to move quickly to enforce a further round of capital raising. The question is simple: from where and from whom will the new capital be raised? The failure of RBS's share offer last November, despite a deep discount, illustrated that the only recourse was a government bailout, leaving UK taxpayers the owners of nearly 60 per cent of Britain's second-biggest bank. Others, noting the lack of depth from domestic institutional investors, turned to international "white knights" to bail them out, and Barclays opted for this route through investments by Gulf sovereign wealth funds (SWFs). Recent losses by SWFs might make them more reluctant to pump in extra cash, or it might be done on more onerous lending terms, leading to domestic investor revolt and possible government intervention. Full nationalisation might then become a reality for all major banks around the world, unless banks can head this off by turning to alternative financial tools. One such tool could be old-fashioned debt-for-equity swaps, where banks swap customers' commercial debt into equity in the business. This might involve banks assuming hands-on management guidance in the businesses in which they hold equity. This also raises a rather peculiar situation, where banks, in return for government bailouts, might have to accept some form of government intervention in how they are managed. Debt-equity participation is not new and continental banks, notably in Germany, have practised this for many years, taking long-term strategic partnership views of the businesses in which they participate. Basically, this is a variation of venture capital. Islamic finance calls this musharakah and is one of the purest forms of profit-risk-sharing financing participation. Who knows, the evolving global financial crises might yet force many to reconsider basic financing tools again. In the long term, and if balance sheets deteriorate, there might be fewer independent banks around the world come the end of this year. Dr Mohamed A Ramady, a former banker, is a visiting associate professor in the finance and economics department at King Fahd -University of Petroleum and -Minerals in Dhahran, Saudi Arabia