Under pressure from plunging oil prices, GCC banks face a double whammy of rising interest rates on the one hand, and, on the other, declining government deposits on account of decreasing revenues.
The fall in oil prices has also led to an increase in government borrowing as spending on infrastructure projects continues across the region. The private sector thus looks alienated as the government crowds out lendable funds during a period of increasing short-term interest rates.
This would constrain net interest margins for GCC banks, and subsequently lower profitability, which in turn affects spending on areas such as technology. Stalling adoption of newer facets of banking such as e-commerce and m-commerce could hamper the banks’ ability to tap younger generation customers.
To prevent flight of capital from the Gulf region and to maintain the dollar peg, the GCC governments are under pressure to raise their own interest rates. After the recent increase of 25 basis points (bps) by the US Fed last December, barring Qatar and Oman, central banks in other GCC countries followed the Fed’s lead and raised their own policy rates. This was incorporated in Kuwait (discount rate), UAE (certificates of deposit), Saudi Arabia (reverse repo) and Bahrain (one-week deposit rate).
Oman continued to maintain rates at current levels to stimulate growth. In Qatar, government revenue is more diverse than in its GCC peers, barring the UAE, and so stable growth and expansion of non-oil sectors has led to Qatar’s wait-and-watch approach.
Gulf currencies are pegged to the US dollar, either directly or via a basket of currencies, as in the case of Kuwait. A peg to a currency implies a loss of monetary policy independence, and the follower is obliged to mimic policy movements (rate rises) of the reference currency’s country (US), or else risk capital outflows.
The GCC banking system can keep local currency values low in the short term, but in the medium term currency values need to rise in line with the US dollar. While Oman and Saudi Arabia are facing currency pressures owing to the peg, the peg is likely to continue, although the extent to which they follow the path set out by the US Fed could be dictated by local economic conditions.
A combination of factors has led to the liquidity crunch in GCC banks: low oil prices have led to lower government revenues deposited with the bank and has also led to the scrapping of non-priority projects; governments have also borrowed from banks to fund infrastructure spending, and finally the increase in the cost of capital to the private sector because of a combination of the above factors, along with the increase in interest rates.
Government borrowing could also increase, leading to the issuance of billions of dollars’ worth of bonds in Saudi Arabia. Qatar, Oman and other GCC nations are likely to follow suit, as governments in the region issue paper, both domestically and internationally, to bridge their budget deficits in 2016.
Although, the banks in the region are well capitalised, they may not be able to act as the sole funding avenue for the governments. For instance, Saudi Arabian banks that have about $100 billion in cash, central bank deposits and treasury bills, could only absorb government securities to the tune of $75bn to $100bn without constraining their balance sheets.
With rising borrowing costs, credit growth will simmer down across the region, which will directly affect net interest margins of the banks across the region. GCC banks may not only be forced to charge more for loans, but also become selective on lending to customers.
More creditworthy borrowers would be preferred during a period of low liquidity, which would again affect their bottom line. Sectors such as construction and real estate may not receive as much patronage as they used to, as banks attempt to minimise operational risk. Revenues from hospitality and the tourism industry could also be affected, as the GCC nations may seem pricier, resulting in a fall in tourist traffic. The good news may now be limited only to depositors as local banks offer higher deposit rates to beef up their funding before subsequent rate rises kick in.
The impact of asset quality is expected to be low and contained in the short term, as non-performing assets were subject to a steady decline over the past few years, since the 2009-10 debt crisis, on back of stronger provisions.
While lower oil prices and rising interest rates could renew asset quality pressures, it could be largely managed for the following reasons: the GCC credit cycle is still in its early stages as the banks are yet to revert to their riskier underwriting habits as in the past cycle; historical evidence suggests that the impact of rate increases acts only with a lag, and finally, GCC governments, with their large financial reserves, have the ability to support the banking system, if required. Various measures such as sectoral lending caps and improved underwriting systems have also led to reduced credit risk in the system.
MR Raghu is managing director of Marmore Mena Intelligence, a research house focused on conducting Mena-specific business, economic and capital market research
