x Abu Dhabi, UAEMonday 22 January 2018

This time, let's keep the banking rules in place

After the global financial crisis, regional monetary authorities focused their attention on loopholes and failures of domestic banking systems and their practices.

After the global financial crisis, regional monetary authorities focused their attention on loopholes and failures of domestic banking systems and their practices.

Most GCC financial regulators toughened their provisioning requirements, sometimes forcing banks to strengthen their capitalisation ratios.

New credit policies and procedures have been formulated requiring banks to improve their customer knowledge and profiling, as well as adhering to more cautious lending rules. Central bank auditors are now stimulated to roll up their sleeves and gear up their oversight of asset quality in the system, looking for cracks and early alerts for potentially large problems.

This is a good exercise anyway. Strict provisioning requirements and proper assessment of credit portfolios is good practice and preparation for Basel III, the result of which is obviously positive for banks' long-term fundamentals.

In the meantime, banks have retrenched significantly from the credit market and the continued sluggishness of bank credit could become counter-productive.

As the credit market is constrained from the supply side, corporate organisations and households dependent on bank financing must look for alternative sources of financing or cut back their consumption and investment plans. The absence of wholesale funding creates a drag on the economic recovery.

As a matter of fact, the tightening of credit policies in the GCC and the MENA region had a major impact on sharp credit slowdown, and was driven by (or has led to) a slowdown in deposits and the unavailability of foreign funding. This risk aversion was dented by some specific regional problems -the failure of a large Saudi conglomerate, the Dubai World issues, and severe losses incurred by the banking system in Kuwait.

The property market is also likely to remain weak and could suffer extended losses. Although each market is different when it comes to property, prices are not expected to recover this year and the drop could extend as far as 2012. This could push up non-performing loans and force banks into additional provisions.

The credit market recovery is timid. As economic activity has recovered, uncertainty has been reduced and credit demand is showing signs of improvement. But the revival of credit growth will require two inter-related conditions: banking balance sheets becoming healthier; and a better macroeconomic outlook, which in turn could influence both funding sources (borrowings and deposits).

Policymakers should step in to expand long-term financing options primarily for banks (but also for the corporate sector) and thereby reduce reliance on deposits and on banking credit for financing. Boosting debt and mezzanine financing, particularly after the recent recapitalisation of the banking system, could trigger credit revival.

Consequently, we can safely presume that banks with more funding availability and higher net margin growth will be able to perform their financial intermediation function and should have stronger lending growth.

Moreover, banks that have higher cost to income, possibly because of higher wages, a larger branch network or more credit officers, might have higher marginal lending. The lending of banks in oil-exporting countries should be more sensitive to swings in oil prices.

Banks with strong balance sheets could look for specialised financing schemes targeting dynamic segments of the economy, such as small and medium-sized enterprises (SMEs). Special financing schemes that target SMEs have been excellent stimulus for the economy, as they encourage creativity and provide solutions for unemployment by encouraging entrepreneurship. Those enterprises have problems accessing long-term funding and often need financial advice.

Looking at it from a different angle, and to give credit where credit is due, the conventional monetary policy of cutting interest rates has achieved some effectiveness in dampening the slowdown. It has encouraged borrowers to seek more financing at a lower cost of debt and lenders to look for better yields to enhance their returns.

This was also helped by the global low-yield environment leading to foreign funding becoming more widely available than last year, as witnessed by the success of the latest regional bond issues.

But lingering risk aversion, along with a lack of transparency, will prove more difficult to overcome. The system had to deal with unprecedented turmoil in the region, since the magnitude of the credit crisis in GCC markets was never so intense in the past.

It has also raised uncertainties in relation to the development model the region has adopted for the past decade. Nevertheless, local governments, helped by resilient oil prices, have succeeded in regaining market confidence and signs of an economic recovery are clearly identifiable across the region.

It is now up to individual banks to ensure they remain part of this recovery, as any future problem will be isolated and contained within a limited number of institutions. The current slowdown phase may also include a possible shift within credit culture in the region, as banks de-emphasise name lending in favour of a more conventional arm's-length approach to conducting business.

In oil-exporting countries, supply and demand should respond favourably to oil prices.


Walid Hayeck is the head of asset management at The National Investor