Although banks operating in the Arabian Gulf have achieved seemingly material improvements in recent years, they have to date enjoyed only selective, rather than multi-notch, upgrades in their financial strength ratings (FSRs), Moody's Investors Service says in a new Special Comment. The rating uplift has typically been constrained by Moody's concerns about certain risk pockets relating to the rapid growth in lending and the possible build-up of asset bubbles.
Nevertheless, the otherwise favourable Gulf economic and banking environment is reflected in the stable or positive outlooks on all rated banks' FSRs. "Gulf banks have been benefiting from the strong economic cycle underpinned by the substantially increased oil and gas prices. In particular, over the past two to four years, most institutions have been reporting strong business growth and material improvements in their financial performance, which now compares favourably with that of higher-rated institutions in emerging markets," says Mardig Haladjian, a General Manager in Moody's Financial Institutions Group and author of the report. "Nonetheless, Moody's maintains a cautious approach as we believe that the surge in economic and banking activity has also led to a build-up of new risks, which are largely of a systemic nature."
Firstly, Moody's is concerned, based on the experience of other markets, that the rapid growth in lending to corporates, consumers and small- and medium-sized enterprises may hide both individual and systemic risks. The currently impressive loan quality indicators do not, in the rating agency's view, fully capture the normalised loss content of such loans, which could become more apparent when the books mature and repayment ability is tested under adverse economic conditions.
Secondly, Gulf banks' direct and indirect exposure to local capital markets has not only inflated their business volumes and earning levels, but also exposed them to a possible asset bubble, especially in Saudi Arabia and Qatar. In this context, Moody's main concern relates to lending secured by equity holdings and indirect exposure to the capital markets in the form of personal and corporate loans that were diverted to the capital markets. "We have not been able to obtain dependable data to quantify banks' indirect exposures and have thus maintained a cautious stance," says Haladjian, adding that "the full extent of the indirect impact of the recent capital markets correction may appear in banks' financial results with a time lag, possibly towards the end of 2006".
Another development of concern to the rating agency is the increasing level of exposure to the construction, contracting and property markets, especially given the short-term funding profiles of most Gulf banks, with a possible reversal in real estate values potentially placing some institutions under financial strain.
Looking forward, Moody's believes that the strengthened economic conditions are likely to prevail over the medium term and to continue to benefit Gulf banks, while the banks' franchises should continue to grow and deepen as their risk management practices are reinforced. "In our view, the markets will enter a phase of more moderate growth and excessive risks in the capital markets will be reduced, while necessary changes will also take place at the level of individual banks including a lengthening of funding profiles to match the longer-term lending practices. As these changes occur, Moody's expects that more, though still selective, rating upgrades in the Arabian Gulf will occur,"
Haladjian observes in the Special Comment -- entitled "Arabian Gulf Banking: Stable to Positive Rating Outlooks Amid Concerns over Rapid Loan Growth and Possible Asset Bubbles".
