The fundamental credit outlook for the Jordanian financial institutions is stable for the time being, reflecting the good operating environment and the banks' solid financial fundamentals, but also their exposure to the struggling real estate and volatile local equity markets, the large concentration of banks relative to the small economy and tightening international credit conditions, says Moody's Investors Service in its new Banking System Outlook on Jordan.
Moody's stable outlook for the Jordanian banking system expresses the rating agency's view on the likely future direction of fundamental credit conditions in the industry over the next 12 to 18 months. It does not represent a projection of rating upgrades versus downgrades. "Jordan is a small and concentrated economy that, however, demonstrates resilience and offers limited but improving opportunities for the banking sector. The system is dominated by the country's largest bank, Arab Bank, which accounts for more than half of total banking assets, while there are also a relatively large number of small banks," explains Nondas Nicolaides, a Moody's Senior Vice President and author of the report. On the whole, the banks have modest risk profiles as they tend to offer relatively plain vanilla products. However, Moody's cautions that they are susceptible to high levels of systemic risk stemming from exposure to the Palestinian territories and spill-over effects from political turbulence in neighbouring countries.
Jordanian banks have displayed strong profitability metrics over the past few years, benefiting from the booming operating environment, but going forward Moody's believes that bank profits could be affected by higher credit costs. Moreover, the decline in the stock exchange could have a number of adverse effects: notably, lower trading income, lower brokerage fees and mark-to-market losses.
Moody's notes that, although Jordanian banks do not seem to experience liquidity pressures, the Central Bank of Jordan (CBJ), in Q3 2008, reversed previous actions aimed at containing excess liquidity, reducing the reserve requirement to 9% from 10%. Additionally, the CBJ did not issue any certificates of deposits during September and October 2008, to allow liquidity to remain in the system. The reference rate has been cut by only 50 basis points as the CBJ remains concerned about inflationary pressure.
The country's banks benefit from low operational costs due to their smaller scale of operations, but Moody's expects efficiency levels to weaken as banks report lower profitability in the challenging economic environment. Meanwhile, capitalisation levels are healthy, providing a comfortable cushion for growth and for the absorption of possible loan losses. Nevertheless, the rating agency expects them to be adversely affected by reduced earnings capacity and higher credit costs.
Furthermore, downward mark-to-market adjustments due to declines in the value of securities in late 2008 are expected to have a negative impact.
The asset quality of Jordanian banks has been on an improving trend, due mainly to a benign economy and the expansion in retail lending. However, Moody's expects delinquencies to rise in line with the weakening domestic and regional economies and as portfolios go though a full credit cycle. Going forward, as the cycle gradually turns, the robustness of the banks' respective credit policies and risk management during the boom years will be tested, and they will either reap the benefits or face the consequences in the form of increased credit charges and declining asset quality.
"The recent action taken by the government to guarantee all deposits in the system of any amount confirms Moody's view that the regulator, in collaboration with the Ministry of Finance, would support any bank in case of need as the political consequences of a failed bank would be too great. That said, the rating agency notes the special case of the largest bank, Arab Bank, the asset size of which is a multiple of Jordan's GDP.
Although Moody's recognises the high willingness to support this bank, it questions the country's ability to do so," says Mr. Nicolaides.
