Sharia-compliant lenders in the Gulf Cooperation Council (GCC) are expected to show resilience over the next two years after weathering tough market conditions in 2018, S&P Global Ratings has said.
“In 2018, GCC Islamic banks expanded slower than conventional peers for the first time in five years,” said S&P Global Ratings Global Head of Islamic Finance, Mohamed Damak.
“However, the growth difference was a mere 1 percent, which explains why we think the conventional and Islamic banks in our sample will see similar growth patterns in 2019-2020,” he added.
The growth forecast for Islamic banks for 2019-2020 is the same as what the rating agency is estimating for conventional lenders in the region.
The mid-single-digit growth for both types of banks predicted by S&P is based on several factors, including “our forecast of muted GCC economic growth over this period, despite some benefit from government spending and strategic initiatives such as national transformation plans … and Dubai Expo 2020”, Damak wrote in the report.
GCC Islamic banks’ asset-quality indicators stabilised in 2018, with the nonperforming financing ratio averaging 3.1 percent of total financings for the banks, the report said.
Provisions more than covered these exposures with a coverage ratio of 167.7 percent on the same date. This was an improvement over 2017, thanks to the adoption of International Financial Reporting Standards (IFRS) 9.
Also, last year, Islamic banks’ asset quality indicators did not deteriorate as did those of conventional banks, which saw their nonperforming loan (NPL) ratio increase to 3.1 percent on average from 2.7 percent at the end of 2017.
“We attribute this development to the clean-up and write-off operations of some Islamic banks in our sample, rather than a genuine improvement in asset quality. We think that Islamic banks’ asset quality should be similar, if not slightly weaker than that of conventional banks in the GCC,” the report said.
“This is because both bank types are comparable, with businesses primarily comprising the collection of deposits and extending of finance to the real economy in their countries,” it added.
Furthermore, the report said, Islamic banks tend to have higher exposure to the real estate sector due to the asset-backing principle inherent to Islamic finance.
“We also note that Islamic banks cannot charge late payment fees, unless they are donated to charities at the end of the exercise, meaning that clients tend to prioritize payments on conventional rather than Islamic exposures.”
However, with the transition to IFRS9/FAS 30, Islamic and conventional banks will even more closely align. At end-2018, the average Stage 2 exposure for Islamic banks in our sample reached 10 percent of total exposure.
It is worth mentioning that this number is just indicative as it includes an estimation of Stage 2 exposure for Kuwaiti Islamic banks, which are yet to publish their numbers.
The amount of Stage 2 financing to total financing was 11.2 percent at end-2018 excluding our estimates for Kuwait.
“We expect problematic assets to stabilize at about 15% of total assets in the next 12-24 months, with some transitions between Stage 2 and Stage 3 given the pressure on the real estate and contracting sector in some countries,” the report said.
Another trend is the significant increase in Islamic banks’ coverage ratios at end-2018, coupled with a stable cost of risk (excluding outliers) that is lower than conventional banks.
Banks have taken the opportunity of IFRS 9 transition to set aside as many provisions as they can, given that the opening impact is charged to equity and not to income.
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