Banks chase growth in regional markets

Published in MEED, 31 December 2018

Rising oil prices over the past two years have led to improved liquidity conditions for banks in the Middle East, but is that relatively benign environment coming to an end?

In late 2018, oil prices fell sharply, dropping below $60 a barrel for the first time since October 2017. While they may yet recover, it was a reminder of how many Middle East economies are closely tied to the fortunes of oil prices, despite the myriad diversification plans.

Any extended period of weak energy prices will filter through to subdued conditions for the region’s banks. Coupled with the undimmed political turmoil around the region, it could mean 2019 will be a challenging year for lenders.

On the other hand, there are some reasons for optimism. Many governments are pushing ahead with large capital spending programmes, which will bolster growth prospects and consumer confidence.

Credit ratings agency Standard & Poor’s estimates the funding needs of GCC sovereigns between 2018 and 2021 at about $300bn. While a third of that is expected to be sourced from national savings, most of the money will be raised in the debt markets, providing a steady stream of income and work for banks.

One country benefitting from state-backed spending is the UAE, not least with preparations for Expo 2020 in Dubai. Analysts suggest the outlook for the country’s banks is positive. The promise of rising oil production as well as robust infrastructure spending should contribute to higher demand for credit. Rising interest rates should also boost banks’ net interest margins and contribute to slightly higher profits. 

An improving economy should also reduce the amount of problem loans, notwithstanding the ongoing weakness in the local real estate sector.

“Loan performance will progressively stabilise,” says Mik Kabeya, an analyst at Moody’s Investors Service. “The recovering economy and the resilience of large borrowers will offset ongoing problem loan formation among small and mid-sized businesses and individual borrowers.”

The situation in Saudi Arabia is harder to judge. The fallout from the unlawful killing of Jamal Khashoggi and the unpredictable policies of Crown Prince Mohammed bin Salman mean the environment is more volatile than it has been for some time. Foreign direct investment has been weak in recent years, denting the prospects for the economy and, by extension, its banking sector.

The government has redoubled its commitment to capital spending, however, with King Salman bin Abdulaziz al-Saud inaugurating billions of dollars’ worth of projects in trips around the kingdom in late 2018.

While lending activity in Saudi Arabia is not growing as quickly as it was in 2015 and 2016, it has been picking up momentum since mid-2017 and deposit growth has also started to show signs of life. Riyadh-based Jadwa Investment says bank deposits were up 2.1 per cent in September, while loans to the private sector rose by 1.4 per cent – the largest increase since January 2017.

Lending activity was particularly strong for the mining and financial services sectors in the third quarter, where it rose by 33 per cent and 15 per cent year-on-year respectively. However, there was a contraction in lending to commerce, construction and transport borrowers.

The picture among other Gulf countries is mixed. In Kuwait, robust consumer spending alongside low inflation and the government’s expansionary fiscal stance offer banks an attractive environment. In Bahrain, however, the fiscal balance programme announced in October 2018 is likely to suppress economic activity.

In Oman, the economic outlook is improving, but the banking sector may find it hard to shrug off the recent slowdown. “We are expecting a softening in loan performance despite the upturn in the economy, as the sluggish economic growth of last year weighs on borrowers,” says Kabeya. Indeed, in some ways the situation in Oman is the reverse of what is happening in stronger Gulf economies. Kabeya suggests bank profits may “soften” as rising interest rates drive up the cost of finance. Moody’s is also predicting a rise in loan-loss provisions in the year ahead.

In the other Gulf economies, there are also plenty of concerning signs. Iranian banks are set to feel the pinch of international sanctions in the coming year, while some Iraqi banks will continue to struggle with severe undercapitalisation.

In the Levant, key markets continue to struggle from a mixture of deep-seated economic weakness and political turmoil. In Jordan, the economy was given a boost in early October when Kuwait, the UAE and Saudi Arabia agreed to provide $2.5bn in aid, including a $1.1bn deposit in the Central Bank of Jordan. Whether that will feed into greater activity in the wider economy remains to be seen. The performance of local banks was mixed in 2018, with the Housing Bank for Trade & Finance posting a fall in profits for the first half, while Arab Bank saw its profits rise.

In Lebanon, which also suffers from the effects of the civil war in neighbouring Syria, the country’s banks have managed to continue growing in 2018, albeit at a slower rate than before. Beirut-based Bank Audi reports that deposit growth across the country’s banking sector in the first three quarters of the year was 3.1 per cent.

In other parts of the region, there are also mixed fortunes. In Morocco, the government issued its first Islamic sovereign bond (sukuk) in early October. The MD1.1bn ($116m) debt could herald further sukuk issuance around Africa – Moody’s is predicting at least $1bn-worth of sukuk over the next 18 months. That could prove attractive for Moroccan banks, which have already been profiting from their expansion into sub-Saharan Africa.

Their profits are expected to rise further in the coming year, particularly for those institutions most heavily exposed to cross-border trade and international markets. In a context of low interest rates and modest credit growth inside Morocco, the largest banks with more profitable pan-African activities such as Attijariwafa and BMCE Bank will be best placed, in contrast to the likes of Credit du Maroc, whose domestic focus will bring lower returns, says Moody’s.

The other key North African market is Egypt, where the gradually improving economy is leading to a better outlook for lenders. GDP growth is expected to reach 5.5 per cent in 2019, according to the IMF. With higher private sector investment, continued state spending on infrastructure projects and rising export earnings, there should be greater demand for borrowing and other bank services.

One perennial question is whether the region will see further banking consolidation in the year ahead. A number of deals are in the pipeline, including the $5bn merger in Saudi Arabia between Sabb and Alawwal, which is scheduled to be wrapped up in the first half of 2019. It remains to be seen if there is much appetite for other deals between local rivals – recent history suggests large mergers do not happen often. 

However, there may be greater enthusiasm for cross-border transactions, such as Emirates NBD’s bid for a stake in Turkey’s Denizbank, which is inching forward. For some banks, expanding overseas may prove to be the surest route to growth.