The weak economic environment can continue to dampen the financial performance of Islamic banks in Gulf Cooperation Council countries in 2017 and the next, according to S&P Global Ratings.
In its report published on Wednesday, the agency says the end of the commodities super-cycle has sparked a fall in the economic growth and prospects of the GCC region, implying both lower growth opportunities and deteriorating liquidity for its conventional and Islamic banking systems.
“We foresee further declines in GCC banks’ asset quality and profitability indicators in 2017-2018,” said agency Islamic finance head Mohamed Damak. “Still, we think that the banks have built sufficient buffers to make the overall impact on their financial profiles manageable,” he added.
By global and regional standards, the Islamic banks continued to display strong asset quality indicators, profitability, and capitalisation in 2016. The current environment was creating an opportunity for the local regulators to start inching towards a more stringent application of Islamic finance profit and loss-sharing principle. A few attempts in the industry had been made in this direction earlier through the issuance of Tier 1 and Tier 2 Sukuk with loss absorption at the point of non-viability. Such issuances are expected to continue, though slowly, over the next two years, the report said.
The asset quality indicators of GCC Islamic banks remain on a par with those of their conventional counterparts. Both are well entrenched in their local real economies. As the economic cycle turns, asset quality indicators will continue to deteriorate. The weakening that has already occurred was not noticeable in 2016 because – as is typical – banks started to restructure their exposures to adapt to the shift in the economic environment. Therefore, there was an increase in restructured loans in the GCC in 2016, but not a marked increase in nonperforming loans (NPLs) or cost of risk.
Though some market participants maintain that Islamic banks will fare much better than their conventional counterparts due to the asset backing principle inherent to Islamic finance, they will be on equal footing, the report says. Overall, subcontractors, SMEs and expatriate retail exposures will bear the brunt of the turning economic cycle and prominently contribute to the formation of new NPLs.Growth in customer deposits slowed to 6 per cent in 2016, compared with 9 per cent in 2015 for the Islamic banks.