The GCC Banking Sector: Topography and Analysis
Author: Ms. May Y Khamis, Abdullah Al-Hassan1, and Nada Oulidi
  • 1 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund

Contributor Notes

Authors’ E-Mail Addresses: aalhassan@imf.org; mkhamis@imf.org; noulidi@imf.org
Publication Date:
01 Apr 2010
eISBN:
9781451982619
Language:
English
Keywords:
WP; banking sector; bank; asset; Bahrain; GCC bank
Download PDF (511.2 KB)

In this paper, we analyze the evolution of the Gulf Cooperation Council (GCC) banking sectors in the six member countries including ownership, concentration, cross-border linkages, balance sheet exposures and risks, recent trends in credit growth, and financial soundness. We identify risks to the banking sector's financial stability in the context of the current global crisis and their mitigating factors.

Abstract

In this paper, we analyze the evolution of the Gulf Cooperation Council (GCC) banking sectors in the six member countries including ownership, concentration, cross-border linkages, balance sheet exposures and risks, recent trends in credit growth, and financial soundness. We identify risks to the banking sector's financial stability in the context of the current global crisis and their mitigating factors.

I. Introduction

The economies of the country members of the Gulf Cooperation Council (GCC)1 share a number of commonalities. All GCC countries are large oil exporters with fixed exchange rate regimes,2 which exposes them to the vagaries of international oil prices. The similarities in economic structure imply common sources of strengths and vulnerabilities of their financial systems. The existing literature is, however, devoid of analyses or regional comparisons of GCC countries’ financial systems.

As analysis of GCC banking sectors is essential in gauging sources of strengths and vulnerabilities, and understanding how these systems could be affected with changing economic conditions. In this paper, we examine GCC banking sectors’ balance sheet exposures, funding sources, shareholders and capital base structures, and financial soundness. We show that the financial systems in the region are dominated by the banking sector, which exhibits a number of common structural characteristics across countries. These have supported to a large extent GCC banks’ resilience to the financial crisis. First, the predominance of domestic banks across the region minimized direct cross-border spillovers through the ownership channel within GCC and from international banks. Second, the high share of the traditional banking book in banks’ on- and off-balance sheets limited losses from exposures to structured products and derivatives to a few isolated cases. Third, the banking sectors in the GCC countries were buttressed by high profits and capital buffers in the run-up to the 2008-09 global recession and international financial crisis.

However, the GCC banking systems had some vulnerabilities that were revealed by the recent global crisis and the impact it had on the economies of the GCC countries. Among those are increased reliance on external financing, and high exposures to the real estate and construction sectors and equity prices. During the 2003–08 oil price boom, procyclical government spending, abundant banking sector liquidity, and bullish consumer and investor sentiments spurred non-oil real sector and rapid credit growth with associated build-up of domestic imbalances (e.g., asset price bubbles). While credit growth was essentially funded by a relatively stable domestic deposit base, more volatile external funding became increasingly important. The 2008–09 global recession put an end to the boom by diminishing oil revenues, reversing short-term capital inflows to the GCC region, and straining the rollover of private sector external debt.

The remainder of this paper is organized as follow. Section I describes the structure of the financial sector, including cross-border ownership within the GCC. Section II analyses the balance sheet of the banking sector including recent trends in credit growth and its contributing factors. Section III examines the funding sources for banks and the importance of external funding in view of the current drought in international capital markets. Section IV examines the loan portfolio exposures and the resulting credit risk. Section V analyzes the financial soundness of the banking sector with regard to capitalization, earnings quality and sustainability, asset quality and concentration, and liquidity, and Section VI concludes with policy lessons.

II. Structure of the GCC Financial System

The financial sector in the GCC is generally dominated by the banking sector, which is relatively concentrated with a few domestic players dominating the market (Box 1, and Table 1).3 Islamic banks have grown in recent years to become a prominent source of financial intermediation in the Gulf countries, controlling on average 24 percent of the region’s banking system assets. In all six countries, the largest five banks are domestic and account for 50–80 percent of total banking sector assets.

Table 1.

GCC: Total Banking Sector Assets, 2002–08

(In percent of GDP)

article image
Sources: IFS; and authors’ estimates.

The increase in 2007 for Bahrain is due to the fact that some wholesale banks were re-licensed to retail banks.

Nonbank financial institutions (NBFIs) have limited presence in the GCC, with some exceptions. Investment funds have been growing rapidly in several countries, although they tend to remain largely focused on domestic equity and real estate.4 Most mutual investment funds are bank-owned; they are present, although on a limited basis, in Bahrain, Saudi Arabia, and the U.A.E. Kuwait has 95 Investment companies (ICs) with total assets under management of more than 100 percent of GDP at end-2008, of which, 42 percent is proprietary.5 Their relatively large asset size and increasing reliance on the banking sector for financing has raised their systemic risk and possible spillover effects on the banking sector. Investment banks in Bahrain are fewer, but larger.

Highlights of the GCC Financial Sector

The following are the main highlights of the structure of the financial sector in the individual GCC countries.

Bahrain. The retail banking sector is the largest in the region, with assets amounting to close to 260 percent of GDP at end-2008. Together with the U.A.E., Bahrain’s retail banking sector is the least concentrated among the GCC systems. The three largest retail banks (Bank of Bahrain and Kuwait, National Bank of Bahrain, and Ahli United Bank) constitute 41 percent of the total banking sector’s assets. Bahrain also has a vibrant wholesale banking sector1—the largest of which is Arab Bank Corporation—which provides off-shore, investment banking, and project finance services to the rest of the region. The financial sector altogether contributes about one-third of the country’s GDP and employs around 3 percent of its workforce, with total assets at around 1200 percent of GDP. In view of its linkages with global financial markets, the wholesale banking sector has been strongly affected by the global crisis. In addition to the banking sector, Bahrain is home to a number of investment funds with assets under management close to 80 percent of GDP.

Kuwait. The banking sector is highly concentrated with the two largest banks (National Bank of Kuwait and Kuwait Finance House) accounting for half of the banks’ total assets. In addition to the banking sector, there are 95 Investment companies (ICs) with total assets (both on- and off-balance sheet) of around 102 percent of GDP—around 42 percent of which is on account of proprietary trading. This sector has been strongly affected by tight global liquidity conditions and falling asset prices.

Oman. The banking system is the smallest in the region with a share of 66 percent of GDP. As a result, some of the largest government projects are directly financed by foreign banks. The banking sector is highly concentrated with the largest two banks (Bank Muscat and the National Bank of Oman) controlling more than 55 percent of the sector’s assets.

Qatar. The banking system in Qatar is the third largest after Bahrain and the U.A.E., with assets around 94 percent of GDP at end-2008. The sector is highly concentrated with the three largest local banks (Qatar National Bank, Commercial Bank of Qatar, and Doha Bank) accounting for close to 70 percent of total assets. The entry of foreign banks under the Qatar Financial Center has increased competition, but local banks still have well-established franchises in domestic business. Foreign banks are essentially engaged in financing large infrastructure projects and investment banking. In addition to banks, there are three specialized government-owned banks operating mainly in developmental and housing projects, in addition to six finance and leasing companies, but these have a marginal share of financial sector assets.

Saudi Arabia. The banking sector is relatively small, with assets at around 68 percent of GDP at end-2008, The sector is only moderately concentrated with the three largest banks (National Commercial Bank, Samba Financial Group, and Al Rajhi Bank) accounting for 45 percent of total assets. Public ownership (including quasi government) is fairly extensive in four banks and reaches 80 percent in the largest bank, the National Commercial Bank. There are five sizable specialized credit institutions with asset size close to half that of the banking sector. These provide interest free loans for public policy purposes. There are also three autonomous government institutions (the Pension Fund, the General Organization for Social Insurance, and the Saudi Fund for Development) that dominate the primary market for government securities. The rest of the nonbank financial institutions (NBFIs) account for a marginal share of the total financial system’s assets.

U.A.E. The U.A.E. has the second largest banking sector in the GCC after Bahrain, with total assets accounting for over 140 percent of GDP. The banking system is the least concentrated and the three largest banks (National Bank of Abu Dhabi, Emirates Bank International, and Abu Dhabi Commercial Bank) account for 32 percent of total assets. Bank ownership is still predominantly held by the government. In addition to banks, the financial sector of the U.A.E. includes two important Islamic mortgage finance companies, with combined lending amounting to around 16 percent of banks’ officially reported real estate lending and 3 percent of banks’ private sector credit.The two companies are being restructured by a federal committee after the Government announced in November 2008 that they were to be merged. The authorities are currently considering the possibility of converting the two companies to a bank, with the ability to obtain funding through deposit taking. The two companies have been highly dependent on short-term funds from the domestic banking sector to finance their long-term lending operations.

GCC: Concentration of the Banking System, 2007

(as percent of total banking sector assets)

article image
Sources: Country authorities; Moody’s; and authors’ estimates.
1/ Wholesale banks are prohibited from accepting retail deposits (both domestic and foreign) and are subject to minimum loan limits to the domestic economy. Loan limits do not apply to interbank loans or to investments in locally-incorporated banks. Minimum domestic loan sizes and deposits are $27 million and $100,000 million, respectively. Wholesale banks include branches of global banks, banks from the Middle East and South Asia, and locally-incorporated banks (domestically owned and subsidiaries of foreign banks).

Nonbank finance companies are scarce, and are most important in the U.A.E., although the two largest companies, now in restructuring, had lending worth only about 3 percent of the banking sector’s loans. The insurance sector remains small and is focused on property/casualty risks. Contractual savings are underdeveloped and dominated by public pension systems, which are mainly defined benefit, “pay-as-you-go” schemes. They contribute little to the accumulation of long-term resources for investment. For example, pension fund assets amounted to 3.2 percent of GDP in Saudi Arabia (end-2007), 2.7 percent in U.A.E. (end-2007), and 20.5 percent in Bahrain (end-2006).

Stock market capitalization has grown strongly in recent years. GCC market capitalization leapt from $117 billion (29 percent of GDP) in 2003 to $1.1 trillion (177 percent of GDP) in 2005, but fell back to $650 billion (73 percent of GDP) by mid-2009. GCC markets generally lack institutional investors whose long-term horizons help dampen volatility. Local debt markets are underdeveloped, particularly as governments drew down outstanding debt in recent years. However, GCC issuers boosted the use of sukuk until mid-2008 when sukuk issuance worldwide grew from around $5 billion per year in 2001–04 to $32 billion in 2007, before falling to $15 billion in 2008, most of it dollar-denominated by GCC entities.

The ownership structure of banks6

The banking sector is largely domestically owned. This reflects entry barriers and licensing restrictions for foreign banks, including GCC banks. Except for Bahrain, all GCC countries have limits on foreign ownership: Oman (35 percent), Kuwait and Qatar (49 percent), Saudi Arabia (40 percent for non-GCC nationals and 60 percent for GCC nationals), and U.A.E. (40 percent). Therefore, the cross-border presence of GCC banks and other foreign banks is limited and is mostly in the form of branches, in many cases as single branches. However, foreign bank presence in Bahrain and the U.A.E. is important, at 57 and 21 percent of total assets, respectively. Market shares of foreign banks by total assets in the rest of the GCC are 2 percent in Saudi Arabia, 12 percent in Oman, 10 percent in Qatar, and 10 percent in Kuwait.

The domestic banking sector in the GCC (i.e. banks that are majority owned by domestic shareholders) continues to have significant public and quasi public sector ownership, but its extent varies considerably, ranging between 13 percent in Kuwait and over 52 percent in the U.A.E. (Table 2, and Appendix III).7 Oman and Saudi Arabia have a relatively high public sector ownership (30 percent and 35 percent, respectively), although the majority of this is attributed to quasi government ownership. The U.A.E.’s domestic banking system stands out with almost half of the domestic sector’s assets owned by the public sector, a significant amount of which is attributed to direct ownership by the Government (41.5 percent) and the Royal family (10.3 percent). Contrary to common perceptions, except in the U.A.E., royal family ownership in the GCC is almost nonexistent.

Table 2.

GCC: Ownership Structure of the Domestic Banking System, end-2007 1/

(In percent of total assets)

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Sources: Bank’s annual reports; and authors’ calculations.

The domestic banking system refers to banks that have domestic majority ownership.

Quasi government includes public pension funds and social security.

In view of the above, direct cross-border linkages within the GCC and also with other foreign jurisdictions through cross-border ownership are relatively low, with some exceptions. As noted above, the U.A.E. and Bahrain have important foreign bank presence in the banking sector, and Bahrain and Oman have sizeable joint ventures in the domestic banking system with foreign investors, mostly from the GCC. Joint ventures in the domestic banking sector in Saudi Arabia are small, mostly by non-GCC investors (around 13 percent of the domestic sector’s assets), and are negligible in Kuwait and the U.A.E.

III. Recent Trends in Credit Growth

The GCC region has witnessed in recent years rapid credit growth to the private sector (Figure 1). Over the period 2003–08, Qatar and the U.A.E. experienced significant private sector credit growth at around 45 and 35 percent, respectively, while Oman had the slowest rate in the region at around 20 percent. In view of this growth, the ratio of private sector credit to GDP compares favorably to other emerging countries (Figure 2). When measured in relation to non-oil GDP, credit to the private sector in the GCC registers the highest rates among emerging countries. Notwithstanding the positive impact of increasing bank intermediation in the GCC on economic activity, as international experience shows, high rates of credit growth during an economic upturn almost invariably lead to high levels of credit defaults when economic activity slows. Therefore, high rates of credit growth witnessed in some GCC countries during 2003–08 have increased these systems’ vulnerability to a downturn in economic activity.

Figure 1.
Figure 1.

GCC: Average Annual Private Sector Credit Growth, 2003-2008

(In Percent)

Citation: IMF Working Papers 2010, 087; 10.5089/9781451982619.001.A001

Source: Country Authorities.
Figure 2.
Figure 2.

Selected Emerging Countries: Private Sector Credit to GDP, 2008

(In percent)

Citation: IMF Working Papers 2010, 087; 10.5089/9781451982619.001.A001

Source: IFS and World Economic Outlook (IMF).

Albeit indirectly, credit to the private sector has been spurred by the increase in international oil prices (Figure 3).8 Higher oil prices have boosted government spending and non-oil GDP growth and, as a result, spurred business confidence and local and regional private sector activities and investments. The impact was translated into a concomitant increase in the demand and supply of credit. As regard to supply, deposits in the banking sector grew as private sector income increased (Figure 4). This in turn boosted banks’ lending capacity. As for demand, banking sector credit was reoriented from the public to the private sector, where the latter expanded economic activities and investments (see Figure 9).

Figure 3.
Figure 3.

GCC. Oil Prices and Private Sector Credit Growth

Citation: IMF Working Papers 2010, 087; 10.5089/9781451982619.001.A001

Source: IFS; and authors’ estimates.
Figure 4.
Figure 4.

GCC: Deposits as Percent of Non-oil GDP

Citation: IMF Working Papers 2010, 087; 10.5089/9781451982619.001.A001

Source: IFS, and authors’ estimates.

IV. GCC Banking Sector Balance Sheets: Stylized Facts

The banking sector in the GCC still relies on the traditional deposits and loans as the main sources and uses of funds (Figures 5 and 6, and Appendix IV). The role of foreign liabilities as a source of funding is still limited, although it has increased in some countries particularly in 2006 and 2007 (Figure 7). Interbank liabilities are significant in Kuwait and also important in Oman and Qatar at 27, 16, and 16 percent of the total balance sheet (end-2008), respectively. GCC banks continue to have a very small share of bond financing (up to 2 percent of total liabilities). This has exacerbated the maturity mismatches between assets and liabilities in GCC banks in general.

Figure 5.
Figure 5.

GCC: Banking Sector Liability and Equity Structure, 2008

Citation: IMF Working Papers 2010, 087; 10.5089/9781451982619.001.A001

Source: Banks’ Annual Reports from Zawya; and authors’ estimates.
Figure 6.
Figure 6.

GCC: Banking Sector Assets Structure, 2008

Citation: IMF Working Papers 2010, 087; 10.5089/9781451982619.001.A001

Source: Banks’ Annual Reports from Zawya; and authors’ estimates.
Figure 7.
Figure 7.

GCC: Foreign Liabilities to Total Liabilities, 2003–08

(In percent)

Citation: IMF Working Papers 2010, 087; 10.5089/9781451982619.001.A001

Sources: Country authorities; and IMF staff estimates.Note: Bahrain is excluded from the chart as the relicensing of some wholesale banks into retail banks in early 2007 complicates the analysis of the ratio of foreign liabilities to total liabilities.

Banks’ assets are mainly composed of loans and, to a lesser degree, securities investments. Loans and Islamic finance products constitute between 50 percent (Saudi Arabia) and 71 percent (U.A.E.) of banks’ portfolios,9 and securities range between 8 percent in Qatar, up to 23 percent in Saudi Arabia, which is an important share of banks’ balance sheets by international comparison (Figure 8). In the current crisis, banks have registered significant losses related to these investments through mark-to-market valuations of their trading portfolios, although there is no indication that these assets were held in high risk asset classes, equities, or financial derivatives. An analysis of the 50 top GCC banks (conventional and Islamic) based on Bankscope data indicates that, on average, banks in the GCC held 18 percent of their portfolios in securities at end-2008. Of which, only about 1 percent was held in equities or derivatives (2 percent in the case of Islamic banks).10

Figure 8:
Figure 8:

International Comparison of Banks’ Holdings of Securities

(in percent of total assets)

Citation: IMF Working Papers 2010, 087; 10.5089/9781451982619.001.A001

Source: A. Sy (2005).

Funding of credit growth

A breakdown of credit growth during 2002–08 into its contributing factors confirms that client deposits have been the main contributor to credit growth for the six countries over the period (Table 3). The funding pattern, however, has been relatively volatile, which increases banks’ funding risk generally.11 A closer look shows that foreign liabilities have played a significant role in explaining the rapid credit growth for the U.A.E. in 2006 and for Oman, Qatar, Saudi Arabia, and the U.A.E. in 2007. The increase in 2006 in net foreign liabilities in the U.A.E. relates largely to banks’ issuance of foreign debt to support credit growth and also to address asset/liabilities maturity mismatches through the issuance of medium-term notes. In 2007, the increase in the four countries reflects short-term capital inflows in speculation of an appreciation of GCC currencies. As oil prices declined in the second half of 2008, foreign financing markedly declined as speculative capital inflows reversed and, to a lesser extent, international capital markets dried out.

Table 3.

GCC: Contribution of Balance Sheet Items to Private Sector Credit Growth, 2002-08

(percent)

article image
Source: IFS; WEO; and authors’ calculations.

V. Credit Concentration and Risks

The concentration of credit portfolios in GCC countries varies considerably within the GCC (Figure 9). Banks’ exposures to the construction and real estate sectors are significant in Kuwait and Bahrain and are also important in Qatar and the U.A.E. This exposure increased sharply since 2002 in Qatar and Bahrain and, to a lesser extent, Kuwait. U.A.E. banks’ exposure to the construction and real estate sectors appears relatively low in view of the construction and real estate boom that the country witnessed during this period. This could be attributed to the presence of domestic real estate and mortgage finance companies (although these are relatively small), but more importantly to direct external financing of large real estate projects, in particular by Dubai corporates. As regards large exposures, GCC banks have a relatively high concentration of credit to large business groups and high net worth individuals.

Credit to nonbank financial entities has witnessed a notable increase in Kuwait and the U.A.E., with levels specifically high in Kuwait. On the other hand, lending to the public sector has declined sharply as GCC governments benefited from rising oil prices in recent years and therefore a decline in the need to finance domestic projects through bank borrowing. Direct credit to the government constitutes a marginal share of loans in most countries with the exception of Qatar, where it constitutes more than 27 percent of loans, although credit to government declined from much higher levels witnessed in the early 2000s.

Figure 9.
Figure 9.

GCC: Bank Loans Sectoral Distribution

(in percent)

Citation: IMF Working Papers 2010, 087; 10.5089/9781451982619.001.A001

Source: Country authorities; and authors’ estimates.Note: Construction and Real estate in Bahrain, Kuwait, Saudi Arabia, and the U.A.E. inculde both residential and commercial.Households sector in Oman and Qatar might inculde residential mortgages.

Within household lending, there has been a marked increase in consumer lending in the U.A.E., and lending for equity investment in Kuwait (Figure 10). Household lending in Saudi Arabia for consumption or possibly equity investment appears to have also increased as indicated by the increase in the “other” category from around 46 percent of household loans to 72 percent during 2002–08.12 Household loans in the GCC are generally limited to salaried individuals, which lowers the risk of lending to this category, although risks remain in relation to situations that involve significant layoffs of expatriate workers (for example, in cases where there is a significant slowdown in economic activity). The following is an analysis of the main risk exposures for the GCC, by country.

Figure 10.
Figure 10.

GCC: Distribution of Household credit

(in percent of total household credit)

Citation: IMF Working Papers 2010, 087; 10.5089/9781451982619.001.A001

Source: Countries’ central banks; and staff estimates.

Bahrain. Overall, the retail banking portfolio in Bahrain is highly exposed to construction and real estate (33 percent of total loans) and the household sectors (23 percent). However, household loans in Bahrain are mainly secured by salary which mitigates the risk of default.

Kuwait. The banking portfolio is highly exposed to the real estate and construction sectors, which constitute close to 50 percent of total loans. Household loans (excluding mortgages) and nonbank financial institutions (mainly to investment companies) are also important in banks’ loans portfolios accounting for 16 and 12 percent of total loans, respectively. With regard to household loans, these are mainly composed of loans facilitating equity margin purchases (36 percent of total household lending, or close to 12 percent of banks’ loan portfolios in 2008).13 This highly exposes Kuwaiti banks to market induced credit risk.14 Additionally, banks are highly exposed to Kuwait’s troubled investment companies. The stressed domestic investment companies have put strains on the banking sector during the current crisis. Two of the largest investment companies, mainly active in the real estate and stock markets, have already defaulted on some or all of their debt (the events occurred in January and May 2009), but are in the process to negotiate or have successfully completed debt restructuring agreements.

Oman. Oman’s banking sector is highly exposed to the household sector, which accounts for approximately 40 percent of total loans.15 Rising consumer indebtedness raises concerns as Omani households are highly leveraged with household loans accounting for 17 percent of GDP. Additionally, a high proportion of the corporate loan portfolio is in a handful of large exposures. This has posed important risks to Omani banks historically: banks’ asset quality deteriorated in 2000–02 due to the financial troubles faced by large corporate clients to which most banks were exposed. The exposures are mostly to family-owned businesses, where despite improvements, corporate governance and transparency are still modest.

Qatar. The banking sector is mostly concentrated in the household, construction and real estate, and government sectors, which account for 26, 20, and 27 percent of total loans, respectively. As regards the household sector, although data is not readily available on the uses of these loans, an important share of these loans might be for securities investments.16 This could be a potential risk due to risk concentration and the difficulty arising from monitoring margin lending. One mitigating factor, however, is that household loans are largely extended to those with a salary assignment.

Saudi Arabia. The loan portfolio appears well diversified with respect to the corporate sector with trade being the main sector at 25 percent of total loans (mirroring the structure of the economy). However, concentration of credit to high net worth individuals could pose risks, similar to other GCC countries. Household loans in turn are well diversified with no dominating sub-sector. Real estate loans in Saudi Arabia are marginal compared to the rest of the GCC at less than 10 percent of total loans. However, similar to the rest of the GCC countries, some margin lending for equities could be a source of risk. Prudential regulations in Saudi Arabia curb credit growth risks by requiring banks to obtain Saudi Arabia Monetary Authority’s approval for foreign lending and by imposing statutory caps on individual indebtedness.

U.A.E. The banking sector is highly exposed to the construction sector and the highly speculative real estate sector (25 percent of total loans, including household mortgages), and to the household sector (20 percent, excluding household mortgages). Trade is also an important sector in bank loans accounting for 13 percent of total loans. The banking portfolio is concentrated in the corporate sector, which accounts for around two-thirds of total loans. Financing, however, is mainly directed to large private business groups or government-owned related enterprises and there is currently a high level of concentration of credit risk due to large financings of a few family-owned businesses and sizeable government-related entities.

VI. Financial Soundness

Capitalization

The banking sectors in the GCC countries are well capitalized across the board with capital adequacy ratios (CAR) well above minimum CARs (Table 4), and comfortable leverage ratios by international comparisons.17,18 The high capitalization levels of the banking sectors is related to high profitability, although they have declined significantly in recent years as a result of rapid credit growth and increasing leverage. In 2008, the profitability of the banking sectors have been affected by the higher provisioning requirements related to the crisis, impacting the ability of banks to increase capital internally.

Table 4.

GCC: Financial Soundness Indicators, 2003-08 1/

(Percent)

article image
Source: Country authorities.

Data for Bahrain reflects the retail banking sector only. 2008 data for Kuwait is as of September 2008. 2009 data is as of June for Oman, September for Qatar (except for the provisioning rate, which is for end-2008), and November for the U.A.E.

The CAR of the banking sector in the U.A.E. was the lowest among the GCC countries in 2008 at 13.3, declining significantly from 2005 when it stood at 17 percent. However, U.A.E. banks have received capital injections by the government in 2009, raising their CAR to 17.6 percent by June 2009 and making them among the best capitalized in emerging markets. Risks to capital adequacy, however, exist as the fallout from the crisis on the asset quality of banks continues to unfold, in addition to the risk of credit rating downgrades of U.A.E. corporates by major rating agencies.19 The latter could impact banks’ CARs through the valuation of risk weighted assets.

Asset quality

The asset quality of GCC banks has improved significantly over the past five years. The ratio of nonperforming loans (NPLs) to total loans has been on a declining trend since 2003, when it was at double digits, although the underlying trend is masked by the high credit growth rate during this period. NPLs stood at low levels in 2008 by international comparisons despite the crisis. However, the supervisory authorities in the GCC have required banks to take substantial general loan loss provisions in anticipation of rising amounts of NPLs in 2009, and possibly 2010. The coverage ratio of provisions to NPLs across the GCC is very high by international standards.20

There are, however, continued risks of a possible worsening of asset quality as the fallout from the crisis continues to materialize on banks’ balance sheets. This risk is heightened in countries with the highest credit growth rates prior to the crisis, and in systems that have significant concentration in construction and real estate, as these sectors have been hit hard throughout the GCC. The high concentration on lending to large business groups is also an issue as indicated by the recent default of two prominent Saudi conglomerates; in addition to Saudi banks’ exposure to these two groups, a number of GCC banks also had significant exposures. Additionally, the recent announcement by Dubai World—one of the three major Government-related holding companies in Dubai—on seeking a debt standstill and restructuring could have an important impact on U.A.E. banks and other GCC banks that have exposure to this group.21 The impact, however, is still unclear pending the conclusion of the debt restructuring process.

Profitability

The banking sectors in the GCC have stable sources of earnings from traditional banking. Net interest margins represent the main source of income, ranging from 53 percent of gross operating income in Qatar in 2008 to 80 percent in Saudi Arabia (Figure 11). Notwithstanding, losses from investments in securities in addition to increasing provisions have weighed on banks’ operating profits in 2008-2009 across the GCC (Figures 12–13). Investment losses mostly affected Saudi and Bahraini banks, while loan loss provisioning affected Kuwaiti banks most. Returns on equity (ROE)—hovering around 20 percent—and returns on assets (ROA) stood at comfortable levels by international comparisons, with Bahrain and Oman being the least profitable.

Figure 11.
Figure 11.

GCC: Income Analysis of GCC Banks, 2005- Q1 2009

(In percent of gross income)

Citation: IMF Working Papers 2010, 087; 10.5089/9781451982619.001.A001

Source: Banks’ annual and quarterly reports from Zawya; and authors’ estimates.
Figure 12.
Figure 12.

GCC: Banks’ Provisions and Investment Income, 2005-Q1 2009

(As percent of gross operating income, excluding investment income)

Citation: IMF Working Papers 2010, 087; 10.5089/9781451982619.001.A001

Sources: Banks’ annual and quarterly reports from Zawya; and Fund staff estimates.
Figure 13.
Figure 13.

GCC: Change in Bank Profitability 2007-2009

(In percent)

Citation: IMF Working Papers 2010, 087; 10.5089/9781451982619.001.A001

Source: Kamco Research; and Authors’ estimates.

Together with Saudi Arabia, the banking sector in Kuwait has been one of the most profitable within the GCC in recent years, although the latter has been affected relatively more by the current crisis (Figure 13).22,23 The retail banking sector in Bahrain has been the least profitable in the region in the last few years and returns have further suffered in 2008 and 2009.24 On the other hand, Islamic retail banks in Bahrain continued to be very profitable (with an ROA of 5 percent, up from 4 percent in 2007).

In view of limited global linkages, the Oman banking sector has been little affected by the global crisis. While the Qatari economy is more open, the economy (and consequently banks) have been least affected by the global crisis due to the thriving gas sector. Banks have also had significant government support that helped reduce their losses; the government purchased equity and real estate assets of banks up to $6 billion (6 percent of GDP) during the first half of 2009. It is also worthwhile noting that Qatari banks have the most diversified income within the GCC with net interest margins contributing with 50 percent, while banking fees and commissions, FX income, and investment income constitute the rest. In the U.A.E., more recent data indicate that while bank profitability increased in 2008, it was negatively affected by global and domestic developments in the first half of 2009. Profitability is likely to be further jeopardized by increasing provisions due to the continuing slowdown in economic activity and the bursting of the real estate bubble. Provisions could also potentially rise in relation to exposures to Dubai World.

Liquidity

Liquidity in the GCC banking sector has been severely squeezed in 2008 with the reversal of speculative foreign deposits and tight liquidity in international capital markets. GCC banks had become increasingly reliant on external financing, which increased fourfold since 2003 peaking to $103 billion in September 2008 (Figure 14). The majority of the issuances were by Bahrain, Saudi Arabia, and U.A.E. entities. Liquidity ratios for all countries ranked on the low side by international comparisons, reflecting the relatively high asset/liability maturity mismatches in GCC banks (Figure 15).

Figure 14.
Figure 14.

GCC: Banks’ External Financing 1/

(In U.S. dollar billions)

Citation: IMF Working Papers 2010, 087; 10.5089/9781451982619.001.A001

Source: BIS Consolidated Banking Statistics.1/ Includes foreign currency interbank lending extended by foreign bank branches in GCC countries.
Figure 15.
Figure 15.

Banking Sector Liquidity in Selected Countries, 2007

(In percent)

Citation: IMF Working Papers 2010, 087; 10.5089/9781451982619.001.A001

Source: Bankscope.

Liquidity peaked in GCC countries in 2007 reflecting the inflow of capital in speculation of an appreciation of GCC currencies (Figures 16–17). The U.A.E. received the bulk of these inflows as indicated by the significant rise in its liquidity ratios in 2007. Liquidity conditions started to tighten in early 2008 as speculative capital inflows reversed. Liquidity was squeezed further following Lehman’s collapse in September 2008. The injection of liquidity by the GCC authorities via central bank repos and direct placements of government deposits restored liquidity conditions quickly. Narrow and broad liquidity indicators show that liquidity conditions have returned to their 2006 levels or even above by March 2009.

Figure 16.
Figure 16.

GCC: Commercial Banks’ Reserves with Central Bank, December 2007=100

Citation: IMF Working Papers 2010, 087; 10.5089/9781451982619.001.A001

Sources: GCC central banks; and authors’ estimates.
Figure 17.
Figure 17.

Liquidity Indicators of GCC Banking Sectors

Citation: IMF Working Papers 2010, 087; 10.5089/9781451982619.001.A001

Source: Banks’ Annual and Quarterly Reports and authors’ estimates. Narrow liquidity ratio is calculated as cash and reserves at the central bank to total liabilities. The broad liquidity ratio is calculated as cash, reserves at the central bank, and securities holdings as a share of total liabilities.

VII. Conclusions and Policy Implications

The moderate impact of the global financial crisis on the GCC banking sectors has generally demonstrated the soundness of these systems. The banking sectors in the GCC countries continue to be well capitalized across the board with capital adequacy ratios well above minimum standards and comfortable leverage ratios by international comparisons. There are, however, risks of a possible worsening of asset quality as the fallout from the crisis continues to materialize on banks’ balance sheets. This risk is heightened in countries with the highest credit growth rates prior to the crisis, and in systems that have significant concentration in construction and real estate, as these sectors have been hit hard throughout the GCC.

Notwithstanding the general soundness of GCC banks, our analysis indicates some weaknesses associated with the operational aspects of GCC banks and the characteristics of the GCC economies. These would need to be evaluated and addressed by GCC policy makers.

First, some GCC countries witnessed rapid credit growth in the oil boom period preceding the financial crisis. As indicated above, this rise in available bank liquidity and the consequent increase in lending rates have been indirectly associated with higher oil prices. This linkage presents risks and introduces significant liquidity volatility for banks. International experience indicates that rapid credit growth in periods of high real economic growth is likely to result in high levels of asset impairment once economic conditions reverse. As observed in the current crisis, sharp declines in oil prices have brought about a slowdown in economic activity, along with a worsening of banks’ asset quality and strains on their liquidity. Policy makers are encouraged to evaluate policy measures that could dampen the impact of oil prices on economic activity and the financial sector.

Second, there are issues that need to be addressed in relation to banks’ asset management practices. GCC banks generally have significant concentration risk, both in the context of lending to a few obligors and large exposures to sectors that are highly subject to market price fluctuations and asset bubbles (such as real estate and equities). Additionally, some GCC banking systems have high exposures to households. While household lending in the GCC is generally secured by borrowers’ salaries, household defaults could pause risks. These would typically be associated with a slowdown in economic activity and massive layoffs of expatriate workers.

Third, liquidity management practices in GCC banks in general would need to be evaluated. GCC banks appear to maintain low liquidity levels by international comparison. While the banking sector in the GCC still relies on relatively stable deposits as the main source of funds, the fact that banks continue to have a very small share in bond financing complicates banks’ ability to manage the maturity mismatches between assets and liabilities. Furthermore, the increasing dependence of banks on external financing in some GCC countries in recent years has increased banks’ vulnerability to external credit conditions. This was demonstrated in the current crisis as banks’ liquidity was squeezed with the tightening in global liquidity conditions.

Appendix I. List of Commercial Banks in GCC Countries

Table 1.

GCC: List of Commercial Banks in GCC countries (2008)

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Source: GCC central banks.Notes: *Islamic bank.

Appendix II. Concentration of the Banking Sector

Table 2.

Bahrain: Concentration of the Banking Sector, 2007

(In percent)

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Source: Authors’ estimates.Notes: * Islamic bank.
Table 3.

Kuwait: Concentration of the Banking Sector, 2007

(In percent)

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Source: Moody’s Kuwait Banking System Profile (April, 2008).Notes: * Islamic bank.
Table 4.

Oman: Concentration of the Banking Sector, 2007

(In percent)

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Sources: Moody’s Oman Banking Statistical Supplement (July, 2008), Central Bank of Oman, and authors’ estimates.Notes: * Islamic bank.
Table 5.

Qatar: Concentration of the Banking Sector, 2007

(In percent)

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Source: Authors’ estimates.Notes: * Islamic bank.
Table 6.

Saudi Arabia: Concentration of the Banking Sector, 2007

(In percent)

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Sources: Moody’s Saudi Arabia Banking System Profile (July, 2008), and authors’ estimates.Notes: * Islamic bank.
Table 7.

U.A.E.: Concentration of the Banking Sector, 2007

(In percent)

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Source: Moody’s Saudi Arabia Banking System Outlook (December, 007), and authors’ estimates.Notes: * Islamic bank

Appendix III. Ownership Structure of GCC Domestic Banks

Table 8.

Bahrain: Ownership Structure of the Domestic Banking Sector (2007)

(In percent)

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Sources: Bankscope, Bankers’ Almanac, and authors’ estimate.

Quasi-government entities from both Kuwait and Qatar own 21%, while the remaining shares are owned by a royal family member from Kuwait.

The Kuwaiti government owns 9%.

Represents share of different private corporations from the U.A.E. that are owned by Sheikh Mohammed bin Rashid Al-Maktoum.

Part of Albaraka Banking Group (Saudi Arabia).

Ahli United bank owns 33.3%, and the remainder (66.6%) is owned by Bank Mellin Iran and Bank Saderat in Iran.

Notes: * Islamic banks.
Table 9.

Kuwait: Ownership Structure of the Domestic Banking Sector (2007)

(In percent)

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Sources: Bankscope, Bankers’ Almanac, and authors’ estimate.Notes: * Islamic bank.
Table 10.

Oman: Ownership Structure of the Domestic Banking Sector (2007)

(In percent)

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Sources: Bankscope, Bankers’ Almanac, and authors’ estimates.

Represents the share of Arab Bank PLC incorporated in Jordan.

Represents the share of Ahli United Bank in Bahrain.

Table 11.

Qatar: Ownership structure of the Domestic Banking sector (end-2007)

(In percent)

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Sources: Bankscope, Bankers’ Almanac, and authors estimates.

Represents the share of Ahli United Bank from Bahrain.

Represents the share of National bank from Kuwait.

Nsotes: * Islamic bank.
Table 12.

Saudi Arabia: Ownership Structure of the Banking Sector (2007)

(In percent)

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Source: Bankscope, Bankers’ Almanac, and authors’ estimates.Notes: * There is no Islamic bank license in Saudi Arabia and most banks offer a combination of conventional and Islamic banking products. These two banks offer only Islamic banking products.
Table 13.

United Arab Emirates: Ownership Structure of the Banking Sector (2007)

(In percent)

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Source: Bankscope, Bankers’ Almanac, and IMF staff.

Emirates Bank International and National Bank of Dubai completed merger on 17-10-2007 to become Emirates NBD.

Abu Dhabi Ruling Family.

Represent the share of Dubai holding LLC, which is owned by Sheikh Mohammed bin Rashid Al Maktoum

Through the share of government in Emaar properties, since Emaar owns 30 of Dubai Bank.

Notes: * Islamic bank.

Appendix IV: Banks Aggregated Financial Statements, 2005–0925

Table 14.

Bahrain: Balance Sheet of the Banking Sector 1/

(USD 000)

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Sources: Banks’ Annual and Quarterly Reports from Zawya; and authors’ estimates.

Based on data for listed banks only.

Table 15.

Bahrain: Income Statement of the Banking Sector 1/

(USD millions)

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Source: Banks’ Annual and Quarterly Reports, and authors’ estimates.

Based on data for listed banks only.

Table 16.

Kuwait: Balance Sheet of the Banking Sector 1/

(USD millions)

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Source: Banks’ Annual and Quarterly Reports from Zawya; and authors’ estimates.

Based on data for listed banks only.