Kuwait: Selected Issues

Abstract

Kuwait: Selected Issues

Macro-Financial Linkages and Resilience of the Financial Sector1

A. Introduction

1. Kuwait’s financial system has remained sound despite the headwinds from the slump in oil prices that are exerting pressures on the macro economy. With hydrocarbons accounting for about half of GDP and well over two thirds of fiscal and export revenues, the decline in oil prices has led to a sharp deterioration in fiscal and external accounts and a softening in nonoil GDP growth. However, while equity markets also corrected and the real estate market has begun to slow down, the banking system has continued to perform well.

2. This paper identifies macro-financial linkages, assesses the resilience of the financial system, and discusses policy options to safeguard financial stability. The paper focuses on the banking sector but also discusses the financial markets, equities and investment companies in so far as their performance impact banking system stability. It also provides a comparative analysis of conventional and Islamic banks’ performance and employs a balance sheet approach to identify risks from households and corporates. Stress tests to determine banks resilience to shocks is undertaken at both the aggregate and bank by bank level, and builds on earlier work by Fayad (2015).

3. The paper is structured as follows. Section II discusses Kuwait’s macro financial structure, and highlights the channels through which oil price shocks propagate through the macro economy to the financial sector, as well as the feedback from the financial sector to the macro-economy. Section III reviews Kuwait’s financial sector performance since oil prices began to decline in June 2014, and the drivers of that performance, including policy responses to the shocks. Section IV uses stress testing techniques to assess the resilience of the banking system to macro financial risks and highlights the comparative resilience of Islamic and conventional banks. Section V assesses the adequacy of liquidity management and prudential frameworks to mitigate financial stability risks and the arrangements for crisis management, in case banking system stresses emerge. Section VI summarizes the findings and highlights policy options to safeguard financial stability.

B. Overview of Macro-Financial Linkages in Kuwait

4. Kuwait’s financial sector performance is interwoven with the oil price cycle through multiple channels that form a complex web of interactions. Changes in oil prices affect the financial sector through its impact on the domestic macro-economy, expectations and, to some degree, through spillovers from regional financial markets (Figure 1). These channels also interact with each other in a complex way, thus the impact on the banking system is non-linear. The speed with which the shocks transmit to the financial system vary between financial markets and institutions and also depend on the authorities’ policy response.

Figure 1
Figure 1

A Schematic Overview of Macro Financial Linkages in Kuwait

Citation: IMF Staff Country Reports 2017, 016; 10.5089/9781475566598.002.A002

Source: IMF staff calculations.

The Domestic Macro Economy Channel

5. Oil price shocks can impact several macro variables simultaneously and create multiple and mutual reinforcing risk channels for the banking sector. Before the oil price shock, hydrocarbons accounted for over 90 percent of exports and fiscal revenues and close to 60 percent of GDP. As a consequence, declining oil prices typically impact the balance of payments and system wide liquidity, which slows down deposit growth. The deceleration in deposit growth, in turn, can curtail credit growth, business volume, profitability and, therefore, internal capital generation. Concurrently, reduced fiscal revenues—should it lead to curtailed public expenditures—could slowdown non-oil GDP growth, household disposable income, demand for and supply of credit and reduce debt service capacity of both households and corporates.2 In the past couple of years, however, these inter-relations have weakened, as large accumulated fiscal buffers have provided the policy space to maintain public expenditures in a low oil price environment, thereby limiting the potential adverse impact of low oil prices on the real economy and liquidity (Figure 2).

Figure 2
Figure 2

Links Between Oil Prices, the Macro Economy and Financial System Performance

Citation: IMF Staff Country Reports 2017, 016; 10.5089/9781475566598.002.A002

Sources: CBK, Bloomberg

6. Transmission of the macro shocks to the banking sector and broader financial system occurs with a short lag because banks derive most of the business from the domestic economy and financial segments are interlinked. Kuwait’s financial system is bank dominated, with commercial banks accounting for about 80 percent of total financial system assets. Banks largely depend on domestic market for business, with domestic liabilities accounting for 92 percent of total liabilities while domestic assets account for 80 percent of banking system assets. Banks also account for over half of stock market capitalization and are a significant source of funding for investment companies (ICs), equities and real estate markets (Figure 3).

Figure 3
Figure 3

Banking System Linkages with the Financial System

Citation: IMF Staff Country Reports 2017, 016; 10.5089/9781475566598.002.A002

Source: CBK.

The Expectations Channel

7. Oil price shocks affect expectations about the business environment which, in turn, affects investments in asset markets and the broader economy. Given the heavy economic dependence on hydrocarbons, declines in oil prices, by weakening confidence and possibly giving rise to expectations of a slowdown in the real economy, can create negative expectations of a slowdown in the real economy, which affect investment decisions and discourage investments in equities and real estate. Pressures on asset prices can also adversely affect the financials of banks and ICs, as both have direct and indirect exposures to equities and real estate through loans, investments and collateral (Figure 4). This could also create negative feedback loops within the financial sector given the interlinkages alluded above.

Figure 4
Figure 4

Financial Linkages of Banks with Equities, Real Estate and Investment Companies

Citation: IMF Staff Country Reports 2017, 016; 10.5089/9781475566598.002.A002

Source: CBK.

Regional Spillovers

8. Developments in the regional markets have some implications for financial stability in Kuwait through financial and ownership linkages. At end July 2016, local banks’ foreign liabilities and foreign assets accounted for 5 percent and 20 percent of banking system assets, respectively. The GCC accounts for about 10 percent of the total loans (Figure 5). A number of Kuwait banks also have subsidiaries operating in the region and other countries, including some with challenging operating environments such as Iraq, Egypt, Tunisia, Turkey and Algeria. The banks are, therefore, directly exposed to regional equities and real estate through their subsidiaries’ lending activities and investments in the host markets. The share of ICs foreign liabilities accounted for 15 and 20 percent for Islamic and conventional companies, while foreign assets averaged 32 and 59 percent, respectively. Shock transmission from the ICs to banks has, however, significantly weakened since the Global Financial Crisis (GFC), because of the reduced balance sheets of ICs following the various restructurings and the reduced financial exposures by banks.

Figure 5
Figure 5

Spillover Channels from Regional Financial Markets

Citation: IMF Staff Country Reports 2017, 016; 10.5089/9781475566598.002.A002

Source: CBK.

Feedback from the Financial System to the Macro Economy

9. Kuwait’s financial system structure and performance has the potential to affect macroeconomic performance through a number of channels, most notably the credit and fiscal channels. The banking system is the principal source of credit for corporates and households, thus a slowdown in credit can affect growth through both investment and consumption. The banking system is also concentrated and this creates systemically important banks that could have fiscal implications in a stress scenario. Due to the high retail participation in Kuwait’s stock market, declines in the stock market have a wealth effect that can affect consumption and nonoil GDP growth. The significant presence of Islamic banks in the financial system has potential implications for monetary policy conduct and transmission through the interest rate channels. However, because the CBK has developed Shari’ah compliant monetary instruments and the Islamic banks assets comprise largely of financing items (Murabahah and Ijara) whose characteristics are similar to conventional banks, transmission of monetary policy to the real economy has not been materially impacted (Figure 6).

Figure 6
Figure 6

Feedback Effects

Citation: IMF Staff Country Reports 2017, 016; 10.5089/9781475566598.002.A002

Source: CBK.

C. Financial Sector Performance since the Oil Price Shock and Drivers

10. Kuwait’s financial sector has remained sound and stable, with incipient pressures largely mitigated by broadly supporting fiscal and monetary policy responses. The slump in oil prices exerted further pressures in equity markets and more recently dampened real estate transactions while money markets and financial institutions have continued their strong performance. Generally supportive fiscal policies, a neutral monetary policy stance, the dividends of sustained financial sector reforms and strong economic performance have provided a favorable operating environment for banks.

Financial Sector Performance

11. Pressures from the slump in oil prices, that began in June 2014, have been largely felt in asset markets. Equity markets that were slowly recovering from the effects of the GFC registered broad based declines and increased volatility, in tandem with other equity markets in the region.3 The real estate market cooled significantly in 2015, following a strong five year run, with sales in both investment and residential real estate sectors declining by 45 and 31 percent by the second quarter of 2016. Liquidity in interbank markets, which had begun to decline towards the end of 2015 eased thereafter and, as a result, inter-bank rates declined even as policy rates were raised in December 2015 following the increase in US rates. 4

12. Banking sector fundamentals have remained sound (Figure 8). The aggregate capital adequacy ratios (CAR), which has been trending up since 2014 from an already elevated level of 16.9 percent, was estimated at 17.9 percent by July 2016, in part reflecting the capital raising efforts to meet Basel III capital requirements. NPLs have steadily declined to 2.4 percent, reflecting a combination of loan write offs and the steady growth in new loans. Loan loss provisioning has been increasing and coverage averaged 206.2 percent. The banking system remains profitable, though margins have been declining. In addition, several indicators of liquidity point to a banking system that enjoys ample liquidity, despite the reduced oil related inflows, reflecting, to some degree, increased public sector deposits. Both conventional and Islamic banks performed well, although there are some disparities in performance across individual banks (Figure 8).

Figure 7
Figure 7

Financial Market Performance

Citation: IMF Staff Country Reports 2017, 016; 10.5089/9781475566598.002.A002

Sources: Bloomberg, and NBK.
Figure 8
Figure 8

Banking Sector Performance

Citation: IMF Staff Country Reports 2017, 016; 10.5089/9781475566598.002.A002

Source: CBKNote: the blue bars are conventional banks, the green bars are Islamic banks, and purple bar is a specialized bank.

13. The banking system is, nevertheless, exhibiting some incipient pressures. Banking system asset and deposit growth, though still positive, have slowed down significantly. Deposit growth moderated from 7 percent in 2014 to 3.8 percent in 2015 and only modestly picked up to 4.6 percent in the first half of 2016, helped by increases in government deposits. Bank asset growth exhibited a similar trend, declining from 9 percent in 2014 to 5.3 in 2015 and 4.4 in the first half of 2016. Credit growth, by contrast, accelerated to about 8 percent in 2015 (compared with 6.3 percent in 2014) with all sectors registering higher growth except the real estate sector. As of end-September 2016, total credit was still growing at around 7 percent year-over-year, but with a decline in credit to the real estate sector and consumer loans.5

Key Drivers

14. The overall strong performance of the banking sector reflects a combination of policy and other factors. These include supportive macro policies, dividends of enhanced risk management, and structural and other coincidental factors.

15. Fiscal and monetary policies have been supportive. A very gradual adjustment of current expenditures combined with a continued increase in growth enhancing capital expenditures has supported nonoil GDP growth and provided business opportunities that supported both asset growth and quality. The resulting deficit has, thus far, been financed mainly by drawing down external buffers, and public sector entities have at the same time increased their deposits in the banking sector. While the government stepped up government bond issuance since April 2016, the magnitudes issued were limited to avoid crowding out the private sector. As a result, the impact on system wide liquidity has been limited. The initial increase in interest rates in tandem with the interest rate hike by United States Federal Reserve in December 2015,6 and improving confidence on account of the recovery in oil prices helped moderate the capital outflows, which would otherwise have tightened liquidity conditions. Monetary operations were neutral with the CBK rolling over its maturing bonds.

16. Dividends from sustained financial sector reforms were also an important factor. The Central Bank of Kuwait (CBK) continued to implement elements of Basel III for local Banks. Building on already introduced regulations—additional Tier 1, Tier 2 and leverage ratio—the CBK continued to increase the Common Equity component of Tier 1, increased minimum CAR, implemented two new liquidity standards (the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR)) and the framework for domestically systemically important banks (D-SIBs). The CBK also continued to enhance stress testing capabilities, introduced corporate governance frameworks and consumer protection frameworks while advancing the efforts to strengthen resolution and crisis management frameworks for banks.

17. Banks, on their part, continued to enhance their risk management. The banks have been proactive in provisioning for impaired loans and writing off the loans from their books while continuing recovery efforts. They have also been raising capital in international markets to meet Basel III compliant tier-1 securities and, in selected cases, to reduce maturity mismatches given the increasing shift to project financing. Since the Global Financial Crisis, banks also reallocated credit in favor of households, mostly public sector employees, for which the loans are secured by salary assignment.

18. Structural and other coincidental factors also contributed. A recovery in government entities deposits helped ease emerging pressures in money markets and moderated the impact of increased government borrowing. The stable employment conditions for Kuwaiti nationals supported household asset quality.

D. How Would Sustained Low Oil Prices Affect Kuwait’s Banking System?

19. Kuwait’s banking system is well-positioned to withstand oil price related macro shocks, though there are some downside risks. The gradual approach to fiscal consolidation combined with increased capital expenditure under the development plan will support nonoil GDP growth, credit conditions, bank profitability and internal capital generation. Banks have also enhanced their loss absorption capacity by building up capital buffers and provisions, and supervision is strong. Downside risks, nevertheless, remain owing to uncertainties about the trajectory of oil prices, high loan concentrations and the banks’ significant exposures to cyclically sensitive real estate as well as the confidence driven equity markets. Slowing deposit growth could also force banks to rely on higher cost wholesale funding to support credit growth.

The Macro Financial Outlook

20. Kuwait’s current macroeconomic outlook is expected to support financial sector growth and stability. Even as oil prices stay low, project implementation under the development plan is expected to support a gradual recovery in nonoil GDP and, therefore, provide a favorable operating environment for banks that provides ample business opportunities. This is supported by the large accumulated financial buffers and low debt.

21. The financial system is, nevertheless, exposed to a number of domestic and external risks, that entail important policy trade-offs. Reform setbacks, a slow DP implementation or a further sustained drop in oil prices could result in slower growth and thereby adversely impact asset growth and quality. Monetary policy normalization in the US monetary policy, which would have to be accompanied by higher policy rates in Kuwait, could increase funding costs for borrowers. On the other hand, allowing a deviation from US rates would expose Kuwait to capital outflows, which could also tighten domestic liquidity conditions and increase domestic funding costs. Also, as some of the countries in which Kuwait banks have expanded are facing an economic slowdown and/or increased security risks, some asset quality deterioration can be expected from cross border exposures.

Resilience of the Banking System to Macro Shocks

22. Stress tests of the banking system undertaken in 2015 pointed to a banking system that is resilient to shocks although, under a severe stress scenario, some banks may require additional capital injections. Fayad (2015) employed a system GMM dynamic panel approach to assess the macroeconomic determinants of NPL, and found that nonoil GDP, real estate prices and equity prices are important drivers of NPL in Kuwait. Sensitivity analyses to shocks in these sectors were thereafter simulated for the period covering 2015 – 2017, based on data for 7 banks that collectively accounted for over 80 percent of the banking system assets. The results showed that, under the moderate scenario, the aggregate CAR would remain above the minimum capital but under the severe stress scenarios, some of the banks would become undercapitalized. 7

23. The current stress tests build on Fayad’s work and extends the analysis to cover all the 11 banks with the aim to identify the credit and liquidity risk events that pose the most stability risks for Kuwait’s financial system. For credit risks, Table 1 below presents the plausible shocks assessed and the potential impact on bank capital based on end 2015 data, without attaching probabilities for the stress events occurring. In each case, the capital of banks is reduced by the amount of provisions needed to cover the NPLs generated under the stress scenario. Underlying collateral or subsequent year’s profits that potentially can be generated from continued growth in credit and non-interest income (such as fees and commissions) are not included, thus the results are static and not dynamic. For liquidity risk, Table 2 presents the Liquidity Coverage ratio (LCR) and the Net Stable Funding (NSR) ratio calculated by the CBK.

Table 1

Credit Risk Stress Test Results

article image
Source: IMF staff calculations.

24. The results corroborate earlier findings that Kuwait’s banking system is resilient, but they also show that loan concentrations are a source of vulnerability. A migration of NPLs across the buckets to loss status has little impact on banking system stability because of the small size of the NPLs relative to capital and provisions. A deterioration of 10 percent of loans in the individual sectors also has a limited impact, except for the real estate and construction where one bank could see its CAR fall below 8 percent because of its sizeable exposure to the sector.8 The default of the single largest borrowers could erode the CAR in one bank to below the 13 percent statutory minimum but a default of the two largest borrowers would result in 6 banks falling short of the minimum CAR requirements. A deterioration in currently performing loans begins to affect banks when it reaches 5 percent, in which case it could erode capital for 4 banks to below the minimum. These results suggest a resilient banking system given the severity of the shocks and the fact that the aggregate capital remains above the statutory minimum while the capital of the banks that become undercapitalization remains above the Basel minimum of 8 percent, with one exception.

25. Kuwait’s banking sector also exhibits resilience to liquidity shocks, despite the high concentrations in the deposit base. The banking system’s high liquidity coverage ratio (LCR) suggests that banks have an adequate stock of unencumbered high quality liquid assets that can be easily converted into cash to meet their liquidity needs over a 30 calendar day liquidity stress scenario. Similarly, the Net Stable Funding Ratio (NSFR) point to a sustainable maturity structure of assets and liabilities and the outliers are for a recently established bank and an industrial bank. As per Figure 12, deposit concentration is very high with one and two depositors respectively accounting for 10 and 20 percent of total deposits for most banks. However, the liquidity risk is mitigated by the fact that most of these deposits belong to public institutions with abundant cash-flows and the government has demonstrated a willingness to support the banks’ liquidity by maintaining or increasing these deposits in periods of stress.

Figure 9
Figure 9

Deposit and Credit Growth

Citation: IMF Staff Country Reports 2017, 016; 10.5089/9781475566598.002.A002

Source: CBK.
Figure 10
Figure 10

Drivers of Banking System Performance

Citation: IMF Staff Country Reports 2017, 016; 10.5089/9781475566598.002.A002

Sources: CBK, IFS.
Figure 11
Figure 11

Bank Lending by Sector

Citation: IMF Staff Country Reports 2017, 016; 10.5089/9781475566598.002.A002

Source: CBK.
Figure 12
Figure 12

Oil Price Trajectory and Concentrations in the Balance Sheets of Kuwait Banks

Citation: IMF Staff Country Reports 2017, 016; 10.5089/9781475566598.002.A002

Sources: CBK, Bloomberg, and IEA.
Figure 13
Figure 13

Resilience to Liquidity Risks

Citation: IMF Staff Country Reports 2017, 016; 10.5089/9781475566598.002.A002

Source: CBK.

Prudential and Liquidity Management Frameworks

26. Financial stability risks posed by a low oil price environment are further mitigated by the strong regulatory and supervisory framework adopted by the CBK. Significant advances have been made in aligning prudential frameworks with international standards, adopting risk based supervision (RBS), implementing consolidated supervision, and aligning supervisory processes with Basel III regulatory reforms related to capital, liquidity, and the Domestic Systemically Important Banks (D-SIB) framework. In particular:

  • Solvency risk: Kuwait’s minimum capital requirements are more stringent, being 2.5 percentage points higher than the Basel III guidance with full phase-in required by December 2016 (as compared to Basel III’s Jan-2019 deadline).

  • Credit and concentration risk: A credit registry, which facilitates banks’ ability to assess borrower credit worthiness, was established following the passage of the law in 2001 and is operational. The concentration of household loans to public employees—for which job security is high and banks’ practice of salary assignment—also reduce credit risk from households. Loan classification and provisioning requirement are stringent. The CBK also applies a Large Exposure (LE) limit of 15 percent of capital, which is more stringent than the Basel LE limit of 25 percent.

  • Liquidity risk: Implementation of Basel III has boosted liquidity risk management. Banks in Kuwait are required to comply with five liquidity indicators, including the Liquidity Coverage Ratio (LCR),9 a Loan to Deposit ratio, limits on maturity mismatches, a regulatory liquidity ratio of 18 percent and Net Stable Funding ratio. The CBK also offers a Shari’ ah compliant Lender of Last Resort (LOLR) facility to Islamic banks through the use of Tawarruq based on commodity Murābaḥah instrument. The government has capacity to support banking system liquidity and has demonstrated a willingness to support banks, including through an increase in deposits of government entities in commercial banks. While there is no formal liquidity forecasting framework, the supervision department closely monitors deposit trends in individual banks.

  • Systemic risks: Considerable progress in managing systemic risks has been made with the introduction of macroprudential tools. Kuwait has made great use of macroprudential tools, including the Loan to Value ratio (LTV) applied to mortgages for second homes for investment in residential areas, a maximum KD70,000 limit on bank lending for primary homes which cannot be mortgaged by law, and debt to income ratio to help reduce leverage among households.

  • Risk identification and monitoring: CBK continues to strengthen its stress testing framework which helps identify emerging risks.

27. The limited diversification of the economy, however, translates into loan concentrations and common exposures. These include sectoral concentrations and common exposures to real estate and households, single obligor loans to family-owned companies that operate across sectors and concentrations to big companies that are financed through syndicated loans. There are also concentrations in collateral in real estate and to some degree, equities. These concentrations could lead to spikes in NPLs while the common exposures increase risk correlations across the banking system and therefore systemic risks. Conglomerate and complex structures of some banks could, also, render risk identification a challenge, including in particular for Islamic banks that include nonfinancial corporations in their groups.10 A liquidity forecasting framework would help the CBK better anticipate possible liquidity shocks.

28. Remaining regulatory gaps also have potential to compound risks. Financial sector initiatives have focused more on prevention but reforms to mitigate losses once the risk has materialized have been slower. In particular, the slower progress in instituting debt recovery frameworks (insolvency regimes, secondary debt markets and Asset Management Companies) potentially increase Loss Given Default (LGD). Moreover, while macroprudential measures are in place, a formal framework for operationalizing the measures is yet to be established. In the absence of a formal framework for activation, the effectiveness of the measures could be reduced if developments and innovations in the financial industry result in products not covered by the measures. The measures, such as the LCR, could also have a pro-cyclical effect if not timely adjusted in line with emerging liquidity conditions.

Resolution and Crisis Management Frameworks

29. Efforts to strengthen resolution and crisis management frameworks are ongoing. This includes a special resolution regime for banks, deposit insurance scheme and arrangements for Emergency Liquidity Assistance (ELA). Arrangements for Technical cooperation with the IMF in these areas are advanced.

30. A special resolution regime for banks is under consideration. The authorities are making advances in developing a resolution framework that will be finalized with assistance of IMF technical assistance. All banks, including Islamic banks are, currently, subject to bankruptcy law that applies to all legal entities. Thus far, no Islamic bank has been liquidated, either voluntarily or compulsorily. Reforms are ongoing to strengthen the insolvency regime in collaboration with the World Bank, but these will need to be accompanied by reforms to establish commercial courts and ensure availability of judges with expertise in commercial disputes.

31. Deposits are currently covered by the blanket guarantee introduced in the aftermath of the GFC. In March 2009 the CBK introduced the Financial Stability Law (FSL), which was developed to support domestic financial institutions – primarily ICs – in distress. The blanket guarantee provides unlimited coverage, both for the insured amount and with respect to the type of deposits covered—ie., wholesale, retail, foreign, domestic, conventional and Islamic banks. The blanket guarantee is not backed by an explicit funding arrangement or infrastructure for pay out. The authorities are considering ways to reform the blanket guarantee to improve the incentive structure in the banking sector and limit the potential fiscal impact.

E. Conclusion and Policy Options

32. Kuwait’s financial sector performance is interwoven with the oil price cycle, but prudent macro and financial sector policies have facilitated banking system stability. Due to Kuwait’s heavy economic dependence on hydrocarbons coupled with the domestic focus of its banking system, deposit and credit growth have tended to move in tandem with the oil price cycle. However, during the recent oil price shock, financial buffers, accumulated in periods of high oil prices, have provided the policy space to support economic growth through measured fiscal adjustment and growth-enhancing capital expenditures, which has supported asset quality, business opportunities and bank profitability.

33. Nonetheless, Kuwait’s financial system is not immune to risks from a sustained period of lower oil prices. A protracted period of lower oil prices, should it constrain public expenditures and weaken nonoil GDP growth, could potentially set in motion unfavorable macro-financial dynamics that increase credit and liquidity risks. The likelihood of such an event is limited in light of the government’s large buffers that is available to support growth and the willingness to use the resources to minimize financial stability. However, if it did happen, vulnerabilities in bank balance sheets, particularly those related to deposit and loan concentrations and common exposures, could amplify the financial stability impact. In selected cases, complex conglomerate structures could affect timely identification of risks.

34. Continued enhanced surveillance will be critical for the timely identification of risks and timely policy responses. The efforts to strengthen stress testing techniques, the currently stepped up efforts to monitor deposit trends and the monitoring of restructured loans augur well for the early identification of financial stability risks. Enhanced monitoring of liquidity risk at the system wide level will also be critical and to this end strengthening the liquidity forecasting framework is key. The completion of the Early Warning Indicators, including the real estate prices, and application of other risk identification techniques to complement stress testing, such as the balance sheet approach, will help to more comprehensively identify risks. Data on household indebtedness and corporate earnings will help identify emerging risks in the balance sheets of corporates and households.

35. Ongoing efforts to close remaining regulatory gaps will contribute to sustained financial stability. Individual capital ratios are a useful measure for addressing concentration risks in loan portfolios of individual banks and can provide incentives for the banks to address concentration risks, but in the case of Kuwait, the capital requirements for banks are already high. Reducing deposit concentrations would contribute to more sustained stability and banks should seek to diversify their funding structures. Further, while great advances have been made in strengthening risk prevention aspects of regulation and supervision—micro and macroprudential regulations, credit registries and stress testing—additional reforms to strengthen insolvency regimes would help minimize losses in the event of a default and safeguard fiscal resources. Strengthening the frameworks for resolution, crisis management, deposit insurance and emergency liquidity assistance, would also help facilitate orderly resolution, if banking system stress were to emerge. Banks with complex conglomerate structures that include non-financial corporations warrant further review to ensure that their corporate structures lend themselves to effective supervision.

36. Macroprudential policies could benefit from further upgrades. A formal framework for operationalizing macro prudential measures, including a formal decision making process would help in activating the measures and in ensuring that the measures do not amplify risks. Regular reviews of macroprudential measures against their objectives from time to time would be useful in ensuring that market developments do not weaken the effectiveness of the instruments.

37. Sound macroeconomic policies and structural reforms are essential for long term and sustained financial stability. Gradual fiscal adjustment that limit the effects of low oil prices on the nonoil economy will help mitigate potential credit risk for banks. Financing strategies that balance the government financing needs, minimize private sector crowding out and promote market development will support financial stability. Finally, since loan concentrations are related to the limited economic diversification, structural policies that help diversify the economy will over time promote financial stability on a more sustained basis.

References

  • Moody’s (2015) “Sizeable Assets Provide Important Fiscal Buffers Against Lower Oil Revenues

  • Standard and Poor (2016) Research Update: Kuwait Ratings Affirmed at ‘AA/A-1+’ Despite Lower Oil Price Assumptions; Outlook Stable, February 12, 2016.

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  • Dominique Fayad (2015) The Resilience of the Banking system to macroeconomic shocks in Kuwait

1

Prepared by Inutu Lukonga.

2

The private sector derives a large share of their business from government contracts and the government also accounts for more than 45 percent of employment in Kuwait.

3

The Kuwait Stock exchange index which had declined by 13 percent between December 2008 and June 2014 declined further by another 22 percent through September 2016.

4

Kuwait is pegged to a basket of currencies and has maintained the peg. Policy rates in Kuwait have been largely correlated with US rates.

5

The decline in lending to the real estate and households is largely attributed to the enforcement of the regulation that requires borrowers to provide proof of deployment of credit for the purpose for which it was approved for and weakening consumer confidence.

6

The CBK also increased its Discount Rate (CBDR) by 25 basis points to 2.25 percent. The increase in policy rates pushed up the average interest rate on loans of commercial banks, after calculating the margins above the discount rate allowed by CBK of 3 percent for customer loans and 4 percent for commercial lending, to be between 5.25-6.25 percent.

7

The moderate scenario assumed declines in non-oil GDP of -4.7, equity price drop of -22.6 and a real estate price drop of -20 percent. The severe shock simulated a fall in nonoil GDP of -8 percent, equity prices, at about -58.7 percent, and real estate (investment) price drop of 30 percent.

8

The stress results for the risk from the real estate, however, do not provide a complete picture to the extent that it does not take into account potential losses from real estate collateral or investments in the sector, particularly for the Islamic banks.

9

The main objective of the Liquidity Coverage Ratio (LCR) is to promote the short-term resilience of the liquidity risk profile of banks by ensuring that they have sufficient level of high-quality liquid assets (HQLA) to survive a significant stress scenario lasting for a period of up to 30 days.

10

Islamic banks are allowed to invest in fixed property while conventional banks are not and the presence of subsidiaries that are outside the regulatory perimeter presents an important challenge.

Kuwait: Selected Issues
Author: International Monetary Fund. Middle East and Central Asia Dept.