The ratings on the banks in the Middle East and North Africa demonstrate a wide range of credit quality, and the gap between the strongest and the weakest is expected to widen, Standard & Poor’s Ratings Services notes. “Banks from the six Gulf Cooperation Council (GCC) countries benefit from good economic prospects, largely due to high oil prices, the rapid expansion of retail banking, and booming local stock markets, while banks in Tunisia, Morocco, and Egypt are subject to the slow pace of structural reforms and limited good lending opportunities,” says Standard & Poor’s credit analyst Emmanuel Volland. “Lebanese and Turkish banks share the challenge of diversifying their revenues, and the ratings on them will continue to be driven mainly by the ratings on their respective sovereigns.”
Banks from the GCC countries will continue to display solid financial performance, capitalisation, and liquidity in 2004. Strong profit generation will benefit from high margins, a low cost of funds and labour, and the absence of income tax. Gulf banks therefore appear rather immune to a crisis. However, risks could arise from the capital and real estate markets that have boomed in 2003. Although this sharp increase reflects the more stable geopolitical situation in the region, increasing liquidity and some structural economic improvements, a financial bubble could be created if this trend continues.
As Gulf banks remain small by international standards and are constrained by their underdeveloped operating environment, external growth will continue to increase in the near future. Expansion in some underdeveloped banking sectors such as Syria, Libya, and Iraq will also provide banks with a new source of expansion. Kuwaiti banks in particular will benefit from their proximity to the rebuilding process of Iraq, thus finding a way out of their narrow domestic market. In line with the long-term target of a regional customs union and single currency, Standard & Poor’s expects to see more cooperation and mergers among the banks in the region. More importantly, Gulf banks will be supported by significant economic growth, as oil prices are not expected to drop sharply and strong foreign investments continue to flow in a number of countries (Qatar, Kuwait, and Bahrain in particular).
“A booming high-yield and low-risk consumer-lending business line is another important factor supporting Gulf banks’ profitability and ultimately the ratings on the banks, particularly in Saudi Arabia,” says Standard & Poor’s credit analyst Anouar Hassoune. Qatar, whose economy is accelerating to more than 7.5% in 2004; and Oman, where the banking sector has learned a lot from its past problems in corporate lending; are expected to perform strongly this year. Finally, the development of Islamic finance will also contribute to the strengthening of the positions of Bahrain and the United Arab Emirates (UAE) as major regional financial hubs, while providing smaller players with an alternative to consolidation, that is, specialisation within a niche strategy. These factors should be complemented by further political and economic reform programs, as these countries remain highly dependent on oil and challenged by a fast-rising population posing severe pressure on their labour market.
“Domestic and external economic shocks, including the impact of global terrorism and sluggish external demand, have thrown a harsh light on the paradox facing the banking sectors in Morocco, Tunisia, and Egypt,” says Volland. While stagnant business prospects, weak profitability, and declining asset quality signal the clear need for banking reforms, structural rigidities continue to hinder the situation. This lack of momentum is reflected in the banks’ stagnant financial profiles and stable outlooks.
“Although Standard & Poor’s views North African banks as having good long-term growth prospects, in the absence of much-needed restructuring and rationalisation, as well as better corporate governance, their risk profiles are likely to remain stable or even deteriorate,” he adds. In all three countries, private sector banks will continue to post more stable and stronger financial performance than those banks in the public sector.
The Moroccan banking system should benefit from still-good economic conditions in 2004, owing to a second year of high rainfalls and satisfactory agricultural output. Moroccan banks will keep on testing the opportunities of consolidating the system toward fewer, but stronger, institutions. The merger in 2004 of two leading Moroccan banks, Banque Commercial du Maroc (BCM) and Wafabank, reflects the need for the system to accelerate consolidation in the face of foreign competition ahead of the free trade agreement with the US and European Union. Other transactions could follow in the near term.
The outlook for the Tunisian banking system is stable and takes into account the expected support of the government to the comparatively weaker public sector banks and a modest recovery in operating performance for most banks. Forecasted by Standard & Poor’s at a strong 5.6% in 2004, GDP growth should stimulate loan demand and stabilise asset quality indicators, which will sustain revenue generation. The slow privatisation process will continue with the sale of the government’s 32.4% stake in Banque du Sud (‘Bpi’).
Limited economic growth, combined with weak industry fundamentals, will continue to have a negative impact on the creditworthiness of Egyptian banks in 2004. If the economic environment deteriorates further, Egyptian banks could find themselves with an unsustainable level of bad loans, already at a level of about 20% of total loans. Systemwide, competition is increasing and profitability and capitalisation are under great pressure. No major change is expected in the competitive landscape, with the four state banks continuing to dominate the system. While their extensive branch network enables them to attract large volumes of stable and cheap retail deposits, leading to adequate liquidity profiles, they carry the burden of large bad loans. Although the long-awaited privatisation of these banks is very unlikely to materialise in the near future, some mergers and acquisitions among the smaller banks are expected, pushed by the more stringent regulatory guidelines introduced in 2003.
The main driver of Standard & Poor’s ratings on Turkish and Lebanese banks will continue to be the political and economic environment. Turkey’s economic programme has delivered a strengthening of market confidence and a fall in interest rates in 2003. Ongoing efforts to keep the program on track and the strengthening of the regulatory regime should allow a continued recovery of the banking sector in 2004. The situation in Lebanon is more problematic. Political tensions have put the brakes on the government’s reform agenda and the future of the banking sector remains more tied in to the fortunes of the republic than ever.