By Hilary Schmidt, International Banker
Thanks to a solid combination of increasing lending volumes, higher fee incomes, stable margins and strong cost efficiencies, credit-rating firms, such as S&P Global Ratings and Moody’s, foresee a bright future ahead for Gulf Cooperation Council (GCC) banks, stretching well into 2025. And with the burgeoning Islamic-finance sector also being touted as taking a front-row seat in terms of growth for many of the leading lenders of the regional political and economic union comprising Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates (UAE), few regions will enjoy as strong an operating environment for their banking industries as the GCC.
Indeed, as McKinsey & Company observed in June, the GCC’s banking sector boasts an “exceptionally high” return on equity (ROE), having yielded healthy gains for shareholders over the past decade and outperformed the global average. “While the gap has narrowed in recent years, ROE among GCC banks continued to exceed the global average by three to four percentage points during the 2022–23 period,” the consulting firm reported, also noting that GCC banking has some of the largest multiples globally. “Historically low valuations and declining price-to-book ratios still characterize the global banking industry, but GCC banks are creating value by delivering ROE above their cost of equity. Meanwhile, elevated interest rates have pushed banking profits—both in the region and globally—to record highs.”
In its thorough analysis of the region, McKinsey highlighted that GCC banks’ exceptional net interest margins continue to “significantly exceed” the global banking average—1.1 percent versus 0.71 percent. “The revenue-to-assets ratio for GCC banks is 3.2 percent, well above the global average of 2.3 percent,” McKinsey further added. “This gap reflects both the region’s wider net interest margins and its superior net interest income of 2.3 percent compared with a global average of 1.4 percent.” And while the report acknowledged that GCC banks have higher average impairment costs than banks globally, it also highlighted that their operational costs are lower and that they are better capitalised.
It should not be surprising, then, that rating firms in 2024 are effusive in their praise for the GCC banking sector, not only regarding its overall health this year but also the strong likelihood that it will continue to thrive over the coming months and years. According to an S&P analysis published on September 4, much of the positive outlook for GCC banks can be credited to the non-oil sectors in Saudi Arabia and the UAE, which generated a 10.4-percent annualised lending growth for the top 45 GCC banks during the first half of 2024, markedly higher than the 6.7-percent growth posted in 2023.
The same six-month period also saw solid net interest margins (NIMs) at 2.7 percent for the regional banking sector posted amid the “higher-for-longer interest rate” environment, despite the continuing long-term declining trend in deposits in non-interest-bearing (NIB) instruments in favour of remunerated ones. Indeed, NIBs reached 45 percent at the end of last year, down from 48 percent at end-2022, and have continued to drop further in 2024. Steady non-oil growth also supported asset quality in the year’s first half, enabling banks to maintain strong profitability, as return on assets (ROA) rose from 1.65 percent at the end of 2023 to 1.74 percent at the end of June 2024.
S&P has forecasted “sustained strong performance” for GCC lenders for the remainder of the year, which, in turn, should help them remain resilient in the face of potentially mounting operational headwinds. “Yet, still-muted real estate performance in Qatar and Kuwait—notably due to oversupply and subdued demand, respectively—could present risks for those banking sectors,” according to the rating firm. “However, banks’ strong provisions in Kuwait and the state’s strong footprint in the Qatari economy will likely support banking sector resilience.” S&P also cited “conservative dividend payouts” as significant in supporting banks’ capitalisation, with the average Tier 1 ratio for S&P’s sample of GCC lenders standing at 17.1 percent, slightly lower than the 17.3 percent recorded at the end of 2023.
This sector strength is also prompting GCC banks to embark on more adventurous overseas activities, with many reportedly keen to expand their presences in important neighbouring markets, such as Türkiye, Egypt and India. According to Fitch Ratings, strongly improving economic conditions and better growth opportunities compared to their domestic markets are leading GCC banks to seek acquisition opportunities in the three countries, with some Gulf lenders seeking to diversify their business models and improve profitability via external markets with strong growth prospects. In turn, this should compensate for weaker growth in their home markets, Fitch also noted.
“Türkiye, Egypt and India each have much larger populations than the GCC and greater potential for bank sector growth given their strong real GDP growth prospects and smaller banking systems relative to their economies. Their banking system assets/GDP ratios are below 100 percent, compared with over 200 percent in the largest GCC markets, and private credit/GDP was only 27 percent in Egypt, 43 percent in Türkiye and 60 percent in India in 2023,” Fitch stated in a research piece published on July 23. “GCC banks’ main exposure outside the GCC region is through subsidiaries in Türkiye and Egypt, where they had about USD150 billion of assets at end-1Q24. While these markets are the main focus for growth, there is increasing interest in India, particularly from banks from the UAE, which has strong and growing financial and trade links with India.”
Another key business line for GCC banks in 2024 to date has been Islamic finance, which has been an instrumental pillar of support for Saudi Arabia’s Vision 2030 programme. Indeed, Saudi Arabia has the largest proportion of Islamic financing (85 percent) compared to its conventional banking system, with the UAE, Oman, Kuwait and Qatar also reportedly showing signs of strong growth potential in this sector. What’s more, Moody’s has predicted growth in the Islamic-finance sector to outpace that of traditional banking across the GCC region over the next 12 to 18 months, thanks mostly to continued economic expansion and buoyant demand for Shariah-compliant products.
According to a mid-September report from Moody’s, Islamic banks in the GCC will enjoy strong profitability over this period, backed by their respective governments’ efforts to diversify economies and increase commercial activities. “Islamic banks across most of the region have ample liquidity to support their expansion, thanks to strong deposit inflows,” the report noted. “However, Islamic banks will continue to hold relatively lower levels of liquid assets than their conventional peers, reflecting a lack of liquid Shariah-compliant financial instruments for liquidity management.”
In Oman, for instance, the combined assets of Islamic financial institutions surged by 18.1 percent last year to reach $20.2 billion, or a sizeable 11.4 percent of the country’s total banking assets. Total financing, meanwhile, reached $16.6 billion, a rise of 10.4 percent across the year, and deposits in Islamic institutions rose by 14.7 percent to nearly $15.5 billion by June 2024. “Sustained economic growth, government commitment to bolstering the broader Islamic finance industry, and increasing demand for Shariah-compliant products in the GCC region will continue to drive Islamic finance growth, outpacing its conventional peers,” Badis Shubailat, assistant vice president and analyst at Moody’s, stated.
Such promising assessments strongly suggest that GCC banking will continue to strengthen into 2025. Estimating possibly 150 basis points in total rate cuts being administered by the Federal Reserve System (the Fed) in the United States between September 2024 and the end of 2025, S&P calculated that around 12 percent of GCC banks’ net income would be trimmed as a result, based on 2023 comparisons of each 1-percent drop in rates reducing the bottom lines of such banks by 8 percent. That said, banks’ ability to control costs may reduce that impact below 12 percent. “This is also likely to create some breathing space for highly leveraged corporates and retail clients, thereby supporting asset quality,” the rating firm added.
And if the ongoing military conflict in Western Asia escalates into a full-blown regional war…what then? Such a scenario remained outside S&P’s base-case assessment. Nonetheless, it showed support for GCC sovereigns and banks in such a situation, arguing that they remain resilient enough to withstand the adverse impacts of geopolitical risks, assuming that severe downside scenarios such as the closures of key export routes or threats to domestic security do not arise.
“A sharp increase in uncertainty could trigger detrimental capital outflows or prompt sovereigns to liquidate external assets and provide support, as we saw in previous episodes of heightened geopolitical risk,” S&P also warned. “Although external debt has risen for Bahrain and Saudi Arabia, the risks are still in check. The Saudi net external debt position remains small and owing to significant regional deposits at Bahrain’s banks, which we expect will remain stable in most scenarios. The UAE and Kuwait remain in a net external asset position. Qatar’s external debt has stabilized, and we assume that any unexpected outflows will prompt government support, as occurred during the boycott in 2017.”