IFRS 9: A Clear View Of GCC Banks Asset Quality

It’s been a year since banks in the Gulf Cooperation Council adopted International Financial Reporting Standards (IFRS) 9. The overall impact of IFRS 9 has been manageable and predicts a stabilisation of asset quality indicators over the next 12-24 months unless the oil price drops unexpectantly or geopolitical risk increases.

Rated banks in the GCC showed a slight deterioration of their asset quality indicators in 2018 because of the less -supportive economic environment. Credit impaired loans (Stage 3) comprised 3.1 per cent of their total loans on average at year-end 2018, up from 2.6 per cent at year-end 2017. 

The deterioration was mostly visible in Qatar, the UAE, and Saudi Arabia.

In the UAE, the proportion of nonperforming loans (NPLs) increased due to the pressure on the SMEs and the real estate sectors. Meanwhile, in Saudi Arabia, NPLs went up due to a significant outflow of expatriate workers as the contracting sector faltered and consumption dropped. Finally, Qatari banks depressed real estate prices and hospitality sector lead to higher NPLs. Banks in Bahrain and Oman showed a smaller increase in NPLs over the past year.

In Bahrain, the primary reasons were a flagging real estate sector and, for some banks, their overseas business; whereas in Oman this was due to the strain on the retail sector. Kuwait is the only GCC country where the asset quality indicators for rated banks have improved. We believe this is because of write-offs, rather than a genuine improvement in the underlying asset quality. The adoption of IFRS 9 clearly shows where asset quality indicators might be heading in the next 12-24 months as each bank’s IFRS 9 disclosures reveal its Stage 2 loans.

On average, Stage 2 loans (those loans which are underperforming) comprised 10.6 per cent of total loans for rated banks, including our estimated figure for Kuwait; excluding Kuwait, the figure is 11.8 per cent. However, the distribution reveals that tier 1 banks saw a minimal level of Stage 2 loans, except in Oman, where the economy has been subject to significant stress. S&P expects the total amount of loans at either Stage 2 or Stage 3 to remain stable at around 15 per cent of total loans over the next 12-24 months.

However, we could see more loans migrating to Stage 3 from Stage 2 and banks pursuing more-aggressive write-off practises. We also anticipate most of the deterioration is likely to occur at smaller banks in each system as large banks typically adopt a conservative risk management practises and are selective in their lending.

The average cost of risk for rated GCC banks dropped by 10 bps in 2018 in comparison to 2017, despite the increase in NPLs. However, we believe this is due to the transition to IFRS 9, where the opening impact is charged to the bank’s equity and not to its income statement. Despite the transition and the fact that banks had to take the hit upfront, most of the banks decided to maintain a stable charge in their income statement.

 It is important to note that cost of risk dropped in Qatar and the UAE but was stable in all the other countries. In the next 12-24 months, we expect cost of risk to remain between 100 - 150 basis points (bps) as we do not exclude migration of some exposures between Stage 2 and 3.

Total coverage (classified as provision for Stage 1, 2 and 3 loans, divided by total Stage 3 gross loans) also increased due to the mechanical effect of the new stock of provisions, reaching 162 per cent for the banks that we rate at year end 2018, compared with 144 per cent at year-end 2017. This supports our finding that IFRS9 did not significantly weigh on banks’ equity statements or cost of risk.

In practise, banks have used their existing general provisions to cover for the additional provisions. In the next 12-24 months, we expect GCC banks’ stock of problematic loans (that is, those at either Stage 2 or Stage 3) to remain stable, but that some Stage 2 loans will migrate to Stage 3. If the GCC maintains its slight economic recovery, we expect the pace of migration to also slow, compared with 2018.

Under our base-case scenario, we assume that oil price will average $60 per barrel in 2019 and that geopolitical risk will remain high but stable. If the oil price were to fall significantly, asset quality indicators might weaken more than we expect.

Although we expect the overall stock of problematic assets to remain stable, and do not exclude migrations to Stage 3 from Stage 2, we consider that our ratings already factor in most of the impact of adopting IFRS 9. In addition, the impact of IFRS9 on banks’ equity was largely manageable and did not cause a major drop in their capitalisation which is why 87 per cent of our rated banks in the GCC carry a stable outlook.