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Amid blockade, Qatari banks face new regulations that may expose vulnerabilities

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Amid blockade, Qatari banks face new regulations that may expose vulnerabilities

Some of Qatar's largest banks may need to raise capital to comply with Basel IV's stricter capital requirements ahead of its introduction in 2022, and in the nearer term the country's banking sector must also take steps to prepare for the introduction of VAT.

Qatar's banking sector has combined assets of $421.76 billion as of year-end 2018, and the country's flagship lender Qatar National Bank (QPSC) is the largest by assets in the Middle East and Africa. The sector has come under pressure due to the imposition of a Saudi Arabia-led economic blockade in June 2017. The Saudis, along with regional partners, continue to enforce their blockade, accusing its former ally of supporting terrorism, a charge Qatar denies.

For Qatari banks, key risk areas are the real estate, contracting and hospitality sectors, according to S&P Global Ratings. "We believe the ongoing boycott is having a negative impact on these sectors and will likely result in new nonperforming loans," the rating agency said in its 2019 Qatar Risk Assessment report.

New regulations

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The introduction of new International Financial Reporting Standards in 2018 led to what S&P Ratings called a "slightly negative trend in asset quality" at Gulf banks and the transition has highlighted some fragility in Qatar's banking sector.

Tougher capital requirements as part of the Basel IV regulations, which are poised to be introduced in 2022, are expected to do the same as some Qatari lenders will have to significantly raise their capital, while banks generally will have to upgrade their data, systems and reporting standards, KPMG said in a report into the country's banking sector.

"The implementation of the Basel IV standards will change banks' risk measurement and risk models to a much greater extent than Basel III," KPMG said.

In terms of capital strength, Doha Bank QPSC and Commercial Bank (PSQC), Qatar's third- and fifth-largest banks by assets, according to S&P Global Market Intelligence data, have the lowest common equity Tier 1 ratios among the country's banks. They may have to increase their capital to meet new Basel IV requirements, but not in the short-term.

"Some banks have already changed their dividend policies to reduce payout ratios as a result of Basel III and IFRS 9 adoption," said Elena Sanchez-Cabezudo, head of MENA financials and equity research at EFG-Hermes in Dubai.

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The IFRS 9 accounting standard deploys an expected loan-loss model, so banks must take provisions on each loan at its outset, rather than booking provisions when a borrower defaults.

"So far, there's been little impact in terms of the cost of risk although in the long-term the cost of selling loans may increase because banks will have to take a provision upfront in case of a future default," said Sanchez-Cabezudo.

Among Gulf banks it is two Qatari banks, Commercial Bank and Doha Bank again, which have the highest Stage 2 loan ratios under IFRS 9, according to an S&P Ratings report into the accounting standard's impact on banks in the region. These underperforming books at Commercial Bank and Doha Bank — as opposed to Stage 1 performing loans and Stage 3 nonperforming loans — are a result of their exposure to Qatar's real estate sector, the ratings agency said.

Qatari lenders posted among the largest increases in Stage 3 loans, with S&P Ratings also warning that some Stage 2 loans will progress into Stage 3 over the next 12-24 months.

Commercial Bank and Doha Bank are most vulnerable to any changes to minimum capital adequacy ratios as mandated in Basel IV, analysts said.

"Both banks are compliant with Basel III, but their buffers aren't substantial," said Chiradeep Ghosh, a banking analyst at Sico in Bahrain.

Qatari banks' average core Tier 1 capital adequacy ratio is around 11.5%, which is comfortably above the Basel III minimum, according to Sico estimates.

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VAT to hit margins

Qatar had originally planned to launch VAT at a rate of 5% in late 2018 but delayed its introduction following the imposition of the blockade.

Banks in the UAE and Saudi Arabia, which imposed VAT in 2018, have been able to recoup only a small part of VAT expenses incurred on the likes of office leases, utility bills and marketing, according to KPMG. In those countries margin-based products, including loans and mortgages, are VAT-exempt, while fee-based products and those that include commissions, rebates or discounts are liable for VAT. These include money transfers and ATM charges.

Doha could take a different approach, KPMG has predicted, by exempting core financial services. Advisory-based services such as wealth management and writing would still be taxed.

"VAT will apply primarily to fee income, which usually is not more than 10% to 15% of bank revenue even if the banks were to totally absorb these extra costs, rather than passing on any of the extra costs to customers, VAT won't have a huge impact," said Ghosh.

"VAT could lower banks' profits by 2% to 3%, but not more than that."

Nevertheless, KPMG warned that irrecoverable VAT costs as well as compliance expenses, which are usually high due to the complexity of financial services, will probably lead banks to up fees to compensate for extra hidden costs.

Any increases will be limited, however, because the central bank regulates bank commission fees, making it difficult for banks to pass on any increased costs arising from VAT, which would turn could pressure profit margins.

VAT will not apply to employee salaries, so banks could opt to bring outsourced back-office activities back in-house, such as call centers and IT support, according to KPMG.

"That assumes banks have the capacity to do that," said Jaap Meijer, managing director of research at Dubai's Arqaam Capital.

Don't discount delay

Qatar's 2019 annual fiscal surplus could be 9.3% and its current account surplus will likely be around 5.8% of GDP, Arqaam has estimated, based on an average oil price of $70 per barrel. This would provide the government with ample room to loosen fiscal policy and potentially delay the implementation of VAT, Meijer said.

Uncertainty remains as to whether VAT will be introduced as scheduled. Sanchez-Cabezudo met with the management of several Qatari banks in Doha in August. The prospect of VAT was little mentioned, she said.