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GCC Islamic Banks Will Likely Stay Resilient In 2019-2020

Like their conventional peers, Islamic banks in Gulf Cooperation Council (GCC) countries have seen growth slow in recent years. Some banks' exposure to Turkey has exacerbated the situation, after the country experienced significant volatility in 2018, and this remains a major source of risk, in our view.

However, despite this and challenges at home, several GCC Islamic banks maintained sound asset-quality and profitability indicators. In addition, their funding profiles remain healthy, dominated by core customer deposits, and capitalization is still a major positive rating factor.

Islamic Banks Lost Ground in 2018

In 2018, GCC Islamic banks expanded slower than conventional peers for the first time in five years. We attribute this to three main reasons:

  • Some of the Islamic banks we analyzed were hit by currency depreciation (particularly of the Turkish lira), which reduced their asset base in U.S. dollar terms.
  • Certain banks in the United Arab Emirates (UAE) recorded strong growth, but they represent only a small proportion of our Islamic banks sample, compared with the conventional one.
  • Islamic banks in Qatar displayed a negative growth rate for 2018 due to consolidation and the slowdown of some economic sectors in the country.

However, the growth difference was a mere 1%, which explains why we think the conventional and Islamic banks in our sample will see similar growth patterns in 2019-2020. We project mid-single-digit growth for both types of banks due to several factors. These include our forecast of muted GCC economic growth over this period, despite some benefit from government spending and strategic initiatives such as national transformation plans, the 2022 FIFA World Cup, and Dubai Expo 2020. We also assume that oil prices will average $60 per barrel (/bbl) in 2019 and 2020, pushing governments and the private sector to adopt a more careful approach to spending. We view the recent oil recovery as somewhat fragile and note that forward curves indicate market expectations of lower prices in the future.

Furthermore, we expect geopolitical risk to remain high, with pressure on some strategic sectors such as real estate in the UAE and Qatar. We think lower oil prices and geopolitical risk, combined with a few pressure points stemming from the global economy, will continue to weigh on consumer sentiment, prompting lower spending--especially if financed with debt.

Chart 1


Table 1

Balance Sheet Growth In Selected GCC Islamic Bank Markets (2013-2018)
(Mil $) 2013 2014 2015 2016 2017 2018
Qatar 58,098 69,419 81,381 87,866 95,756 94,800
Annual growth rate (%) 12.0 19.5 17.2 8.0 9.0 (1.0)
Relative weight is sample (%) 16.5 17.6 19.3 19.6 19.9 19.1
Kuwait 78,457 85,688 83,461 83,560 89,138 92,849
Annual growth rate (%) 8.0 9.2 (2.6) 0.1 6.7 4.2
Relative weight is sample (%) 22.3 21.7 19.8 18.6 18.6 18.7
Saudi Arabia 107,412 121,264 124,563 136,138 140,366 149,102
Annual growth rate (%) 8.0 12.9 2.7 9.3 3.1 6.2
Relative weight is sample (%) 30.6 30.8 29.6 30.3 29.2 30.1
United Arab Emirates 86,212 94,203 107,392 118,014 129,471 134,943
Annual growth rate (%) 16.0 9.3 14.0 9.9 9.7 4.2
Relative weight is sample (%) 24.6 23.9 25.5 26.3 27.0 27.2
Total 351,116 394,026 421,401 448,993 480,176 495,503

The Cost Of Risk Should Increase Slightly

GCC Islamic banks' asset-quality indicators stabilized in 2018, with the nonperforming financing ratio averaging 3.1% of total financings for the banks in our sample. Provisions more than covered these exposures with a coverage ratio of 167.7% on the same date. This was an improvement over 2017 thanks to the adoption of International Financial Reporting Standards (IFRS) 9 or Financial Accounting Standard (FAS) 30 for banks reporting under Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) standards.

Also, last year, Islamic banks' asset quality indicators did not deteriorate as did those of conventional banks, which saw their nonperforming loan (NPL) ratio increase to 3.1% on average from 2.7% at end-2017. We attribute this development to the clean-up and write-off operations of some Islamic banks in our sample, rather than a genuine improvement in asset quality.

We think that Islamic banks' asset quality should be similar, if not slightly weaker than that of conventional banks in the GCC. This is because both bank types are comparable, with businesses primarily comprising the collection of deposits and extending of finance to the real economy in their countries. Furthermore, Islamic banks tend to have higher exposure to the real estate sector due to the asset-backing principle inherent to Islamic finance. We also note that Islamic banks cannot charge late payment fees, unless they are donated to charities at the end of the exercise, meaning that clients tend to prioritize payments on conventional rather than Islamic exposures.

However, with the transition to IFRS9/FAS 30, Islamic and conventional banks will even more closely align. At end-2018, the average Stage 2 exposure for Islamic banks in our sample reached 10% of total exposure. It is worth mentioning that this number is just indicative as it includes an estimation of Stage 2 exposure for Kuwaiti Islamic banks, which are yet to publish their numbers. The amount of Stage 2 financing to total financing was 11.2% at end-2018 excluding our estimates for Kuwait.

We expect problematic assets to stabilize at about 15% of total assets in the next 12-24 months, with some transitions between Stage 2 and Stage 3 given the pressure on the real estate and contracting sector in some countries.

Another trend is the significant increase in Islamic banks' coverage ratios at end-2018, coupled with a stable cost of risk (excluding outliers) that is lower than conventional banks. Banks have taken the opportunity of IFRS 9 transition to set aside as many provisions as they can, given that the opening impact is charged to equity and not to income.

In addition, due to the asset backing principle of Islamic finance, banks tend to have more collateral than their conventional peers, at least in theory. This results in a lower loss given default (LGD) assumption and ultimately lower cost of risk. We believe that collateral realization is still difficult in the GCC although some authorities have implemented more creditor-friendly regulations over the past few years. In our base-case scenario, we expect cost of risk for Islamic banks, in our sample, to increase slightly in the next 12-24 months.

Table 2

Asset-Quality Of Islamic Versus Conventional Banks (2013-2018)
(%) 2013 2014 2015 2016 2017 2018
Islamic banks
Nonperforming advances ratio 4.2 3.3 3.0 3.1 3.2 3.1
Nonperforming advances coverage 106.5 114.2 128.4 135.3 131.6 167.7
New loan loss provisions (LLP)/average customer loans 1.00 0.92 0.95 0.83 0.74 0.65
Conventional banks
Nonperforming advances ratio 3.5 2.9 2.5 2.7 2.7 3.1
Nonperforming advances coverage 133.0 166.7 168.4 158.0 153.6 168.1
New loan loss provisions/average customer loans 1.01 0.87 0.92 1.18 1.06 1.09
Source: S&P Global Ratings, banks' financial statements.

Liquid Assets Should Improve Despite Slowing Deposit Growth

GCC Islamic banks' saw customer deposits growth halve to 2.5% in 2018, compared with 6.4% in 2017, on the back of the relinquishing some expensive deposits and the depreciation of the Turkish lira, which affected the U.S.-dollar denominated financial results of some banks in our sample. However, thanks to relatively muted loan growth, the funding profile of these banks remained stable and comparable with conventional peers. The ratio of financings to total deposits stood at 92.6% for Islamic banks in our sample at end-2018 and we do not expect major changes in the funding and liquidity profile in 2019-2020.

The stabilization of oil prices at $60/bbl and muted loan growth mean that Islamic and conventional banks will continue to accumulate deposits over the next few years. This should also lead to an increase in liquid assets held by banks, which stood at 21.4% of total assets at end-2018, in particular sukuk. Islamic and conventional banks' funding profiles remain a strength in most GCC countries. This is shown in our Banking Industry Country Risk Assessments (BICRAs) through our assessment of systemwide funding, which positively influences our assessed starting point of some bank ratings. Islamic banks tend to attract retail depositors due to their Sharia-compliant nature. The use of wholesale funding sources remains relatively limited and it will not change anytime soon.

Table 3

GCC Islamic Banks' Key Funding and Liquidity Metrics (2013-2017)
(%) 2013 2014 2015 2016 2017 2018
Growth in customer deposits N.A. 14.0 6.0 5.4 6.4 2.5
Liquid assets/total assets 24.7 23.4 22.1 21.3 21.0 21.4
Customer loans (net)/customer deposits 87.1 88.8 92.3 93.2 93.3 92.6
N.A.--Not available. Source: S&P Global Ratings, banks' financial statements.

We Expect Plateauing Profitability Growth In 2019-2020

We anticipate that GCC Islamic banks will see little profit growth in 2019 and 2020. In the past 12 months, the return on assets of banks in our sample improved marginally due to lower cost of risk, because the opening effect of IFRS9 is charged to banks' equity statements.

We expect financing growth to remain limited, with banks prioritizing quality over quantity and avoiding lucrative but higher risk exposures. This is especially the case given that IFRS 9/FAS 30 requires lifetime provisioning for exposures that deteriorate in credit quality or see repayment issues.

While we expect the amount of problematic assets to remain somewhat stable, we think that cost of risk will increase slightly because of higher provisioning requirements under IFRS9. This is somewhat tempered by the presence of a real underlying asset for each Islamic transaction, at least in theory, which reduces the LGD assumptions.

We project that banks' operating costs will stabilize and they will increase their focus on efficiency gains due to lower growth opportunities. However, banks should benefit from a bounty of free deposits, especially with the pause in international and local interest rate rises.

Our base-case scenario excludes any escalation of geopolitical risk in the region or a major drop in oil prices. If that were to happen, the effect on both Islamic banks and conventional banks could be significant.

Table 4

GCC Islamic Banks' Return On Assets (2013-2018)
(%) 2013 2014 2015 2016 2017 2018
Average intermediation margin 2.8 2.8 2.7 2.5 2.6 2.5
New loan loss provisions/average customer loans 1.0 0.9 0.9 0.8 0.7 0.5
Return on assets 1.5 1.5 1.6 1.4 1.5 1.6
Noninterest expenses/operating revenues 41.5 40.7 39.1 40.7 40.6 41
Source: S&P Global Ratings, banks' financial statements.

Banks Are Inching Closer To Profit And Loss Sharing

The GCC Islamic banks included in our sample continue to display strong capitalization by international standards, with an unweighted average Tier 1 ratio of 17.1% at end-2018. The roughly 50-basis-point decline in this ratio compared with 2017 is due to some banks' more aggressive dividend policies and IFRS9 implementation.

However, several banks in our sample have issued capital-boosting sukuk, primarily those in the UAE, Qatar, and Saudi Arabia. The common characteristic of these sukuk is that they allow for loss absorption at some point--generally at the issuer's discretion for Tier 1 sukuk. We believe these sukuk will help the industry progress toward one of its cardinal principles--profit and loss sharing. We incorporate some of these instruments, which allow the issuer to defer the periodic distribution of payments on a discretionary basis, in our total adjusted capital calculation.

It is our understanding that Oman is the only GCC country to progress toward a recovery and resolution regime. The sultanate recently approved a framework but the implementation timeline is unclear. We believe rolling out these regimes would require a profound change in the mentality and approach to bank support. GCC governments have not hesitated to rescue banks, as shareholders or to safeguard the financial stability of their banking systems.

There is a common perception that recovery and resolution regimes should be easy to implement in Islamic finance, due to the principle of profit and loss sharing. This means, in theory, natural and automatic bail-in, but we recognize there is additional complexity for the following reasons:

  • Banks conduct some of their operations in a debt-like format.
  • Covering losses other than those incurred on the specific underlying assets is not possible according to Sharia principles.
  • A lack of clarity on the type of instruments that can be bailed-in.
  • Asset transfers could be problematic.

Chart 2


Composition Of Our Sample

In order to assess the financial performance of Islamic and conventional banks in the GCC, S&P Global Ratings has used a sample of 17 Islamic banks and 27 conventional banks with total assets in excess of $2.0 trillion and sufficient financial disclosures. We have not included the Islamic windows/activities of conventional banks, owing to a lack of disclosure and the risk of distortion of data. For example, because conventional banks' Islamic windows/activities benefit from wider group support in the form of funding or cost sharing.

Study sample details

Table 5

S&P Global Ratings' Sample Of GCC Islamic Banks
Country Islamic Bank Ranking Overall Ranking Assets (bil. $)

Al Rajhi Bank

Saudi Arabia 1 5 97.3

Dubai Islamic Bank

United Arab Emirates 2 10 60.9

Kuwait Finance House

Kuwait 3 11 58.5

Qatar Islamic Bank Q.P.S.C.

Qatar 4 15 42.1

Abu Dhabi Islamic Bank PJSC

United Arab Emirates 5 19 34.1
Bank Al-inma Saudi Arabia 6 20 32.3

Masraf Al Rayan

Qatar 7 25 26.7

Al Baraka Banking Group B.S.C.

Bahrain 8 28 23.8
Bank Aljazira Saudi Arabia 9 31 19.5

Emirates Islamic Bank PJSC

United Arab Emirates 10 32 15.9

Boubyan Bank K.S.C.P.

Kuwait 11 36 14.3

Qatar International Islamic Bank

Qatar 12 37 13.8

Ahli United Bank B.S.C.

Kuwait 13 38 12.9

Barwa Bank Q.S.C.

Qatar 14 39 12.2

Sharjah Islamic Bank

United Arab Emirates 15 40 12.2

Al Hilal Bank PJSC

United Arab Emirates 16 41 11.9

Kuwait International Bank K.S.C.P

Kuwait 17 44 7.1
*Ranking by total assets. GCC--Gulf Cooperation Council. Source: S&P Global Ratings.

Table 6

S&P Global Ratings' Sample Of GCC Conventional Banks
Country Conventional Bank Ranking Overall Ranking Assets (bil. $)

Qatar National Bank (Q.P.S.C.)

Qatar 1 1 236.8

First Abu Dhabi Bank P.J.S.C.

United Arab Emirates 2 2 202.6

Emirates NBD PJSC

United Arab Emirates 3 3 136.2

The National Commercial Bank

Saudi Arabia 4 4 120.9

National Bank of Kuwait S.A.K.

Kuwait 5 6 90.3

Abu Dhabi Commercial Bank PJSC

United Arab Emirates 6 7 76.2

Samba Financial Group

Saudi Arabia 7 8 61.3

Riyad Bank

Saudi Arabia 8 9 61.3

Banque Saudi Fransi

Saudi Arabia 9 12 50.7

Arab National Bank

Saudi Arabia 10 13 47.5

The Saudi British Bank

Saudi Arabia 11 14 46.5


United Arab Emirates 12 16 38.1
The Commercial Bank of Qatar Qatar 13 17 37.1

Ahli United Bank B.S.C.

Bahrain 14 18 35.5

BankMuscat S.A.O.G.

Oman 15 21 31.9

Arab Banking Corp. B.S.C.

Bahrain 16 22 29.5

Union National Bank PJSC

United Arab Emirates 17 23 29.1

Gulf International Bank B.S.C.

Bahrain 18 24 27.5

Doha Bank Q.P.S.C.

Qatar 19 26 26.4

Burgan Bank

Kuwait 20 27 24.1
Al Awwal Bank Saudi Arabia 21 29 21.9

Gulf Bank

Kuwait 22 30 19.8

Al Ahli Bank of Kuwait K.S.C.P.

Kuwait 23 33 15.0

Commercial Bank of Kuwait

Kuwait 24 34 14.7
The National Bank of Ras Al-Khaimah United Arab Emirates 25 35 14.3
Ahli Bank Q.S.C. Qatar 26 42 11.1

National Bank of Fujairah PJSC

United Arab Emirates 27 43 10.8
*Ranking by total assets. GCC--Gulf Cooperation Council. Source: S&P Global Ratings.

Only a rating committee may determine a rating action and this report does not constitute a rating action.

Primary Credit Analyst:Mohamed Damak, Dubai (971) 4-372-7153;
Secondary Contact:Suha Urgan, Dubai (971) 4-372-7175;
Additional Contact:Financial Institutions Ratings Europe;

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