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Stress Scenarios: How GCC Banks Will Perform Amid Further Potential COVID-19 Shocks

S&P Global Ratings believes that the COVID-19 pandemic will continue to dominate the credit story for Gulf Cooperation Council (GCC) banks this year, as part of the wider narrative for emerging markets (EMs). In our view, vaccine rollouts and exceptionally accommodative monetary policy from developed market central banks will support recovery and financing conditions for EMs, excluding a major shift in investor sentiment. However, we still expect the asset-quality indicators of banks in EMs to weaken, with the GCC no exception.

For this report, we estimated rated GCC banks' credit loss absorption capacity under different scenarios of nonperforming loan (NPL) coverage by reserves using two simulations. In the first, we focused on banks' profitability (net operating income before provisions) and any excess or deficit of provisions compared with our predetermined coverage thresholds. In the second, we incorporated banks' excess capital buffers in our calculation of their risk-adjusted capital (RAC) ratio relative to the threshold for a weaker assessment of capital and earnings.

Overall, we estimate that rated banks in our sample can absorb a shock of $31 billion-$45 billion (in aggregate) with a limited automatic effect on our assessment of capitalization. This rises to $114 billion when banks hit the boundaries for a potentially weaker assessment of capital and earnings under our criteria and corresponds to a 3.1%-11.3% increase in their NPLs.

The largest absolute capacity to absorb losses lies with Saudi banks, which dominate the pack due to their size. When compared with total lending, Kuwait's banks stand out given their significant provisions accumulated over the years. At year-end 2020, the total lending of banks in our sample was about $1.0 trillion.

Of note, these aggregate numbers do not reveal important differences between banks. Equally, the figures do not necessarily speak to potential ratings movement because they cover only one narrow angle of banks' credit stories--although they do provide valuable insights for our analysis.

S&P Global Ratings believes there remains high, albeit moderating, uncertainty about the evolution of the coronavirus pandemic and its economic effects. Vaccine production is ramping up and rollouts are gathering pace around the world. Widespread immunization, which will help pave the way for a return to more normal levels of social and economic activity, looks to be achievable by most developed economies by the end of the third quarter. However, some emerging markets may only be able to achieve widespread immunization by year-end or later. We use these assumptions about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: As the situation evolves, we will update our assumptions and estimates accordingly.

The Pandemic Has Already Cost Rated GCC Banks $10.9 billion In New Provisions

Over the past 12 months, GCC banks have set aside $10.9 billion of additional credit loss provisions for the expected negative impact of the COVID-19 pandemic and drop in oil prices on their economies. Despite regulatory forbearance measures, which allowed banks to smoothen the profitability hit, cost of risk for rated banks increased by almost two-thirds--reaching 150 basis points (bps) at year-end 2020 compared with 90 bps at year-end 2019. Some banks were exposed to specific one-off default cases (such as the significant fraud that occurred in a large corporate or the liquidation of a major construction company in the United Arab Emirates [UAE]). Others, simply decided to err on the side of caution and took provisions to prepare for the lifting of regulatory forbearance measures, which would almost certainly crystallize some risks. Although we expect forbearance measures to be lifted in 2021, the process should be smooth, with regulators unlikely to take major steps that could endanger the financial health of their banking systems, in our view. Furthermore, we note that, despite an increase in cost of risk, most rated banks remain profitable and only a few showed statutory losses in 2020, either due to high exposure to vulnerable asset classes or management's conservative stance in dealing with the shock aftermath. GCC banks' high contribution of net interest income to total revenue, hefty margins, and sound operating efficiency have also helped their performance (see chart 1).

Chart 1


What Additional Credit Losses Can Rated Banks Absorb?

To assess banks' buffers against credit losses, we conducted two simulations using three scenarios. The first simulation starts with reported numbers for banks' net operating income before loan-loss provisions for 2020 because these already account for any negative COVID-19-related effects from lower interest margins and declining lending growth. We then looked at the existing stock of NPLs (or assets, depending on the system and using year-end 2020 numbers). We compared this stock to the existing loans-loss provisions using three assumptions:

  • Scenario 1: 70% coverage of the existing NPL stock. This is commensurate with other EM countries' loss experience.
  • Scenario 2: 100% coverage of the existing NPL stock. Here, we pushed the stress a bit further and assumed that recovery prospects would differ from historical performance due to the pandemic. In addition, given regulatory forbearance measures, we think that the full extent of COVID-19-related asset-quality deterioration is yet to crystallize.
  • Scenario 3: 120% coverage of the existing NPL stock. This factored in any additional provisions banks might take on International Financial Reporting Standard 9 Stage 1 and Stage 2 loans.

Looking at the profit and loss statement gives only a partial view of banks' loss-absorption capacity. Therefore, in our second simulation we used banks' projected RAC ratios, stripping out the existing margin in each RAC ratio compared with the lower threshold in our methodology typically associated with maintaining the same capital and earnings assessment. This margin was then converted into loan-loss absorption capacity using the coverage ratio assumption. These numbers do not necessarily speak to potential rating movement because they cover only one narrow angle of banks' credit stories. For example, our assessment of risk position serves to refine the view of a bank's actual and specific risks beyond the conclusion arising from the standard assumptions in the capital and earnings analysis. Therefore, a RAC projection falling under a certain threshold would not automatically lead to a lower rating under our criteria. Conversely, we could lower our ratings on banks well ahead of credit losses that lead to our projection falling below any of these thresholds. Nevertheless, these figures do provide valuable insight in our analysis.

Chart 2


Rated Banks' Capacity To Absorb Losses Varies Significantly

In aggregate, banks in our sample can withstand a shock of $31 billion-$45 billion based on simulation 1 and $54 billion-$114 billion based on simulation 2--depending on the scenario. Saudi Arabia represents 40%-50% of these numbers given Saudi banks are the largest contributor in our sample. They are followed by Qatari banks, but this is instead due to their strong profitability and capitalization, with Kuwaiti banks the third largest contributor. Bahrain and Oman's marginal contribution is explained by the limited number of rated banks in each country, while for the UAE in fourth it is explained by the lower starting point for the coverage ratio. Looking at the relative numbers gives a better perspective on loss-absorption capacity. Kuwait is the outlier here based on the first simulation thanks to the significant provisions accumulated over the years. Saudi and Qatar have the second and third highest resilience due to banks' strong profitability in these countries. The UAE came fourth due to asset-quality issues that emerged in 2020, which have reduced banks' capacity to absorb losses (see table 1). When adding the capitalization angle, credit loss absorption capacity increases significantly. GCC banks tend to have strong capitalization, which will help them navigate the stressed operating environment (see table 2).

Table 1

Absolute Credit Loss Absorption Capacity
(Bil. $)
Simulation 1 Simulation 2
70% coverage 100% coverage 120% coverage 70% coverage 100% coverage 120% coverage
Bahrain 1.8 1.4 1.1 Bahrain 4.7 2.9 2.2
Qatar 11.3 9.5 8.3 Qatar 26.2 16.6 12.8
Kuwait 5.8 5.2 4.8 Kuwait 11.6 7.5 5.9
United Arab Emirates 7.2 3.6 1.1 United Arab Emirates 24.2 13.3 9.0
Saudi Arabia 18.2 16.2 14.9 Saudi Arabia 43.6 28.5 22.7
Oman 1.1 0.9 0.7 Oman 3.5 2.2 1.7
Sum 45.5 36.8 30.9 Sum 113.9 71.0 54.3
Note: For example, with 100% coverage, rated banks in Qatar can absorb a $9.5 billion increase in nonperforming loans based on Simulation 1 results. Source: S&P Global Ratings

Table 2

Relative Credit Loss Absorption Capacity
Simulation 1 Simulation 2
70% coverage 100% coverage 120% coverage 70% coverage 100% coverage 120% coverage
Bahrain 4.9 3.7 3.0 Bahrain 12.6 7.7 5.8
Qatar 4.2 3.6 3.1 Qatar 9.8 6.2 4.8
Kuwait 5.5 4.9 4.6 Kuwait 10.9 7.1 5.6
United Arab Emirates 3.4 1.7 0.5 United Arab Emirates 11.2 6.2 4.2
Saudi Arabia 5.1 4.5 4.2 Saudi Arabia 12.2 8.0 6.3
Oman 4.7 3.6 2.9 Oman 14.6 9.1 7.0
Weighted average 4.5 3.7 3.1 Weighted average 11.3 7.0 5.4
Source: S&P Global Ratings

Furthermore, to assess the magnitude of calculated loss-absorption capacity, we have compared the results of scenario 2 with individual banks' total loans and reported cost of risk for 2020. Based on simulation 1, the top five banks with the highest capacity to absorb losses were in Kuwait, Bahrain, Saudi Arabia, and Qatar. The bottom five were in the UAE, Bahrain, and Saudi Arabia. If we add the capitalization angle, the picture doesn't change materially.

Chart 3


Chart 4


Note: For example, for KUW4, the loss absorption capacity is equivalent to 7.1% of total loans and 4.8x the cost of risk of 2020.

GCC Banks Face A Long Climb To Recovery

Despite the recent rally in oil prices and brighter near-term outlook for economic recovery, GCC banks' operating performance will remain constrained by the protracted recovery in key economic sectors and low interest rates. S&P Global Ratings expects GDP growth in the GCC countries will slowly recover from last year's sharp recession triggered by the COVID-19 pandemic and low oil prices. However, we see long-lasting adverse effects from the 2020 shock on GCC economies and banking sectors. Saudi and Qatar's banking sectors will be less affected than those in the UAE, Oman, and Bahrain, while in Kuwait the story will depend on the evolution of the fiscal impasse.

We expect banks' asset-quality indicators will continue to deteriorate and cost of risk to remain high as they start recognizing the true impact of 2020 and forbearance measures are lifted in second-half 2021. Given continued low interest rates, banks' profitability will remain low in 2021 and beyond, with some potentially showing losses this year. Nevertheless, strong, and stable capital buffers, good funding profiles, and expected government support should continue to reinforce banks' creditworthiness in 2021.

Related research

This report does not constitute a rating action.

Primary Credit Analyst:Mohamed Damak, Dubai + 97143727153;
Secondary Contact:Dhruv Roy, Dubai +971 (0) 4372 7169;

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