Gulf-based banks should consider setting up an independent body to mitigate undesirable non-performing loans (NPLs) amid the ongoing pressure brought on by the coronavirus pandemic, according to global management consulting firm Arthur D Little.
The recommendation of the dedicated body closely aligned with the risk departments and commercial banking units comes as the volume of NPLs is expected to rise.
Arthur D Little said in a new report that the ongoing pandemic has resulted in Gulf economies confronting severe repercussions, with banking institutions widely expected to experience companies defaulting on loans and cashflow problems.
“The Covid-19 pandemic has devastated economic activity across the globe and GCC countries have not been shielded from these effects,” said Philippe DeBacker, managing partner, global practice leader financial services, at Arthur D Little.
“Major disruptions to the hospitality, retail, F&B, and travel and tourism sectors will severely impact both companies’ financials and overall employment levels in the GCC countries. This will, in turn, hinder the ability of GCC banks’ corporate and retail customers to repay loans and honour other commitments,” he added.
The report said the current crisis will impact banks with a “significant degree of strain” as economies in the region see severe GDP declines following pandemic-inducted lockdowns that will have a “devastating effect on companies and retail customers’ creditworthiness”.
“Looking ahead, it’s inevitable that NPL figures will rise quite substantially in the next year or two,” said Nima Obbohat, partner, global head of banking, Arthur D Little.
“Given the implications of rising NPLs on profitability and capital position of banks, it’s crucial to be well prepared and make the necessary adjustments ahead of time.”
The report said the current crisis will impact banks with a “significant degree of strain”
In the UAE, the report highlighted a slowing economy that will weaken banks’ asset quality and profitability.
“From a UAE standpoint, the impact of Covid-19 on SMEs compounded by the current low oil prices and the economic slowdown will drive problem loan increases and a rise in associated risks,” added DeBacker.
“Besides real estate, other industries are also witnessing substantial revenue declines. This damages credit quality and nonperforming loans will, most probably, reach a record high in this particular crisis. Although most banks are expected to remain profitable and government support to the banking sector is likely, asset quality will deteriorate and bank profitability will remain low. Therefore, minimising impacts and securing NPL value is essential.”
With regards to Saudi Arabia, the report said lower interest rates, hindered growth and higher risks will collectively increase pressure on Saudi banks’ profitability.
“Although institutions can navigate these issues and maintain a return on average assets of approximately 1.2 per cent in due course, careful management of NPLs will be essential,” it noted.
“So far, we do see a rather small uptake in NPL numbers at major financial institutions and the national level for all GCC countries,” revealed DeBacker. “We believe GCC banks became much more adept in handling NPL situations after the previous crisis, improving their capital position considerably.
“However, we are also of the view that a major uptake of the NPL levels across the region is not preventable. GCC banks should, with this in mind, have a strategy ready to go as soon as possible to manage their balance sheets through 2023.”
Arthur D Little also recommended that banks in the region might want to create a “bad bank” which entails segregating NPLs operationally, financially, and legally.
“It is crucial that banks confront today’s reality directly and make a well-informed decision on the strategy they wish to pursue,” said Obbohat.
“Because every bank will experience financial and operational situations stemming from higher NPL volumes, the issue is very time-sensitive. Middle Eastern banks are required to choose a strategy, build their capabilities, and ensure resources are in place ahead of schedule.
“Those that do so while adhering to these best practices will be better positioned to emerge from this crisis, with quicker recovery periods and better access to capital if and when required.”
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