Islamic Finance

Fitch Ratings: Kuwaiti banks more resilient than most GCC peers in current crisis

Fitch Ratings-Dubai/London-26 March 2020: Fitch Ratings believes Kuwaiti banks are in a better position than most peers in the Gulf Cooperation Council (GCC) to weather pressures in the current crisis of declining oil prices and coronavirus fallout.

We expect banks' Viability Ratings (VRs) to remain stable in the short-to-medium term. However, if the impact on the economy and on banks deepens, rating actions on VRs cannot be ruled out. This could, for instance, stem from halting oil or gas production, although the siloed nature of many oil sector facilities makes this a tail risk. All Kuwaiti banks' Long-Term Issuer Default Ratings (IDRs) are driven by an extremely high probability of support from the Kuwaiti authorities. All IDRs remain on Stable Outlooks, as Fitch does not expect any changes in the Kuwaiti authorities' propensity or ability to provide timely support to Kuwait banks if needed, in the short-to-medium term.

The Central Bank of Kuwait (CBK) has acted swiftly to weather the negative impact of the current crisis on the economy. It cut its discount rate (benchmark rate for Kuwaiti dinar lending) twice in March by a cumulative 125bp to a historical low of 1.5% in order to reduce the cost of lending and support domestic growth. The CBK does not automatically follow the Fed's rates changes: in 2017 and 2018, the CBK increased its discount rate only twice (by 25bp each time) out of the seven Fed-rate increases. The current CBK measures, therefore, reflect the severity of the current crisis and the authorities' high willingness to support the economy.

The recent sharp decline in oil prices will have adverse effects on Kuwait's public finances and debt dynamics, external balances and economic growth and will add to the pressure on the banks from the coronavirus fallout. As a result, we expect the banks' loan books to deteriorate, with additional restructuring and write-offs. Kuwaiti banks are highly exposed to real estate (about 23% of loans in Kuwait at end-2019), construction (about 5%) and consumer lending (about 43%, including 31% installment loans), which are all likely to be under pressure in the current crisis.

Real estate and construction sectors are likely to soften because of a slowdown in cash flow owing to delay in payments and project postponement, including from the government due to an expected tighter budget, as well as weaker demand for commercial and residential properties. The services and hospitality sectors will also suffer due to weaker domestic demand, even if tourism is underdeveloped in Kuwait.

Disruption to delivery of equipment for the energy sector, due to the effects of the virus on global supply chains or factory closures in countries of origin, may constrain the maintenance or construction of key facilities in Kuwait, similarly to other GCC countries. There is a further risk that oil infrastructure may face closures as part of efforts to contain the spread of the virus.

Interest-rate cuts will hit Kuwaiti banks' net margins. Repricing of the dinar loan books is highly sensitive to the CBK discount rate, essentially owing to regulatory pricing caps. The historical cut in the CBK discount rate to 1.5% will therefore act as downside pressure on the loan pricing of the Kuwaiti banks, especially given that the majority of corporate books re-price automatically with any change in the CBK discount rate and that the CBK closely monitors the banks' loan pricing. The Kuwaiti banking sector is also highly competitive and fewer lending opportunities will add downside pressure on loan pricing and margins.

Deposits reprice at maturity and not with the CBK discount rate. This means deposits typically reprice at a slower pace than loans. The resulting positive gaps and mismatches give rise to interest-rate risk, especially in the context of lower interest rates. The CBK's intervention on the market and close monitoring of banks may also affect deposit repricing.

However, we believe continued government spending on wages (civil servants are an important part of consumer lending in Kuwait with salary assignment) and investments (especially in the oil sector) and the CBK's proactive measures listed above will support bank credit growth to a larger extent than in most other GCC countries. Even if the banks' interest margins suffer from the lower interest environment, we consider that bank profitability will continue to be supported by strong cost efficiency.

In addition, bank liquidity should remain strong as it did during times of lower oil prices (unlike in most other GCC countries), supported by large and stable deposits from government-related entities (weighted average was between 25% and 30% of total customer deposits in the past five years). The Kuwaiti authorities are capable of covering the country's funding and liquidity needs from ample fiscal buffers and possibly larger Eurobond issuances despite the volatile financing conditions. Liquidity in Kuwait is neither dependent on remittances nor on external funding. Nevertheless, the CBK also cut the repo rates by 125bp (to 1% for overnight repos; 1.25% for one-week repos; 1.75% for one-month repos) to support bank liquidity and funding costs, if necessary. Kuwait interbank offered rates were also cut, which will support local interbank borrowing, but this remains a secondary funding source (about 4% of non-equity funding in Kuwait at end-2019; about 10% if non-resident banks are added).

Finally, bank capital ratios are expected to remain adequate. Kuwaiti banks also have the highest loan loss allowances of all GCC countries, owing to precautionary reserves (representing about 50% of total loan loss allowances) as imposed by the CBK over and above the specific and collective loan loss allowances. These provide good buffers for the banks to absorb higher and unexpected losses from the current crisis without consuming their capital.

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