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Gulf-based Islamic banks grapple with weakening regional economies

UAE. After delivering strong results in 2014, Islamic banks in the Gulf region face a gradually weakening operating outlook in 2015-2016, largely due to declining oil revenues, says a report published today by Standard & Poor’s Ratings Services.

But as the report, titled “Gulf-Based Islamic Banks Grapple With Weakening Regional Economies,” also points out, we believe investor demand for Sharia-compliant products and supportive government actions will enable Islamic banks in the region to continue to grow and gradually increase their market share.

Report overview

• Gulf-based Islamic banks ended 2014 with healthy balance-sheet growth and improving bottom line results.
• We expect 2015–2016 to be relatively less benign for Gulf Islamic banks in general, although we still believe the long-term supportive factors for these banks remain unchanged.
• In our view, Qatar, Saudi Arabia, and the United Arab Emirates continue to offer the strongest growth opportunities in the GCC region.

Global oil prices have plummeted since June 2014, and Standard & Poor’s expects them to remain relatively weak through 2016. Specifically, we forecast Brent crude to average $55 per barrel in 2015, $65 in 2016, and about $75 in 2017.

Given the importance of oil-related revenues to the region’s economies, the ensuing gradual weakening in economic conditions for the sovereign states that make up the Gulf Cooperation Council (GCC)–Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates (UAE)–will in our view adversely affect their banking sectors.

That said, we believe investor demand for Sharia-compliant products and supportive government actions will enable Islamic banks to continue to grow and gradually increase their market share.

“After several years of improving returns and strong growth we expect a gradual change in the operating conditions for Islamic banks in the Gulf in 2015–2016, largely as a result of the weakness in oil prices and its effects on regional economies,” said Standard & Poor’s credit analyst Timucin Engin.

 “Although our credit growth projections remain largely unchanged for 2015, we believe deposit growth will slow somewhat due to relatively weaker liquidity conditions and asset quality will gradually deteriorate in line with the economic slowdown.”

 “These factors will in our view gradually increase credit losses at Islamic banks in 2015, leading to lower net income growth than in 2014,” added Standard & Poor’s credit analyst Suha Urgan. “Given that Islamic banks generally operate with healthy funding and capital positions, we expect them to adopt a conservative stance in 2015 and maintain strong levels of capital while looking to further diversify their funding base.”

The report focuses on pure-play commercial Islamic banks and does not take into account the Islamic assets of conventional banks in the Gulf Cooperation Council (GCC) region. We also exclude Islamic investment banks whose revenues are primarily driven by capital markets and investment-related activities. Our research shows that GCC-based Islamic banks increased their balance sheets by an average of 15.2% between 2009 and 2014, while their conventional peers registered an 8.8% increase. In 2014, Gulf-based Islamic banks grew at a rate of 12.6%, against 9.6% for conventional banks.

In our opinion, the two most important factors influencing the Islamic banks’ faster growth are an increasing demand for both retail and corporate Sharia-compliant banking products and government initiatives designed to support Islamic finance.

Photo Caption: Timucin Engin, Standard & Poor’s credit analyst

Standard & Poor’s Ratings Services’ analysis of the 2014 performance of a sample of 17 GCC-based Islamic banks–all pure-play commercial Islamic banks with a minimum balance sheet size of $5 billion–shows that they registered healthy balance-sheet growth of around 13% last year. At the same time, these financial institutions continued to make further recoveries in their lending books and improve bottom line results, supported by declining credit losses.

Standard & Poor’s Ratings Services, a part of McGraw Hill Financial (NYSE: MHFI), is the world’s leading provider of independent credit risk research and benchmarks. We have approximately 1.2 million credit ratings outstanding on government, corporate, financial sector and structured finance entities and securities. With nearly 1,400 credit analysts in 26 countries, and more than 150 years’ experience of assessing credit risk, we offer a unique combination of global coverage and local insight. Our research and opinions about relative credit risk provide market participants with information and independent benchmarks that help to support the growth of transparent, liquid debt markets worldwide.

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