Gulf Cooperation Council (GCC) banks are likely to face persistent structural asset-quality challenges and elevated event risks over the next credit cycle, Moody's Investors Service said Friday. These challenges have exacerbated the effect on banks of the last boom-and-bust cycle and will likely remain vulnerable to these stresses in the future, it added. ‘At the heart of these banks' structural asset-quality challenges are the undiversified GCC economies that are dependent on oil and gas exports which magnify the impact of economic cycles on the banks. This is further aggravated by the dominant role of governments and large family-owned conglomerates in the region, which then leads to large sector and single-borrower concentrations in bank loan portfolios,” it noted. As a result, a few large corporates in distress or a downturn in one key sector can have an outsized effect on bank asset quality. This overall lack of diversification makes the region, and therefore its banks, more vulnerable to political, economic and credit event risks, Moody's pointed out. Furthermore, less developed corporate governance standards and historically loose underwriting criteria in the region have contributed to a high level of related-party and so-called “name lending”, which is the practice of basing lending decisions primarily on the borrower's reputation rather than on objective, risk-based criteria. Widespread related-party lending and a heightened risk appetite at banks facilitated rapid balance sheet growth during the boom that lasted from approximately 2002 through 2008, but also laid the foundation for sharp asset-quality deterioration experienced in the subsequent downturn. Despite the economic recovery that has broadly taken hold across the GCC region since 2010, “we expect that these structural asset-quality challenges will persist,” Moody's said. The economic base and institutional structure of the member states are unlikely to change substantially over the next few years, as a result, structural asset-quality challenges will continue to limit GCC banks' credit strength and constrain many of their standalone ratings. Moody's moreover said that during the past boom, banks made efforts to diversify through growth in neighboring booming markets, yet, “in many cases this only deepened their exposure to the region's most leveraged and ultimately distressed credits.” More prudent lending since the crisis started in 2008 and stricter regulatory requirements are credit positives, but will only partly mitigate the aforementioned risks, it added. Regional tensions can materially and rapidly alter the operating environment for banks, Moody's said in its Special Comment. Political event risk is another factor that affects GCC banks. Recent unrest in Jordan, Egypt, Tunisia, and GCC member state Bahrain has already weakened the credit strength of banks domiciled in these countries, resulting in negative rating actions. “Political event risk is another factor that affects GCC banks. Recent unrest in Egypt, Tunisia, Jordan and GCC member state Bahrain has already weakened the credit strength of banks domiciled in these countries, and resulted in negative rating actions.” This can, in turn, also have a significant negative impact on asset quality, both in the short and long term, while liquidity and other aspects of a bank's standalone credit strength can also be affected, it noted. Moody's said a few large corporates in distress or a downturn in one key sector can have an outsized effect on bank asset quality, it pointed out, saying that “this overall lack of diversification generally makes the region, and therefore its banks, more vulnerable to political, economic and credit event shocks.” However, Moody's also said that government support keeps GCC banks strong and maintain the positive rating. “The principal factor that underpins these banks' structural asset-quality challenges are the undiversified GCC economies that are dependent on oil and gas exports, an aspect that tends to magnify the impact of economic cycles on the banks. This is exacerbated by the dominant role of governments and large family-owned conglomerates in the region, which then leads to large sector and single-borrower concentrations in bank loan portfolios,” the report noted. “A crucial positive factor that underpins the majority of ratings for banks' debt and deposits is the solid track record of GCC governments in supporting their banks, both directly and through various economic initiatives.” “All GCC governments have thus far demonstrated a strong willingness to support their banking systems and that this capacity of governments to support their banks is underpinned by their vast energy resources and the associated revenues,” Moody's said. Dr. Muhammad Al-Jasser, Governor, Saudi Arabian Monetary Agency, emphasized at the Euromoney Saudi Arabia Conference last May the role of government in enabling the environment for private enterprises including the SMEs. “Saudi Arabia's fiscal policy provides a stable background for investment. It works on counter-cyclical basis, so that it runs budget surpluses when times are good, as at present, so as to allow for deficit spending to keep the economy on a steady growth track when global demand for oil weakens. The result is that Saudi Arabia currently has a very low debt/GDP ratio of less than 10 percent,” he said. He further said the government provides support for investment projects besides developing a supportive legal and arbitration structure. “Saudi Arabia's economic policy remains cautious and long-term and provides global investors with an ideal backdrop for allocating their capital to the different sectors of the Saudi economy,” Al
