April 25, 2016
- Islamic finance – Driving UAE’s sustainable development goals
- GCC banks face bottom line pressures even as loan demand continues.
Despite the failure of the talks in Doha to lead to a freeze in oil production, markets reacted positively and prices rebounded to almost $45/barrel, well off recent lows. In the coming weeks, as the earning season for banks in the GCC continues, the question that will be at the forefront is whether a year of low oil has significantly dragged down bottom line performance, and whether tighter liquidity for corporates is leading to rising loan growth which Finance Forward explores below.
Standard & Poor’s argues that Islamic finance “will likely remain a modest contributor [to the Sustainable Development Goals] due to the industry’s small size and the issues it has yet to resolve to unlock its global potential.” Looking at the industry’s track record supports this modestly pessimistic outlook for the contribution of Islamic finance to the SDGs. However, looking forward at the potential for Islamic finance to have an impact, there is significant potential for it to contribute greatly to the SDGs.
The way that Standard & Poor’s approaches the question is by assigning a link between the currently applied or preferred principles of Islamic finance—prohibitions of riba, gharar and haram activities, and the asset-backing and profit-sharing approach—and the different SDGs. This approach, however, limits an analysis to the areas where the contrasts with conventional are the greatest.
The prohibition of riba and gharar are ‘form’ issues. The exclusion of financing haram activity is an ‘exclusionary’ screen. Asset backing and profit-and-loss sharing is mostly done on the margins and asset-based transactions and fixed rate contracts are more common. By focusing mostly in the areas where the impact from Islamic finance is most limited or the practical application is the least practiced, it will naturally find a ‘modest’ contribution for Islamic finance to the SDGs.
Instead, looking at the positive aspects like the relationship between money/finance and the rest of the economy, as well as the specific markets in which Islamic finance operates, and there are more hopeful signs. The most significant way that Islamic finance can support the SDGs is by continuing to see growth across markets that currently score in the middle ground on the metrics. A preliminary ranking released in February 2016 includes a few Muslim majority countries where Islamic finance operates today in the second quintile but most with the best developed Islamic finance are in the third (middle) quintile.
In terms of having an impact on improving the SDGs, this may actually be a strength because more modest changes in the way that Islamic finance operationalizes its values can have a larger marginal impact than in more developed markets. A shift, for example, the goal of creating decent work and economic growth could be improved with just a modest increase in financing to SMEs. The International Finance Corporation estimated the gap in Islamic SME finance is between $8.6 and $13.2 billion across the whole MENA region which is home to Islamic banks managing hundreds of billions in assets.
There is clearly a lot of work ahead for Islamic finance within markets that have less developed financial, legal and regulatory systems. However, the good news is that the SDGs have become a focal point for measuring impact across the world and if Islamic finance continues to build on what it has built until now with a focus on extending its impacts deeper into the real economy, the marginal effect will be larger than the same developments occurring within countries starting higher on the list of SDG rankings.
A preliminary look at the first quarter results that are available on Bankscope forbanks based in Bahrain, Kuwait, Qatar and UAE) show bottom line pressure for many banks with the exception of banks in Qatar (both conventional and Islamic) and Khaleeji Commercial Bank, an Islamic bank based in Bahrain.. With the exception of Emirates NBD based in Dubai and Khaleeji Commecial, the other banks outside Qatar delivered very modestl performance in terms of net income.
National Bank of Kuwait for instance posted negative growth over Q1 2015 in large part because of the impact of oil prices which fell dramatically during 2015 and pulled liquidity out of the banking system and steam out of the entire economy. The effect was felt across most of the banks presented in the table. Compare the growth in deposits over the previous year with the growth in loans—on an aggregate basis customer deposits rose 9.2% while loans grew 13.9%.
Although the entire region is edgy over the fiscal deficits that are swelling up due to the high breakeven levels, Oman and Bahrain are particularly vulnerable to a liquidity squeeze One of the reasons that Qatar’s bank seem to be in better shape is the continued loan growth and deposits entering the economy from increased government spending on infrastructure and other projects linked to the 2022 soccer World Cup.
A trickle-down effect of the low oil prices will adversary affect the region’s banking sector growth as the economy will take a hit as the government cuts down its expenditure. A weaker deposit growth will affect the lending practices which directly impacts the asset quality. A compromise on asset quality is likely to bring down the profits and the earnings growth will see a big dip and banking assets and profitably will erode if the non-oil economy fails to fuel and rive the engine of economic growth.
Even if oil prices remain at low levels for the longer term, the GCC banks will, for the most part, remain insulated from significant rises in bad debts and write-offs because the credit cycle of the GCC countries is still in early stages. Moreover, banks in the countries with large sovereign wealth fund asset such as UAE, Kuwait, Qatar and Saudi Arabia have ample buffer to maintain their spending and to support banks if necessary.