How much risk are Qatari banks exposing themselves to? The average return-on-equity for the banking industry was 19% in 2011, which was a reflection on how well they did last year, but is it also tempting them to squeeze out a little bit more, especially with the Qatari government’s track record of providing liquidity and capital during periods of market turmoil? Stéphanie Méry Carillon, Director of Financial Services at Standard & Poor’s looks at Qatar’s banking sector from a distance.
Standard & Poor’s Ratings Services ranks the banking sector of Qatar (AA/Stable/A-1+) - in group “4” under its updated Banking Industry Country Risk Assessment (BICRA) methodology. Other countries with a BICRA group “4” score include, Kuwait, Mexico, Oman, Peru, South Africa and Taiwan.
Our criteria define the BICRA framework as one “designed to evaluate and compare global banking systems”. A BICRA is scored on a scale from 1 to 10, ranging from the lowest-risk banking systems (group “1”) to the highest-risk (group “10”). The BICRA comprises two main areas of analysis - economic risk and industry risk. For Qatar, we have assigned a score of “4” to the economic risk and “5” to the industry risk.
Strong oil- and gas-based economy but geopolitical and credit risks remain.
Our economic risk score of “4” reflects our opinion that Qatar has “low risk” in economic resilience as Qatar’s hydrocarbon reserve contains almost 14% of the world’s natural gas -making it the third-largest reserve in the world - and 2.2% of the world’s proven oil reserves. As a result of prudent management of this natural resource endowment, Qatar has very high per capita income; we estimate it was $111,000 (QR404,000) in 2011. Moreover, Qatar has made significant progress toward diversifying its economy despite the fact that it still depends heavily on oil and liquefied natural gas (LNG) production. We believe the economy will continue to show strong momentum, reflecting Qatar’s positive market dynamics and significant infrastructure development programme. High oil prices and long-term LNG contracts at fixed prices are also helping the country to secure its revenues. We also expect Qatar’s real estate market to recover from its sharp decline in 2009-2011, although the commercial sector still faces more risk than the housing segment.
Political risk, however, heightens our assessment of Qatar’s economic resilience. Like other sovereigns in the region, Qatar is exposed to geopolitical risk such as a potential escalation of tensions between the West and Iran, with which Qatar shares the large North Field gas reservoir. In addition, Qatar’s more aggressive foreign policy stance could result in an escalation of antagonism amongst uneasy allies in the region. Institutional transparency and accountability are a further consideration in our assessment of Qatar’s political risk.
One of the main risks for the Qatari banking sector is its exposure to credit risk, in our view. This is underpinned by very rapid loan growth (28% growth in 2011), lending and underwriting standards that we view as “aggressive”, and a high concentration in lending to cyclical or vulnerable sectors like real estate and construction (19% of total loans at year-end 2011 and almost 25% when contractors are included). In addition, foreign currency lending has recently increased dramatically and accounted for 47% of total loans at year-end 2011. We expect sustained lending growth over the next few years, although Qatar’s central bank is currently tightening regulation, which may limit business and lending growth in the short term. The banking system is also penalised by a modest payment culture, as shown by recently increased problem loans in retail despite the assignment of salaries on personal loans, something which usually protects banks.
The industry risk score is “5” for Qatar.
Qatari “institutional framework” is considered “intermediate risk” as banking regulations are in line with international standards, although we consider that supervision has some room for improvement. While the central bank could have taken more proactive measures during the global 2008-2009 crisis, the authorities identified potential problems relating to real estate or equity exposures and acted quickly to fix them. The central bank also severely tightened regulation surrounding personal borrowing in the second quarter of 2011 by capping the amount and rate at which banks can lend to an individual.
We classify as “high risk” Qatar’s “competitive dynamics”. Even if banks in Qatar have stable market shares, and barriers to entry remain high, we consider Qatar’s banks to have an “aggressive” risk appetite. The banking sector’s profitability has been higher than that of other sectors of the local economy for the past few years. The average return-on-equity for Qatar’s banking sector was 19% in 2011. This high level of profitability is also the result of the low cost of labour and absence of income tax. In addition, the small size of the domestic market leads to high price competition and concentration, and pushes the banks to expand abroad. That said, strong margins and efficiency, and the absence of income tax, give them an effective cushion to face a potential increase in the cost of risk.
Qatari “system-wide funding” is considered “intermediate risk” as banks rely mainly on customer deposits for funding. The banking system has a stable share of core customer deposits to loans although the share of net external funding to loans has been increasing recently. We expect the deposit-to-loan ratio to decline further as a result of strong loan growth largely linked to the 2022 FIFA World Cup and infrastructure programme financing. This risk of decline is partially mitigated by the Qatari government’s successful track record in providing liquidity and capital during periods of market turmoil.
The government’s role improves our score on system-wide funding for Qatar. We view the government’s role as “strong” and believe the authorities are likely to provide extraordinary liquidity support to the banking system, if needed. The government has recently significantly increased its borrowing in capital markets. In our view, enlarged government debt is being issued to foster the development of domestic capital markets and to build up a domestic sovereign bond yield curve.
Stéphanie Méry Carillon
Director - Financial Services
Standard & Poor’s