Low oil prices have dented Qatar's economic success story of late but its banks are thriving. Some are looking to domestic consolidation for the next phase of  growth, others to foreign acquisitions, while a deal that will create the region’s biggest Islamic bank is in the pipeline. Kit Gillet reports. 

QNB

After years of benefiting from the strong growth of Qatar’s economy, especially within the hydrocarbon sector, domestic banks have faced a more challenging operating environment since global oil prices dropped markedly in 2014. In particular, tighter liquidity caused by reduced government and public sector deposits has led many banks to rethink their priorities and growth targets.

Yet despite the challenges, Qatari banks have continued to record solid growth figures, with the banking sector showing impressive signs of resilience.

“Banks are a proxy for the underlying economy, and with the Qatari economy being one of the strongest in the Gulf Co-operation Council [GCC] region, the overall picture for the sector is healthy,” says Joseph Abraham, CEO of Commercial Bank of Qatar (CBQ), the country's third largest lender by Tier 1 capital according to The Banker Database.

Banking assets boom

According to its April 2017 Qatar Monthly Monitor, Qatar National Bank (QNB), the largest in the country, says total banking sector assets grew 14.2% year on year in February 2017, to reach QR1270bn ($348.7bn), with domestic assets up 12.1%. Meanwhile, deposits grew 19.8% year on year in February 2017 (up from 14.8% in January), with private sector deposits showing a year-on-year growth of 10.6%.

“Overall, the banking system remains healthy, reflecting high asset quality, strong capitalisation and high profitability,” says a QNB spokesperson, who adds that non-performing loans (NPLs) were low at 1.6% of total loans in 2016, regulatory capital to risk-weighted assets were 16.1%, and return on equity was high at 14.5%.

Meanwhile, credit growth moderated from 15.2% in 2015 to 12.1% in 2016, mainly due to slower lending growth to the real estate and retail sectors.

Liquidity strain

With significant financing needed to support the major infrastructure projects necessary for the 2022 FIFA World Cup, which will be hosted in Qatar, domestic banks have been well positioned to grow their loan books. However, a major challenge of the past few years is the reduction in overall liquidity, which has affected the banks' ability to lend, as well as the cost of lending. The sector’s average cost-to-income ratio increased by 3.5 percentage points in 2016, due to higher funding costs, according to rating agency Fitch.

That liquidity crunch may be slowly changing. In May 2016, the Qatari government issued a $9bn international bond, with some of that money finding its way into the local banking sector. A follow-up 2017 issuance is unconfirmed, with finance minister Ali Sherif Al-Emadi telling reporters in February that it might not be needed as the government was close to breaking even on the national budget.

A March 2017 report by rating agency Moody’s predicted that stabilising global oil prices, as well as large international sovereign debt issuances and lower credit growth, would help the overall funding conditions for banks in the GCC in 2017, with Qatari and Omani banks benefiting in particular.

According to industry insiders, liquidity in the system has largely stabilised since mid-2016, with banks able to keep loan-to-deposit ratios close to 100%, as recommended by the central bank.

“Stress on liquidity was visible in the first two quarters of 2016, but improved in the second half,” says Dr R Seetharaman, CEO of Doha Bank, the fourth largest lender in the country by Tier 1 capital. He adds that 2017 will be a better year, saying: “Last year the loan-to-deposit ratio was peaking at 130%, and averaged out to 116%. So far this year it is 114%.”

Outside depositors

With a small domestic population of about 2.3 million, Qatari banks rely heavily on government and public sector deposits, which in the past have accounted for upwards of 45% of all deposits. However, with reduced public sector revenue on the back of lower oil prices, coupled with continued government spending on infrastructure projects, the size of public sector deposits in the system has decreased markedly.

“At peak levels, about 42% of deposits in the system belonged to government or government-related entities. Those levels are now down to 27%,” says Nitish Bhojnagarwala, a vice-president at Moody’s.

One way that Qatari banks have dealt with liquidity issues has been to seek outside depositors. However, this has its risks.

“What we’ve seen as a result of lower oil prices is a significant drop in government and government-related deposits in the banking sector,” says Redmond Ramsdale, head of GCC bank ratings at Fitch Ratings. “To balance this out we’ve seen large inflows of non-domestic deposits: money from South Korea, Thailand, elsewhere in Asia, new depositors seeking higher yields.

“Non-domestic deposits are a concern related to how stable they are,” he adds. “If interest rates change in Asia, what does that mean? Will they leave quickly?” 

According to rating agency Standard & Poor’s, Qatari banks increased their external liabilities sharply throughout 2016, by 24 percentage points of gross domestic product, with non-resident deposits increasing by 17 percentage points. Fitch reports that non-domestic deposits represented 26% of banking sector deposits at the end of February 2017, up from 15% at the end of February 2016.

“The main source of concern [in the banking sector] is the rapid increase in external funding,” says Mohamed Damak, global head of Islamic finance at S&P. “If you look at the external debt of the banking system, it has been on an upward trend, quite significantly, over the past couple of years and for us this creates a source of risk in the event where global liquidity changes.

“On the positive side, the government of Qatar is highly supportive of the banking system, and if there were any issues its support would be forthcoming.” 

Continued growth

First-quarter 2017 results for the Qatari banking sector showed solid growth, both in terms of profitability but also operating income and loan and deposit books. Industry leader QNB saw its net profits jump 12% year on year to QR3.2bn, driven by an operating income growth rate of 34%, which increased the bank’s operating income to QR5.4bn. The bank's loan growth was also up, 33% year on year, while customer deposits jumped 34% to QR541bn.

Qatar Islamic Bank (QIB), Qatar’s largest sharia-compliant lender, reported a 12.8% rise in first-quarter net profits, up from QR492.4m in the first quarter of 2016 to QR555.4m. Meanwhile, CBQ reported a net profit of QR91.2m for the first quarter of 2017, a decline of 66.7% compared with the first quarter of 2016, with net operating income decreasing 4.2% to QR885.4m. The bank’s loan book grew 8.6% year on year, driven by services, consumption and the industry sector.

Doha Bank, another leading player, saw its first-quarter 2017 net profits rise 2.9% year on year to QR364m, with net operating income up 1% to QR724m.

“As banks announce their results, it is clear that, despite it not being a stellar year for some, they remain very profitable by international standards,” says Omar Bouhadiba, managing director of International Bank of Qatar (IBQ), which registered a year-in-year net profit growth of 14% in the first quarter of 2017, with total assets up 4% to QR33bn and operating income rising 17%.

“People often say that there are too many banks for such a small market,” he adds. “This may be true, but at the end of the day, banks are still generating double-digit returns on shareholders’ equity, way above what you would expect to see in a developed market.”

Despite this, rating agencies have started to show more caution towards the Qatari banking sector. In May 2016, S&P downgraded its long-term rating for CBQ to BBB+ from A-, while affirming its A-2 short-term rating, and also changed its outlooks for QIB and Doha Bank from 'stable' to 'negative'.

Moody’s chose to keep its outlook for the Qatari banking system 'stable' in July 2016, unchanged since 2010, reflecting a belief that operating conditions remain favourable as a result of strong government spending. However, in April 2017 Fitch downgraded the viability ratings of six Qatari lenders, reflecting what it said was a tougher operating environment and rising funding costs. (At the same time, it affirmed the support rating floor and issuer default rating of all Qatari banks at A+, with a 'stable' outlook, with the exception of QNB, which it rated at AA- due to its status as Qatar’s flagship lender.)

Riskier business

Qatari banks have continued to target overseas expansion as a way to increase both profits and diversification. This is happening both organically, through opening branches and foreign operations, and inorganically, through the acquisition of banking assets in other countries.

Among the recent acquisitions is QNB’s 2013 purchase of a 97% stake in Egyptian lender NSGB, Doha Bank’s 2015 acquisition of the Indian assets of HSBC Bank Oman, and CBQ’s 100% acquisition of Turkish lender ABank, which was completed in December 2016. QNB also finalised its takeover of Turkish lender Finansbank in June 2016, in a deal worth $2.95bn.

However, many of the markets Qatari banks are moving into come with greater political and economic risks. “Foreign expansion provides Qatari banks with some geographic diversification, in countries that are not that correlated with Qatar. But on the other hand, most is being done in riskier countries such as Egypt and Turkey,” says S&P’s Mr Damak.

One example is QNB’s purchase of Turkish lender Finansbank. The deal made QNB the largest lender in the Middle East and Africa by assets but also affected its overall risk position, with bad loans rising to QR398.93bn in 2016, up from QR20.12bn a year earlier, and causing the bank’s NPLs to rise from 1.4% to 1.8%.

QNB’s international loans now make up almost 32% of the bank’s total loan book, and in terms of profitability, international operations have already passed 35% of total group profitability.

“QNB’s projected growth over the coming years is, to a certain extent, dependent on the success and performance of these international acquisitions and investments in certain emerging markets,” says the QNB spokesperson, adding that with recent political turmoil, civil unrest and violence in certain markets QNB has invested in, growth could be materially affected.

Analysts believe that going forward, QNB will be an outlier in its appetite for foreign acquisitions, with other Qatari banks more likely to focus on organic and domestic growth opportunities.

“QNB’s aspiration is to be a leading bank in the Middle East, Africa and south-east Asia,” says Moody’s Mr Bhojnagarwala. “For the rest of the banking system, we expect limited future international growth – they are more domestically focused.” 

Consolidation needed

Despite the profitability of Qatar’s financial institutions, with its relatively small population some believe the country’s banking sector is overcrowded.

"There is no need for 17 banks to operate in this small market,” says Doha Bank’s Mr Seetharaman. “We need maybe two Islamic banks and two commercial banks, so it makes sense to go for industry consolidation. Shareholders expected decent returns. Regulators must also be counting on these kinds of combinations for long-term financial stability and competitive value offering.”

In a February 2017 research paper on potential consolidation in the Qatari banking sector, Moody’s said the structure of the banking sector, where QNB holds an outsized share of the domestic loan market and smaller banks compete for the remaining opportunities, “has driven intense price competition, resulting in pressure on asset yields, profitability and leading in some cases to inappropriate risk pricing in their lending activities”.

A major merger?

Merger talks between Qatari banks Masraf Al Rayan, Barwa Bank and IBQ were announced in December 2016, with the potential combined bank set to be the second largest bank in the country by asset size. The new bank, which would have assets worth upwards of $44bn, would comply with Islamic banking principles and be the GCC’s largest Islamic bank.

However, despite optimistic talk by the banks involved (at an annual general meeting in early April 2017, Masraf Al Rayan chairman Hussain Ali al-Abdulla told reporters the merger would be finished within six months), others are less convinced it will go ahead.

“It’s not the first time such a merger has been proposed and gone nowhere,” says Fitch’s Mr Ramsdale. “The merger of three banks is quite difficult. What makes this even more difficult is that this is the merger of two Islamic banks and one conventional bank; IBQ is not Islamic.

“This doesn’t mean that this won’t happen,” he adds, suggesting that if it went ahead they would probably initially merge the two Islamic banks and then hold IBQ as a subsidiary until it has time to convert.

All three banks enjoy significant government or ruling family ownership, as well as close relations with the government and high-net-worth individuals in Qatar, and while they are mostly corporate focused they have solid growing retail businesses.

Mr Ramsdale does see a benefit in the merger. “In addition to the obvious cost synergies, it would create a regional Islamic banking champion, and Qatar would no doubt like to have the biggest Islamic bank in the GCC in Qatar. Just like Qatar National Bank is the biggest GCC bank,” he says.

“We see reduction in competition as good for the banking system,” says Moody’s Mr Bhojnagarwala, who adds that there has been increased competition on both sides of the balance sheet for banks: on the asset side, yields have been coming down and profitability has been declining, and on the liability side, costs of funding have been rising, which means deposits are reduced.

“It will also be beneficial for the Islamic finance industry, where we’ve seen significant growth across the GCC, outpacing traditional banking sector growth,” he adds. “Creating such large entities will mean having more teeth to bite and will push up Islamic banking asset growth in the GCC.”

With or without the proposed merger, Qatar’s banking sector is likely to continue to grow at pace.

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