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IMF Survey : Gulf Banks Face Concentration Risks, IMF Study Says
December 22, 2014
- Region’s dependence on oil prevents banks from diversifying portfolios
- Banks should undergo stress tests to show large exposures, ownership linkages
- Banks need to focus on maintaining high capital buffers in face of risk
While banks in the Gulf Cooperation Council (GCC) countries are generally well capitalized, it is difficult for them to have a truly diversified credit portfolio given the structure of their economies, which exposes them to risks that require a greater amount of scrutiny, a new IMF study finds.
Oil refinery in Saudi Arabia: Gulf bank portfolios are heavily concentrated in the oil sector and with a few borrowers, exposing the banks to greater risks, the IMF says (photo: Jacques Langevin/Sygma/Corbis)
GULF COOPERATION COUNCIL
With the recent plunge in the price of oil, the region’s banks face heightened risks, which could extend to the broader economy, according to Assessing Concentration Risks in GCC Banks. IMF staff provided the study to the October annual meeting of GCC finance ministers and central bank governors in Kuwait.
The GCC member states are Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates.
Three of the study’s authors—Mariana Colacelli and Andre Oliveira Santos of the IMF’s Middle East and Central Asia Department and Suliman Rashid S. Aljabrin of the IMF’s Monetary and Capital Markets Department—spoke to the IMF Survey about their research. (The other three authors of the study are Pierpaolo Grippa, Ananthakrishnan Prasad, and In Wong Song.)
IMF Survey: What is the main finding of your study?
Santos: The main finding of our study is that concentration matters for GCC countries. If a bank’s loans are heavily concentrated with a few borrowers or in a certain economic sector, there are higher risks if these borrowers or sectors get into trouble.
In GCC bank portfolios, we have found that two types of concentrations are important: economic concentration and “single name” concentration—that is, individual borrowers holding large loans. This latter type is significant because if one large single borrower fails, it can put the bank in a difficult position. This risk can have implications for economic activity, fiscal policy, and even the diversification of economic activity in GCC countries.
IMF Survey: What are the unique features of the GCC economies that make the banking system more vulnerable to risk?
Colacelli: The region’s economic structure, with its large dependence on oil, makes it unique. This factor constrains the ability of the banking sectors to truly diversify their portfolios. As we reviewed the region in detail, we found that even the non-oil sectors were significantly linked to oil.
Close to 80 percent of government revenue in this region comes from oil, and that government revenue affects government spending. That spending, in turn, affects the non-oil sector of the economy. In addition, the geographic distribution of credit portfolios is quite local. Banks that we studied had exposures mainly in GCC or other Arab countries, so the banks don’t diversify their portfolios in this manner, either.
IMF Survey: The paper also points to the risk of single-name borrowers and groups of borrowers that are connected to each other.
Santos: We discovered that there are a lot of ownership linkages in the GCC countries. Some of the individual borrowers might not attract attention with their size. But when you take into account their connections with other borrowers, together these groups might hold loans that represent a large percentage of the bank’s capital. If one borrower from that connected group fails, the others risk being affected as well. The shock is amplified, and that can lead to distress in the banking system.
In addition, certain families own a large percentage of the corporates. The combined effect of the public sector and families being very large stakeholders makes the region unique.
IMF Survey: With the plunge in oil prices in recent months, is it more urgent to do something about the concentration risk?
Colacelli: Over the next few months, the effects will be clearer. They will vary across countries and depend on countries’ policy responses, their buffers, and other factors. While fiscal consolidation is needed in most of the GCC countries over the medium term, there is no need for abrupt cuts in spending, given that most countries have fiscal buffers in place. But certainly we would expect some negative consequences from this large oil price decrease.
We found important correlations between oil prices and government spending for these countries. The fact that government spending is affecting credit in all kinds of sectors, not just oil-related sectors, is where the vulnerability lies. This highlights the importance of the fiscal response to the change in oil prices. It's important to highlight the role of the fiscal authority when such a shock hits, in order to properly predict what's going to happen in the banking system.
IMF Survey: What can the governments in the region do—on a regulatory or supervisory level—to guard against the risks of concentrated exposure?
Aljabrin: The first thing would be to do stress-testing exercises. These stress tests should strive to capture the existing and evolving nature of the interconnectedness and exposure concentration. They need to map out the relevant linkages among banks and their borrowers.
They should also align their single name regulations with the new Basel guidelines. Under these guidelines, you can only include tier one capital, while some Gulf countries have a wider definition. Narrowing down the base will help decrease the amount of exposure.
Gulf countries could also set up aggregate limits on large exposures. Large exposures are defined as anything above 10 percent of the bank’s capital. Some countries have ruled that banks can’t have more than 400 percent or 800 percent of their capital in large exposures. While some Gulf countries have established these aggregate limits, we encourage all of them to do so.
Since the financial crisis, international financial regulation has been continuously evolving. It’s important that GCC countries, while applying these new regulations, focus on maintaining their current capital buffers.
IMF Survey: What additional steps should banks require in terms of information disclosure?
Aljabrin: Regulators need to have greater legal power to collect information on the ultimate beneficial owners, as that is the only way they can actually assess interconnectedness and concentration disclosure. There should also be more consistency in disclosure across countries.
One thing we suggest in the paper is to establish a GCC-wide Working Group to review international disclosure practices and see what is relevant to the banking environment in GCC countries, especially with regard to Pillar 3 disclosures in Basel III. [Under Pillar 3, firms are required to make certain regulatory disclosures on a quarterly basis regarding their capital structure, capital adequacy, and risk-weighted assets.]
IMF Survey: Your study found the current level of capital buffers to be roughly adequate.
Aljabrin: Yes, they’re around 15-16 percent on average, which is considered very good. They are formally required to be at 8 percent. But as more regulation comes, there’s a risk of those buffers dipping lower.
Santos: As Suliman notes, GCC banks’ buffers are higher than those of international peers, so the countries are ahead of the curve. But, with oil prices having fallen sharply, these high buffers might not be as high as we once thought. Credit risks might increase because of all of the links that we have described.