The operating environment for banks in Kuwait will improve in 2022 thanks to higher oil prices and continued recovery from the coronavirus pandemic, but some challenges remain, S&P Global Ratings estimates.
The rating agency expects Kuwaiti banks' earnings to fully recover in 2022, supported by higher margins, since the lenders’ balance sheets are geared towards rising interest rates and lower credit charges.
“The macroeconomic outlook, higher oil prices and rising interest rates are smoothening the recovery path for Kuwaiti banks,” S&P said in a statement on Monday.
Funding conditions remain favourable in the Gulf country, supported by stable deposits from the retail sector and government-related entities (GREs), it said.
However, the government’s key liquidity buffer, the General Reserve Fund (GRF), has diminished substantially.
“Despite the boost to Kuwait’s fiscal and balance of payments positions over 2022-2023 from higher oil prices, the government’s medium-term funding strategy remains uncertain,” S&P said.
Banks in the GCC stand to gain from higher energy prices and a rise in interest rates that will significantly improve their bottom lines as cost of risk continues to decline amid economic growth in the region, the rating agency said last month.
On March 16, the central banks of the UAE, Saudi Arabia, Bahrain and Kuwait increased their benchmark interest rates after the US Federal Reserve raised its key rates to rein in inflation, which has hit a 40-year high in the world’s largest economy.
The Fed is expected to raise interest rates six times this year (including the one in March), and five more times in 2023 and 2024.
Most GCC central banks follow the Fed’s moves on key interest rates due to their currency peg to the US dollar, with the exception of Kuwait, whose dinar is linked to a basket of currencies.
The rating agency expects that higher interest rates will support the profitability of Kuwaiti banks … but “it remains to be seen if the increase in interest rates will cause some migration from non-interest-bearing deposits to remunerated products”, S&P said.
“Our Banking Industry Country Risk Assessment (BICRA) on Kuwait remains in group '4' (on a scale of 1-10, with '10' signifying the highest risk). Our starting point for rating Kuwaiti banks is still ‘bbb’,” S&P said.
A ‘bbb’ rating signifies adequate capacity by an entity to meet financial commitments.
Non-performing loans (NPLs) across the Kuwaiti banking sector were low entering the pandemic in 2020. But lenders’ high provisioning buffers allowed them to write off exposures with manageable adverse effects on earnings and asset quality, according to S&P.
“We now expect NPLs and cost of risk to gradually normalise on the back of a more supportive economic environment,” S&P said.
Meanwhile, a high exposure to real estate and construction, which constituted almost 30 per cent of Kuwait banks’ lending at the end of 2021, continues to be a big risk.
S&P expects NPL formation to taper off, projecting a slight reduction in the NPL ratio over the next 12 to 24 months.
While the residential property sector remains robust with rising volumes and prices, the commercial real estate sector remains under pressure from subdued demand for office space and the shift to online retail prompted by the pandemic amid excess supply, S&P said.
However, banks in Kuwait do not anticipate a significant deterioration in asset quality. “This, together with a more supportive economic environment, suggests that the banking system is recovering following the real estate price correction a few years ago,” S&P said.