Moody’s: Strong Oil, Economic Rebound to Boost Islamic Banking Sector

Higher energy prices and the easing of pandemic restrictions will continue to support strong economic recovery across the GCC countries over the next 12 to 18 months, boosting the financial performance of Islamic banking entities in the region, Moody’s Investors Service said. The rating agency in a report said that Islamic finance markets are benefiting from high commodity prices and the economic rebound in the major Islamic finance markets, such as the GCC states, will keep the asset quality of Islamic banks while driving up profitability. ‘Islamic banks can therefore maintain strong capital and liquidity buffers, enabling them to capitalize on the growing demand for Sharia-compliant financial services,’ Moody’s said.

‘Economic growth in the GCC countries is accelerating in 2022 and will remain strong in 2023, driven by the easing of pandemic restrictions and the high prices of commodities such as hydrocarbons. Inflation in these countries will also remain moderate because of government subsidies and policy rate hikes,’ the rating agency added. Strong economic recovery, Moody’s said, will keep the asset quality of Islamic banks stable. It added that the improving economic conditions will keep the performance of Islamic financing stable despite the unwinding of regulatory forbearance.

‘The focus on retail financing will support asset quality because of its secured and diversified nature and prudent underwriting by the Islamic banks. In addition, financing to public-sector employees, who enjoyed stable employment during the pandemic, constitutes the lion’s share of retail financing in the GCC region. Strong provisioning buffers built up during the pandemic will also mitigate asset risks,’ the rating agency said.

Moody’s predicted that Islamic banks’ profitability will rise given their sufficient loss reserves, while efficiency gains from digitalization will offset their higher technology spending. ‘The return on average assets of Islamic banks will improve as provisioning needs decline since they have set aside sufficient reserves through precautionary provisioning. Their profitability will also be driven up by the rise in interest rates, particularly in the GCC states where domestic currencies are pegged to the US dollar. Their cost-income ratios will remain stable, with increases in technology spending offsetting efficiency gains from digitalization,’ it said.

Moody’s noted that the GCC states are major hydrocarbon producers and are benefiting from the surge in oil prices. Despite the recent modest easing in oil prices, the rating agency expects the price of Brent crude to remain at US$105 per barrel in 2022 and at US$95 per barrel in 2023, well above the 2021 average of US$70 per barrel. ‘The high oil revenue is creating positive spillover effects on the non-oil sectors where banks do most of their lending. After expanding by 4 % in 2021, we expect the real GDP in non-hydrocarbon sector to grow by 3.6 % in 2022 in the GCC, still well above the average 2.3 % growth rate between 2016 and 2019,’ Moody’s added.

It further said that over the longer term, Islamic banks in the GCC will also benefit from the economic diversification agendas of countries, which aim to promote higher employment levels among citizens in the private sector. ‘There will also be growth opportunities in the housing market as a result of state-led home ownership programs, particularly in Saudi Arabia. Still, economic diversification plans are significant undertakings and their successful implementation is not guaranteed,’ Moody’s added.