The outlook on Bahrain's retail banking system has been changed to stable from negative, said a report, adding that this reflects an economic recovery driven by increased government spending and construction activity.

Moody's Investors Service (MIS), a wholly-owned credit rating agency subsidiary of Moody's Corporation, explained in the report entitled "Banking System Outlook: Bahrain" that the rating was based on the banks' solid funding base and capital buffers.

While economic growth will buoy banks' credit fundamentals, Moody's notes that increased government spending also puts pressure on Bahrain's fiscal position, which could affect the capacity of authorities to provide support to financial institutions over the outlook horizon.

Moody's notes that real non-oil GDP will strengthen to 3.8 per cent in 2014 (from 3.0 per cent in 2013) [source: IMF]. Given that most bank lending in Bahrain remains directed toward the non-oil economy, Moody's forecasts domestic credit growth of around 7 per cent-8 per cent over the next 12-18 months.

Stronger activity in the construction industry, manufacturing and the ongoing recovery in the tourism/property markets will drive the growth in non-oil GDP.

System-wide asset quality will remain stable overall for the system, as the domestic economy strengthens and the banks diversify into higher-growth GCC countries (Moody's estimates that 40 per cent-45 per cent of loans are granted to entities outside Bahrain).

Moody's expects that non-performing loans will remain around 6 per cent of gross loans over the outlook period (December 2013: 6.2 per cent), as current NPLs are still concentrated toward a few large borrowers that are under stress.

Moody's also expects banks' capital metrics (with an aggregate Tier 1 ratio of around 14.5 per cent as at the end of December 2013) to remain broadly stable over the outlook period, and sufficient to absorb losses under its scenario and stress-testing analyses.

Moody's expects that Bahraini banks will continue to exhibit sound deposit-funded and liquidity profiles. Deposits will remain stable over the outlook period, even though the banking system remains highly concentrated toward government deposits. Deposits accounted for 76 per cent of non-equity funding as of end-December 2013, and liquid assets totalled 34 per cent of total assets as of year-end 2013.

However, Moody's says that as a reflection of the government's increased spending in the economy, debt levels have also risen. In addition, limited oil reserves have raised the country's fiscal break-even oil price.

Accordingly, Moody's considers that this could affect the government's flexibility to absorb oil-price shocks and also potentially affect the authorities' capacity to provide support to financial institutions over the outlook period. – TradeArabia News Service