The credit fundamentals of Islamic banks operating in the GCC countries have converged with those of their conventional peers and they should maintain their improved asset quality and profitability in the coming year, Moody's Investors Service said in a report.

However, the Islamic banks' still high loan concentration to real estate-related sector and higher asset growth remain key moderating factors in Moody's assessment of their standalone profiles, according to the report titled "Islamic banks - Gulf Cooperation Council, Islamic banks' fundamentals converging with conventional peers".

"Islamic banks operating in the Gulf Cooperation Council countries have benefited from sustained growth in their franchises in recent years," said Nitish Bhojnagarwala, vice president - senior analyst and author of the report. "Their solvency has improved, supported by their efforts to reduce the stock of problem loans, and by their sound profitability."

"While both Islamic and conventional banks in GCC countries reported non-performing loan (NPL) ratios of around 5 per cent at the end of 2011, Islamic banks reported a larger decline in subsequent years, to around 2.1 per cent at the end of 2017, compared to 2.9 per cent for conventional banks" he added.

Moody's expects the Islamic banks' NPL ratios to remain low in the next few quarters, underpinned by three factors: Their continued resolution of legacy impairments primarily related to the real estate sector; the lower new NPL formation as a result of their more selective and diversified credit growth and a significant denominator effect from stronger loan growth.

Moody's also anticipates that Islamic banks in the GCC will continue to report higher net profitability compared with their conventional peers. This reflects Moody's view that their lending margins will remain higher, supported by their favourable funding mix and the backdrop of rising interest rates.
While GCC Islamic banks have maintained higher capital adequacy than their conventional peers, this gap has been narrowing as a result of the Islamic banks' stronger asset growth, a trend that Moody's expects to continue.

"Nevertheless, their capital buffers will continue to be supported by their stronger profitability and provide a comfortable cushion to absorb potential losses," said Bhojnagarwala.

As long the Islamic banks continue to have significantly higher real estate concentration and grow their assets at a faster pace, they will continue to face higher asset risks than conventional banks, despite their stronger solvency metrics, he added. – TradeArabia News Service