Kuwaiti banks are coming under increased stress due to contraction in the local economy and exposure to risky asset classes, Fitch said in a special report.

The Fitch report entitled 'Kuwaiti Banks: Annual Review and Outlook', stated that the economic output in Kuwait would shrink by 2 per cent in real terms in 2009, with output in the oil sector, which accounts for over half the economy, shrinking by 10 per cent, following production cuts agreed with Opec.

The bank loan growth is thus expected to slow considerably, negatively impacting profitability, as banks take a more cautious approach to lending due to weaker economic conditions, the ratings agency said.

Kuwaiti banks' exposure to risky asset classes is significant, with over half of the banking system loan book exposed to potentially risky sectors of the economy, including investment companies, real estate and construction, and lending for the purchase of securities, it said.

'This exposes Kuwaiti banks to significant market induced credit risk,' the special report added.

Fitch expects that exposure to these asset classes will lead to a further deterioration in banks' asset quality in 2009. Profitability will also be negatively impacted as banks continue to increase impairment charges for both loans and investments.

The Kuwaiti Parliament is reviewing an $5 billion financial stability law, which was approved by Emiri decree in March 2009. The law, which remains in force unless rejected by parliament, addresses banks, investment companies and the national economy.

The law, Fitch said, has the potential to improve the health of the country's financial system; however, the delay in its implementation and the uncertainty about how it would operate in practice was worrying.

'Fitch's Long-term Issuer Default Ratings (IDRs) for all Kuwaiti banks are driven by sovereign support (Kuwait, rated AA/F1+).'

'Downside risk to banks' IDR ratings could arise from deterioration in the creditworthiness of the Kuwaiti sovereign, although at present Fitch considers the likely cost of support measures to be small in comparison to the resources available to the sovereign,' it added.

In recent months, Fitch has downgraded a number of Kuwaiti banks' Individual ratings including Kuwait Finance House, Al Ahli Bank of Kuwait and Commercial Bank of Kuwait.

Individual ratings may come under further pressure if exposure to investment companies, real estate and construction, and lending for the purchase of securities leads to a marked deterioration in asset quality, profitability and capitalisation, the report added.-TradeArabia News Service