Arab Banks Risk Major Crisis From Over-Exposure To Real Estate & Stock Prices.

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BEIRUT - Arab banks are becoming increasingly vulnerable to shocks in the Arab world's real estate and equity markets. A major downturn in both markets would the affect Arab banks' profitability and capital. The banks' capital bases would be immediately and directly hit by fair-value accounting, while their profitability would be simultaneously impacted by lower business volumes, high provisioning needs, and the loss of value on trading portfolios. The quality of assets which banks have would deteriorate. In a down cycle, a mismanaged financial crisis may well lead to a major banking crisis.

Initial public offerings (IPOs) in the Arab world last year raised US$7.61 bn in capital, representing 10.7% of $71 bn raised in IPOs worldwide. Most of the IPOs were conducted in the six-state Arab Gulf Co-operation Council (GCC) region, where a boom has caused equity and real estate prices to rise to unprecedented levels (see news17-ArabIPOsReformsIranApr24-06).

The Saudi stock market in March and April plunged almost 40% since its February peak to its lowest level for eight months. It was a dramatic reversal after the oil-fuelled boom which led to spectacular share price gains in 2004 and 2005 and saw up to 3m retail investors piling into the market in search of quick wealth.

In Iran, where the economy is stalling despite record high world oil prices, the banks are even more exposed to shocks in the real estate business as property prices have been falling steadily since last August, when Mahmoud Ahmadi-Nejad took office as president (see news16-ArabDemoApr17 and news15-IranA-NejadApr10-06).

The exposures of Arab banks to the region's equity and real estate markets have building up in two ways. Direct exposure has been through lending to these two sectors. The indirect one is through the collateral of property and stocks which banks hold on their books against personal loans.

Although the large Arab banks are well equipped to deal with a major correction in the two markets, the impact on the banking sector as a whole would be noticeable. This is if the ongoing correction in the Arab region's stock markets is followed by a major shock in the real estate market.

Arab banks did extremely well in 2005, with many of them doubling their profit on 2004. The positive trend continued in the first quarter of 2006 with an average increase in profitability of around 25% on the first quarter 2005.

Total assets of Arab banks exceeded US$1 trillion by end-2005, up 20% on the 2004 level of $883 bn. The loan portfolio of Arab banks was up 22.3% in 2005. Deposits increased 13.3%. Shareholders equity surged 22% to reach US$97 bn.

With the exception of four stock markets - Lebanon, Oman, Morocco and Tunisia - all the remaining Arab stock markets have witnessed a major decline since reaching their peak in the fourth quarter of 2005. At current price levels, supply will soon exceed demand and a glut will surface. This may not yet be visible. But most adjustments of market imbalances tend to be well under way before the imbalances become widely identified.

Protracted periods of big surge in real asset prices are followed by a downward adjustment exacerbated by higher interest rates and tighter liquidity. Real estate prices move much more slowly than share prices.

While stock prices could correct downward by 5-8% in a single day, and 20% in few weeks, real estate prices often keep rising for a while even after a housing boom goes bust. So the news that the housing bubble is over will not come in the form of plunging prices. It will be more visible in the form of falling sales and rising inventories, as investors try to sell their holding at prices which buyers are no longer willing to pay.

There are signs that the process has already begun in some Arab countries and the days of windfall profits in the Arab real estate market may come to an end. The equity market is in a different situation and many stocks are still over-valued. But it is already alarming that it is very difficult to assess the risks taken in the banks' exposures to the two sectors. The problem is that information available on lending to the real estate sector is limited. This problem is compounded with the scarcity of detailed data on personal loans and what portions of them are directed to the equity market.