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IMF warns on impact of lower oil prices on GCC banking.

In a paper entitled "The Impact of Oil Prices on the Banking System in the GCC" the International Monetary Fund (IMF) said it 'finds strong empirical evidence of feedback loops between oil price movements, bank balance sheets, and asset prices'.

The research, prepared by Padamja Khandelwal, Ken Miyajima, and Andre Santos, examines the links between global oil price movements and macroeconomic and financial developments in the GCC. The authors say macro-financial linkages in the GCC can amplify the effects of oil price movements over the financial cycle.

"Oil price movements and government spending policies create feedback loops between asset prices and credit that can lead to the build-up of systemic vulnerabilities in the financial sector. Oil price upturns lead to higher oil revenues, and stronger fiscal and external positions. Equity market returns are larger as investors anticipate the impact of higher oil prices on the corporate sector, and generally stronger government spending growth. In turn, stronger government spending leads to higher non-oil output growth, greater banking sector liquidity and credit growth, higher real estate prices, and stronger bank balance sheets. Asset price appreciation also has positive wealth effects. In the event of an oil price downturn, these developments can reverse. With financial sectors being fairly large in the GCC, and oil prices being highly volatile, the unravelling of systemic financial sector vulnerabilities could have significant adverse effects on the real economy.

"-systemic financial sector risks rose in the GCC countries with the oil price upswing in the years before the global financial crisis. An expanding deposit base and high liquidity (owing to high oil prices and short-term capital inflows) resulted in credit and asset-price booms before the global financial crisis."

The paper notes that liquidity conditions have started to tighten and that while credit growth has remained robust, deposit growth has slowed, largely as governments and government-related entities have withdrawn deposits from the banking system. Interbank rates have edged higher since the beginning of the summer of 2015.

Data cited in the paper on actual and projected oil price performance for 2015 to 2020 suggests that oil prices will, on average, remain 50-60 per cent below the 2014 peak in the medium term. "Similarly, non-oil GDP growth is assumed to weaken by three percentage points."

The paper also noted that, "a one percent reduction in oil price growth leads to a 0.8 percent decline in the rate of equity price inflation, which in turn leads to a reduction of bank credit and deposit growth by 0.1 percentage point, further depressing equity price performance."

The performance of key indicators of business and financial cycles has generally strengthened during oil price upturns but equally, the timing of downturns in those variables tends to coincide with oil price downturns, even though greater fiscal buffers have attenuated the linkage.

Oil prices and economic activity significantly affect bank asset quality. The paper also identified feedback loops between oil price movements, bank balance sheets, and asset prices in the GCC. Tentative evidence suggests that banks in the GCC countries have been setting the capital ratio and provisioning for NPLs countercyclically.

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Publication:CPI Financial
Date:Aug 10, 2016
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