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S&P raises ratings for four GCC states

The BICRAs on the United Arab Emirates (UAE; not rated) and State of Kuwait (AA-/Stable/A-1+) are in Group 4.

Standard & Poor's also affirmed its estimate of the incidence of gross problematic assets (GPAs) in the financial systems of the six GCC countries in an economic recession at 15 per cent-30 per cent. These actions in themselves will not automatically lead to upgrades of Gulf banks, but could contribute to case-by-case changes in the ratings.

The BICRA reflects the strengths and weaknesses of a country's banking system relative to those in other countries. BICRAs classify countries into 10 groups ranging from the strongest banking systems (Group 1) to the weakest (Group 10) from the perspective of country risk.

"These actions primarily reflect an improved industry risk profile in Saudi Arabia, Qatar, Oman, and Bahrain that, combined with strong economic growth, have a positive effect on their banking systems," said Standard & Poor's credit analyst Emmanuel Volland.

GCC banking sectors show a fairly high level of concentration, and competition is relatively limited - except notably in the UAE and Bahrain. Saudi banks have by far the largest customer franchises and distribution networks, while banks in Oman and Bahrain operate in significantly smaller economies than regional peers.

Regional integration remains limited. Increasing foreign competition is unlikely to dramatically weaken banks' franchises due to the protected nature of most Gulf markets, especially for retail banking where branch networks are needed. Over time, GCC banks have built up their capital and earnings capacity to the point where they have the strongest financial profiles in the world from a quantitative perspective. Broadly speaking, GCC banks are poised to defend their competitive positions well and maintain their financial strength over the medium term.

Although intermediation and the penetration of banking services are lower than in more mature markets, the earnings power of GCC banks is very strong. Margins remain relatively wide, especially in Saudi Arabia, business volumes are increasing rapidly, the cost of labour is relatively low, and banks do not pay income tax. In addition, the emergence of new banking segments, such as investment banking, private equity, leasing, and mortgage lending, is likely to improve the quality of revenues.

"While banking opportunities are increasing in parallel with oil prices, this also means that new sources of risk have emerged, notably from the rapid growth of loan portfolios that remain untested by an economic downturn and the overheating real estate sector- especially in Dubai," said Volland.

In addition, single-party concentrations in loans and deposits remain high. Gulf banks' appetite for mergers and acquisitions outside their own turf (mainly in Middle Eastern and North African countries) is growing. Although this strategy is helping GCC banks diversify geographically, it could prove costly if the banks do not control the associated execution and integration risks or if above-average credit risks in these countries materialise. Supportive and wealthy shareholders, including governments, with ready capital are a strong mitigating factor to these risks. While the economic environment has been supportive of Gulf banks, GCC economies remain skewed toward the oil and gas industry. Like many other markets, inflation has accelerated, pushing up salaries. In contrast with the tightness in global markets, liquidity in the GCC remains high, although US-dollar-denominated funding has dried up due to some speculation on the depegging of local currencies.

Standard & Poor's classifies the six GCC countries as interventionist towards their banking systems. We believe that the GCC governments would be highly likely to intervene and provide extraordinary support to state banks and systemically important private sector banks in difficulty. However, this classification does not apply to wholesale banks registered but operating mainly (if not only) outside Bahrain. In the six GCC countries, the capacity, willingness, and track record of support is stronger than in most other regions.