November 2, 2017/Fitch Ratings
Fitch Ratings says in a new report that asset-quality metrics for Kuwaiti Islamic banks improved in 2016 and 1H17, with only one exception. Concentration risk remains the biggest risk.
Impaired financing ratios have been improving since the global financial crisis as Islamic banks have been cleaning up their financing books; nevertheless, the average impaired financing ratio rose slightly in 1H17. Financing impairment charges/average gross financing ratios have been falling due to better underwriting standards, but also showed a slight increase in 1H17 due to provisioning of some non-domestic exposures and strict Central Bank of Kuwait (CBK) provisioning requirements, but remain lower than at conventional banks.
Operating profitability metrics have improved due to lower financing impairment charges and remain slightly above conventional banks’. The average cost/income ratio has also slightly improved due to tight cost control but is higher than at conventional banks’. Islamic banks had a 41% market share of total domestic banking system assets at end-1H17. The Islamic market share increased rapidly between 2005 and 2010 and has since stabilised.
The Fitch-calculated sector average gross financing/deposits ratio has been almost flat (about 81% at end-1H17), below conventional banks’ (87%) as Islamic banks tend to have strong retail Islamic franchises (Kuwait Finance House and Boubyan Bank in particular). Term corporate customer deposits remain the main source of funding. Deposit concentration remains high, except for Kuwait Finance House. Islamic banks typically rely less on market funding than their conventional peers.
Slowing financing growth, issuance of additional Tier 1 sukuk, reduction of higher-risk assets and reasonable internal capital generation have helped Islamic banks maintain adequate capital ratios for their risk profiles. The equity/assets ratio was 1% higher for conventional banks at end-1H17. Nevertheless, Islamic banks tend to have higher capital ratios than conventional banks because they typically have lower risk weighting on their assets due to a higher proportion of real estate-related exposure.
While the CBK is the supervisory authority for Islamic and conventional banks, there is a specific regulatory framework for Islamic banks. CBK regulations are comparable between conventional and Islamic banks, but they take account of Islamic banks’ specificities, such as the 50% Alpha factor used to calculate specific real estate risk-weighted assets. Islamic banking activities are only undertaken by Islamic banks.
Asset quality will remain sensitive to concentration risk and volatility in the real estate sector. Financing growth is expected to remain above that of conventional banks as Islamic banks build their franchises. We expect financing growth in the high-single digits in 2017, compared with the mid-single digits for conventional banks.