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The Impact of the Crisis on the Banking The Impact of the Crisis on the Banking Sector in the ESCWA member CountriesSector in the ESCWA member Countries

Dr. Fouad Shaker Secretary General

Union of Arab Banks

Damascus, Syria , 5-7 May 2009

Introduction - All MENA banking sectors are affected by the global crisis

- They face the same issues as those in other regions: liquidity drought, drop in asset values, lower business volumes, asset quality deterioration, declining profitability…

- GCC banks more affected than those in north Africa

- We anticipate further deterioration

- Very limited growth in the short term

- Focus on liquidity and risk management

- Revision of strategy/business plan

- Government support is an important factor

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GCC banks more affected than those in North Africa

Higher impact on GCC banking sectors due to:

• Vulnerability on their economies to oil price movements• Very rapid loan growth in recent years• Large exposure to the real estate sector• Higher reliance on foreign funding: roll-over risk• Higher exposure to structured products

GCC Countries are “interventionist” toward their banking sectors and have large liquidity reserves

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North African banking sectors less affected due to:

• Negligible exposure to “toxic” products

• Very limited reliance on foreign funding

• Positive impact of the drop in oil prices

Lower flexibility to provide support

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Banks In North Africa

Morocco: Facing increasing risk from an adequate position• Rapid loan growth be tested by weaker economic environment• Correction in the real estate sector has already started in the high-end segment• Geographic expansion in Africa might prove riskier than anticipated

Tunisia: Targeted improvements look more challenging• Economic slowdown will limit banks’ ability to improve their asset quality• Additional pressure on already weak profitability and capitalization

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Egypt: Restructuring process at risk?• Slowdown in economy will put pressure on already weak asset quality• Privatization process should prove more difficult (e.g. Banque du Caire)

In addition, these three countries are exposed to the drop in:• Tourism• Textile sector• Foreign direct investments• Workers’ remittances• Trade flows with Europe

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The environment WeakeningThe environment Weakening

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A Sharp Weakening of The Environment

• Observed limited signs of stress until September 2008 but rapid deterioration thereafter• Sharp reduction in GDP growth• Slowdown/delays in infrastructure and real estate projects• Dramatic fall of markets (prices and volumes)• Real estate prices are trending downwards• Lower business volumes• Liquidity drought and sharp increase in cost of funding• Very low debt issuance volumes (e.g. GCC corporate bond issuance down by more than 50% in 2008; GCC sukuk issuance fell by more than 60%)

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A Sharp Weakening of the Environment

Real GDP Growth (%) for some Arab Countries

20072008e2009f

Abu Dhabi7.65.94.2

Bahrain8.07.04.0

Kuwait4.84.51.4

Oman7.710.22.0

Qatar15.417.610.6

Saudi3.45.8-10.9

Egypt7.17.24.2

Morocco2.75.82.8

Tunisia6.34.93.6

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The effect on Stock markets

Market2008 Change

Abu Dhabi-48%

Bahrain-35%

Dubai-72%

Kuwait-38%

Qatar-28%

Oman-40%

Saudi Arabia-56%

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The growth of Arab banking system during the crisis ($ billions)The growth of Arab banking system during the crisis ($ billions)

20072008

Assets1,9131,938

Deposits830999

Loans9911,121

Shareholders Equity171194

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MENA Banking Sectors Under Stress & Areas of Concern

• Major slowdown in business volumes• Drop in fee and commissions from brokerage and IPOs• Cost of funding will remain high• Nonperforming loans are expected to increase rapidly• Sharp increase in Loan-Loss provisions• Goodwill impairment for recent acquisitions• Further mark-downs on investment portfolios• Areas of Concern:

Banks with large exposure to Kuwaiti investment companies Banks with large exposure to Dubai real estate sector Banks with wholesale funding profiles Banks active in private equity Banks with large exposure to structured products

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Government Support

• Willingness of MENA countries to provide extraordinary support is considered high Sharp contrast in term of capacity between GCC and North Africa.

• GCC countries seem to be “interventionist” toward their banking sectors, reflecting the opinion that there is a high probability that extraordinary support would be extend to “systemically important” banks in case of need.

• Their capacity to support their banking sectors is strong (with significant differences among countries), due to liquidity cushions built up during times of high oil prices.

• GCC governments have so far reacted differently given the different impact on their respective banking systems.

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Government Support

• Two types of support: system-wide or bank-specific: Deposit guarantee (legal framework only in Kuwait) Reduction in reserve requirements Relaxation of regulation (e.g. loan-to-deposit ratio) Broader range of securities eligible for repo Swap facility Injection of liquidity through government related entities Capital injection (ABC, GIB, GIC, Gulf Bank, 5 banks in Abu-Dhabi,…)

• Policies need to be comprehensive and coordinated to avoid cross-border effects• Timeliness of support has been perceived as less predictable in some instance due to specificities , e.g. federal structure in the UAE, political tension (Kuwait)

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Where Are We?

• MENA banks are operating in a much weaker environment

• MENA banks’ financial profiles will weaken in 2009

• Ongoing downward trend in asset quality and profitability

• Liquidity will remain tight and cost of funding high

• Government support is critical and an important rating factor

• More differences among banks across the region

• Overseas expansion will be limited and more selective

• Current focus on liquidity and risk management

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Top 10 Banking Risks From Survey*

199620022008

1.Poor Management1.Credit Risk1.Liquidity

2.Bad Lending2.Marco-economy2.Credit Risk

3.Derivatives3.Equity markets3.Credit Spreads

4.Rogue Trader4.Complex instruments4.Derivatives

5.Excessive Competition5.Business Continuity5.Marco-economic trends

6.Emerging Markets6.Domestic Regulation6.Risk Management

7.Marco-economic threats7.Insurance7.Equities

8.Back-office failure8.Emerging markets8.Too much regulation

9.Technology foul-up9.Banking over-capacity9.Interest rates

10.Fraud10.International regulation10.Hedge funds

* Source: Banking Banana Skins 2008- The CSFI Survey of banks risk in association* Source: Banking Banana Skins 2008- The CSFI Survey of banks risk in association with Price Waterhouse Cooperswith Price Waterhouse Coopers

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Some Past Comments from the surveys*

- On Regulation: Eye on the wrong ball: Bankers and regulators seem to be obsessed with implementation of new Basel2 framework. In reality the major risk to financial stability will not be the capital adequacy of individual banks but rather the business cycle and issues around liquidity of markets and institutions. (Prof. Hans Geiger, Swiss banking Institute, University of Zurich, 2005)

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- On Credit Risk: The exotic mortgage products may come back to haunt us in an increasing interest environment. When the bankruptcies in both borrowers and lending reach certain critical mass, the financial system’s capacity to absorb the loss may collapse. If that happens, the shock may spill over into wider markets and economy via two paths: a domino effect through the highly leveraged derivatives markets and a collage of the housing markets which is the main driver of the economy now, and with a heavy dept burden. (US Bank Examiner, 2006).

- On Risk Management Techniques: Model Risk: The goal of quantitative and objective decision making may cause the pendulum to swing too far from the traditional judgmental approach. By giving insufficient weight to qualitative judgment, institution will become even more exposed to model risk, with an increasing reliance upon unregulated third parties (i.e. rating agencies and the providers of risk management systems/methodologies). This will increase the potential for bad lending decisions. (Group Financial Risk Controller Multinational Bank. 2005)

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Why GCC liquidity from flood to Drought

Three main factors behind tightening of liquidityConditions in the GCC during 2008

1. Reduced and more costly access to international capital markets which have become increasingly important sources of funds for both banks and corporate entities

2. A large withdrawal of speculative funds which had flowed into the region betting on exchange rate revaluations

3. Sustained very rapid loan growth which has exceeded deposit growth and led to elevated bank loan/deposit ratios

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Looking ahead, GCC financing requirements remain high, especially in Dubai

GCC Corporate refinancing requirements$ billions2009UAE17.9Of Which Dubai15Saudi Arabia9.3Qatar2.8Kuwait1.7Bahrain1Oman0.2GCCGCC32.932.9

Source Moody’s, Barclays Capital

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GCC Policy Response: Providing and Injecting Liquidity

• Placing deposits in commercial banks (Saudi Arabia, UAE)

• Making lines of funding a available (Kuwait, UAE)

• Buying stakes in banks to provide capital for future project financing (Qatar) and injecting capital (Abu Dhabi)

• Lowering interest rates (all expect Qatar)

• Introducing dollar/LCU swap facilities (UAE)

• GCC governments have the will and the resources to provide additional liquidity to the banking system

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Recent Situation of GCC Banks

1- Although GCC banks in general are well capitalized compared with US and European banks, a sustained shortage of long term funding sources may compel some to shrink their asset size (deleverage). In any event, Liquidity constraints are likely to curtail future asset growth.

2- Banks face significant risks from asset quality deterioration-including on international investments-rising NPLs, inflated provisioning needs, and decreased credit volumes.

3- Exposure to declining real estate sectors is a major concern for some, especially in the UAE where a speculative property bubble has begun to burst and bank exposure is large.

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4- The tightening of liquidity in the GCC was driven by the outflow of speculative funds betting on currency reform, by credit demand outstripping deposit growth, and by reduced access to international capital markets.

5- The GCC governments and central banks have responded swiftly and strongly to provide liquidity, and have the resources to do more if necessary.

6- Economic growth will slow in the GCC, but government support will ensure that the region does not slip into outright recession.

7- Dubai will face the most testing time.

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A Holistic Risk Management Approach

• Effective Governance, Risk Management and Control structure. Appropriate Committees and three lines of defense:

1- First Level: Control Units within Business processes.2- Second Level:

- Risk Management (Credit, Market, Operational, Information Security, Business Continuity, Business Risk Review, and others such as Insurance)- Regulatory Compliance

3- Third Level: Internal Audit

• Risk Management methodologies and procedure. Need for pro-active approach. Some risks require task forces, others require dedicated departments. Importance of discipline.

• Importance of Stress Testing. Expect the unexpected

• IIF July Report on Best Practice Recommendations on Risk Management