Growing need for credible asset valuation as GCC banks face testing times with loan impairments under new international standards

The next 12-24 months could potentially have adverse effects on the asset quality of GCC banks, according to leading analysts. Loan impairments are likely to go up as a result of less supportive economic environments and mandatory loan classifications under new International Financial Reporting Standards (IFRS) 9, which could result in asset value deterioration in the GCC.

According to Mohammad Damak, the senior director and global head of Islamic finance with S&P Global’s Financial Services Research unit, the overall impact of IFRS 9 remained manageable. But in countries where the economy was under more pressure, some assets could be recognised as credit-impaired (Stage 3), rather than as underperforming (Stage 2). Based on the IFRS 9 guidelines, Stage 2 is where credit risk has increased significantly since initial recognition. When a financial asset transfers to Stage 2, stakeholders are required to account for expected credit losses, especially since the classification could lead to business troubles later on.

For banks and lending institutions to be able to mitigate such credit risks, it is important to have accurate, transparent and real-time market data along with vetted asset valuation. This ensures that the underlying asset values are correctly assessed before loans are approved, enabling lenders to identify mortgages with high probabilities of over-valuation when underwriting procedures begin. Maintaining current property value ranges and calculating Loan-to-Value (LTV) ratios to match market prices is particularly important, as it enables regular assessments of loan book values to mitigate any future losses, such as those that can arise with the introduction of standards like IFRS 9.

With some sectors of the economy already under stress, the new mandatory classification of loan impairments under IFRS 9 guidelines has the banking sector concerned about asset risk. Particularly here in the UAE, risks associated with real estate valuations and loan impairments are expected over the next 12-24 months. There is a relatively high concentration of loans – about AED 300 billion, according to a report in Gulf News – that accounts for approximately 20% of total loans. Mortgages amount to around AED 100 billion, which is around 7% of total loans. With the continued downward pressure on the market, asset and credit quality could well be affected.

According to S&P, 3.1% of total loans in GCC banks were Stage 3 at the end of 2018. This is up from the average of 2.6% the previous year. The deterioration was most marked in countries like the UAE, where the proportion of non-performing loans (NPLs) rose because economic performance weakened, and SMEs and real estate sectors were negatively impacted. Kuwait was the only GCC country where asset quality indicators for rated banks improved, according to S&P. However, this could be due to an increase in write-offs and not a genuine improvement in underlying asset quality.

–

Cavendish Maxwell is the MENA region’s leading firm of property consultants and chartered surveyors. We offer credible valuations through our trusted valuation teams.

Poor assessment of financial risk under new IFRS 9 guidelines can lead to asset value deterioration. If you are looking to mitigate financial risks and loss in asset value, or are looking for professional real estate consultation or advice on property related matters, please view our services.