Kuwaiti banks have sufficient financial resources to withstand a fresh crisis despite a sharp rise in their non-performing loans, the International Monetary Fund (IMF) has said. At the end of 2009, Kuwait's banking sector had a combined capital adequacy ratio of 18 percent, far higher than the 12 percent level required by the Gulf country's central bank, the IMF said in a study on Kuwait. At the end of 2009, the Kuwaiti banking sector's leverage ratio (capital to assets) stood at a comfortable 12 percent, supported by increases in paid-in capital by some banks in 2009, it said. Kuwaiti banks' assets are predominantly domestic (80 percent), and external exposures are limited, it said, adding their main source of funding are domestic deposits. “Although the coverage ratio (specific provisions to NPLs) declined to 38.5 per cent from 41.6 per cent in 2008, total provisioning (including precautionary) increased in 2009.... the Kuwaiti banking system appears liquid and insulated against foreign exchange (FX) risk, but exposed to equity risk,” it said. The IMF further said a liquidity stress test was carried out to test banks' capacity to withstand a deposit run over a period of five days without external financing. “The results indicate that banks could withstand a substantial deposit run for the five days, without a need for external financing due to adequate liquidity buffers.” The IMF report also noted that Kuwait banks were heavily exposed to real estate and construction sectors. As a result, the asset quality deteriorated markedly in 2009, with the NPL ratio almost doubling to 9.7 percent from 5.3 percent in 2008. The Washington-based Institute of International Finance (IIF) said earlier that Kuwait's “banking portfolio is highly exposed to the real estate and construction sectors, which together account for close to 50 per cent of total loans.” It noted that “Kuwaiti banks are highly exposed to investment companies (12 percent of total loans), which proliferated in recent years with inadequate controls, “ adding that the “stressed domestic investment companies have put strains on the banking sector during the current crisis.” “Liquid assets account for 26 percent of total assets and cover 35 percent of short-term liabilities. The loans to deposits ratio has been relatively stable since 2007, rising slightly in 2009 to 91 percent.” The profitability of the Kuwaiti banking system has declined sharply since 2007 mainly because of a large increase in NPLs and provisioning, and heavy losses incurred by one large bank in 2008. Return on equity (ROE) plunged to seven percent in 2009 from 29.4 percent in 2007, and net income nearly halved, the report said. “Aggregate financial soundness indicators show that the banking system is highly capitalized, but rising NPLs and large concentrations to volatile sectors are a source of concern.... however, net interest margins remained relatively stable because of excess liquidity resulting from increased private and public deposits, and associated lower funding costs,” the IMF said. “The cost to income ratio deteriorated. The stress tests indicate that the banking system could broadly withstand significant shocks, although some banks appear vulnerable to extreme macroeconomic shocks.” However, the IMF still maintained that Kuwaiti banks' balance sheet composition indicates adequate asset liability management. Equity exposures, both in the form of direct investments and collateral held against credit facilities, accounted for 68.5 percent of shareholders' equity capital in 2009. “Under the intermediate shock scenario, none of the banks loses its entire capital, but three of the largest banks fall below the minimum regulatory capital of 12 percent. The recapitalization needed to restore the CAR to the 12 percent minimum requirement is estimated at 0.9 per cent of GDP,” it said. “Under the severe case scenario, one medium-sized bank would lose its entire capital, while the CAR of three of the largest banks would fall below eight percent. The maximum amount for recapitalization under this scenario is estimated at around 3.8 percent of GDP.” The report pointed out that risks related to the banking sector's high exposure to the real estate and construction sectors “would have the largest impact on banks' solvency. This test assumed a 50 percent haircut on the value of the underlying collateral, which reflects the long and complex foreclosure procedures, and the current illiquidity of the real estate market.” “Market risk stress tests suggest that equity risk represents the most significant risk. The direct impact of exchange and interest rate shocks appears limited due to marginal FX net open positions, and adequate asset liability management.”
