Middle Eastern banks must minimize Non-Performing Loans consequences and ensure portfolios remain high in terms of value


Non-Performing Loans are set to peak in 2021 and effects can be mitigated through a Workout Unit, according to Arthur D. Little

Philippe DeBacker, Managing Partner, Global Practice Leader Financial Services, at Arthur D. Little

Dubai, United Arab Emirates: The ongoing pandemic has resulted in Middle Eastern economies confronting severe repercussions, with banking institutions widely expected to experience companies defaulting on loans and cashflow problems. In times of economic crisis, commercial banks with issues surrounding Non-Performing Loans (NPLs) must, however difficult, minimize such impacts and secure NPL portfolio value, according to a new report by Arthur D. Little (ADL). The report, titled ‘Non-Performing Loan Management: The case of setting up a Workout Unit,’ provides exclusive insights into how banks can mitigate NPL issues and offers a detailed overview of how to establish a dedicated Workout Unit. 

“The COVID-19 pandemic has devastated economic activity across the globe and GCC countries have not been shielded from these effects,” said Philippe DeBacker, Managing Partner, Global Practice Leader Financial Services, at Arthur D. Little. “Major disruptions to the hospitality, retail, F&B, and travel and tourism sectors will severely impact both companies’ financials and overall employment levels in the GCC countries. This will, in turn, hinder the ability of GCC banks’ corporate and retail customers to repay loans and honor other commitments.” 

As per the report’s findings, the current crisis will impact banks with a significant degree of strain. While banking sector problems in the 2007 financial crisis resulted in liquidity problems in the overall economy, the current dilemma has already been unequivocally defined as a ‘real’ economic crisis. The severe GDP declines following pandemic-inducted lockdowns will have a devastating effect on companies and retail customers’ creditworthiness, something that directly affects players in countries across the Middle East. 

“Looking ahead, it’s inevitable that NPL figures will rise quite substantially in the next year or two” explained Nima Obbohat, Partner, Global Head of Banking, Arthur D. Little. “Given the implications of rising NPLs on profitability and capital position of banks it’s crucial to be well prepared and make the necessary adjustments ahead of time”

Challenging Regional Outlook 

The turbulent financial climate from a regional perspective has been reaffirmed by S&P Global’s 2021 Banking Outlook, which details why current events and those that will transpire in the near future represent the most challenging test for banks in over a decade. In terms of the UAE, a slowing economy will weaken banks’ asset quality and profitability. With the national economy expected to contract by approximately 8.5 per cent in 2020, a mild recovery in 2021 is the most likely outcome. Although regulatory forbearance measures delay the recognition of problems, assets-quality indicators will be affected by a less resilient macroeconomic environment and continued correction in the real estate sector. Moreover, the relaxation of certain prudential requirements carries risks for the national banking sector. 

“From a UAE standpoint, the impact of COVID-19 on SME’s compounded by the current low oil prices and the economic slowdown will drive problem loan increases and a rise in associated risks,” continued DeBacker. “Besides real estate, other industries are also witnessing substantial revenue declines. This damages credit quality and nonperforming loans will, most probably, reach a record high in this particular crisis. Although most banks are expected to remain profitable and government support to the banking sector is likely, asset quality will deteriorate and bank profitability will remain low. Therefore, minimizing impacts and securing NPL value is essential.”

With regards to the KSA, the economy was projected to contract by around 4.5 per cent last year. Despite the country’s banking system demonstrating robustness in the face of oil price and economic growth adversity, growth here is heavily dependent on the oil market in any scenario and susceptible to economic and geopolitical trends. In 2021, it is expected that lower interest rates, hindered growth, and higher risks will collectively increase pressure on Saudi banks’ profitability. Although institutions can navigate these issues and maintain a return on average assets of approximately 1.2 per cent in due course, careful management of NPLs will be essential.

“So far, we do see a rather small uptake in NPL numbers at major financial institutions and the national level for all GCC countries,” revealed De Backer. “We believe GCC banks became much more adept in handling NPL situations after the previous crisis, improving their capital position considerably. However, we are also of the view that a major uptake of the NPL levels across the region is not preventable. GCC banks should, with this in mind, have a strategy ready to go as soon as possible to manage their balance sheets through 2023.”

Strategic Non Performing Loan Options 

ADL has identified three strategic options for regional banks to explore when dealing with large NPL portfolios. Despite differing in terms of resources required, each is a viable option:

  1. Continue business as usual: Institutions can abide by pre-crisis processes and practices, keeping NPLs on balance sheets and following traditional methods when dealing with delinquent loans.
  2. Set up a Workout Unit:. As an independent body closely aligned with the risk departments and commercial banking units, such a department will be tasked with mitigating undesirable operational and financial NPL portfolio impacts.
  3. Create a Bad Bank: This entails segregating NPLs operationally, financially, and legally. ADL details the benefits of all three options in the report, elaborating on their effectiveness in particular situations.

“It is crucial that banks confront today’s reality directly and make a well-informed decision on the strategy they wish to pursue,” concluded Obbohat. “Because every bank will experience financial and operational situations stemming from higher NPL volumes, the issue is very time-sensitive. Middle Eastern banks are required to choose a strategy, build their capabilities, and ensure resources are in place ahead of schedule. Those that do so while adhering to these best practices will be better positioned to emerge from this crisis, with quicker recovery periods and better access to capital if and when required.”