Saturday 23 June 2018

Dr Mazen Najjar

$27bn capital shortfall facing regional banks

Dubai, March 2, 2014

Thanks to astute oversight by regulators, GCC and Levant banks emerged from the financial crisis in better shape than many Western banks, but their liquidity and capital positions should not be taken for granted. Management consulting firm Booz & Company recently conducted a study of capitalisation and liquidity levels at 64 regional banks.

The results were sobering, as many institutions face the prospect of capital and liquidity shortfalls in the near term, particularly as Basel III rules are phased in between 2013 and 2018. In response, banks will need to manage their capital and liquidity levels more proactively – and soon.


Since the crisis, capital and liquidity support from GCC and Levant regulators has helped keep the banking sector relatively strong. Across the region, governments acted fast to inject liquidity into the system by placing long-term government deposits into banks. In Bahrain, Oman, and Saudi Arabia regulators also lowered interest rates and modified reserve requirements to improve the liquidity situation. To support capital positions, Kuwait and the UAE made direct capital injections and Qatar purchased bank assets.

These measures had the desired effect.


Although the governments’ capital and liquidity initiatives have helped keep regional banks solvent and strong to date, Booz & Company’s study found that many of these banks could soon face capital and liquidity shortfalls.

Basel III

To a large extent, the new capital and liquidity ratios under Basel III have not yet been finalized, but with the implementation phase around the corner, Booz & Company ran several scenarios based on the most likely new ratios. The findings were noteworthy.

According to the analysis, the new minimum capital requirements set by the Basel Committee and local regulators will significantly affect banks, including systemically important financial institutions (SIFI). Indeed, the new requirements are much more stringent, and they call for meticulous and recurrent capital planning that is integrated into the overall strategy of the banks.

“Based on 2012 performance, 15 of the 64 banks could fail to meet a capital requirement of 16 per cent, and 29 of the banks could fail to meet a capital requirement of 18 per cent,” said Dr Mazen Najjar, a partner with Booz & Company.

“To get an idea of how banks would perform in the future, we also ran two economic scenarios for 2017: one assuming growth in line with the projected expansion in GDP and another assuming decelerated growth. The results for the downside scenario were sobering.”

In effect, under the downside scenario, 28 banks could fail to meet the 16 per cent capital requirement while 39 institutions could fail to meet the 18 per cent capital requirement.

The picture is similar, though somewhat better, when looking at core capital. For instance, based on 2012 performance, two banks could fail to meet a new core capital requirement of 9.5 per cent, 11 could fall short if the level was at 12 per cent, and 22 could fail were the level raised to 14.5 per cent. In a 2017 downside scenario, 25 banks could fail to meet the 14.5 per cent threshold.

Based on possible ratios and various economic scenarios, the capital shortfall increases from a total of about $11 billion in 2012 to a range of $12 billion to $27 billion in 2017. As a result, once these new requirements are set, the shortfall in the availability of capital that banks can use to meet their growth plans will be substantial.

Liquidity Results

On the liquidity side, Basel III introduces two new ratios – The Liquidity Coverage Ratio (LCR) and The Net Stable Funding Ratio (NSFR)   – to improve the banking sector’s ability to absorb shocks arising from financial and economic stress, thus reducing the risk of spillover from the financial sector to the real economy.

These two new ratios pose a number of structural challenges for GCC banks.

Booz & Company ran two scenarios for the liquidity coverage ratio, a conservative one and a more aggressive one. Using Basel III guidelines, the company used various haircut levels and other factors to set the conservative and aggressive ratios. It then tested each bank’s ability to meet LCR requirements as they are gradually implemented from 60 per cent to 80 per cent to 100 per cent.

The different assumptions had an important impact on the number of banks that would potentially fail to meet the threshold, underscoring the need for banks to build greater resiliency measures into their liquidity management.

For instance, under the conservative scenario, based on 2012 data, seven of the 64 banks failed at 100 per cent implementation; that number doubled to 14 using the aggressive assumption.

“In total, the liquid assets needed to satisfy the 100 per cent LCR threshold range from $2.7 billion to $10.5 billion based on the conservative and aggressive scenarios,” added Dr Najjar.

“What emerges from our capital and liquidity study and the subsequent analysis is that a wide spectrum of preparedness exists among GCC banks. Among the 64 GCC and Levant banks studied, 16 have relatively strong capital and liquidity whereas 18 have relatively average capital and liquidity positions.”

The report also covered leverage ratios, but these posed no problem for any GCC bank due to high Tier 1 capital levels and limited off-balance-sheet exposures.


To avoid these shortfalls, GCC banks must begin to manage capital and liquidity ratios more proactively and rely less on reactive “helping hand” measures from their governments and regulators.

There are five strategic imperatives that all banks need to follow:

1.    Integrate Bank-Wide Risk, Capital Planning, and Funding Management Strategies: Maximize value creation by striking the right balance between the strategic objectives, risk appetite, and capital and funding availabilities. Ensure integration and internal alignment among stakeholders by elevating the endeavor to the board and management levels.

2.    Utilize capital effectively and efficiently: Identify the capital gap – the difference between capital availability and capital requirements – and identify internal and external sources for capital raising initiatives. Consolidate these findings into a holistic capital plan and mobilize resources for implementation.

3.    Enhance funding and liquidity management: Identify the funding gap – the difference between funding availability and funding requirements – and identify sources of funding to bridge the gap. Consolidate these finding into a holistic funding plan. Establish a centralized, consolidated, timely view of the bank’s liquidity positions to understand all liquidity needs and sources to avoid unexpected shortfalls or other liquidity surprises.

4.    Integrate risk governance with the organization, culture and processes: Articulate and tailor risk processes, policies and procedures. This includes defining the end-to-end credit process; assigning clear roles and responsibilities; and, embedding the processes in policies and procedure manuals.

5.    Invest in reporting, solutions, data and IT infrastructure: Produce reports and dashboards to support senior management and board decision-making. Create transparency around performance and risk-adjusted profitability at the group and subsidiary levels to improve measurement and increase accountability. – TradeArabia News Service

Tags: GCC | liquidity | Basel III |

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