Message from Qarar

As per the UAE’s directive, the Qarar team is continuing to work regular business hours – albeit remotely. Please be assured it is business as usual and we are in full contact with our clients and partners. We are continuing to drive our projects forward, and delivering our expertise and guidance on credit risk management and advanced analytics to the banking and finance industry during this challenging period. We’re in this together.How can we help?

It has been well documented over recent years, that retail banks should be prepared for adverse market events and as such ‘stress’ all financial portfolios in the event of an economic or financial downturn. To date there is little information that has been shared on the impact of an economic slowdown on consumer lending in Saudi Arabia and the Middle East specifically.

The following article describes the causal factors of a downturn, the subsequent impact on the Kingdom of Saudi Arabia, and the retail bank lending market and suggested actions to mitigate consumer lending related exposures and losses.

Causes of the slowdown

There are a number of macro level indicators that can trigger an economic downturn:

  • Global Recession: lower exports and lower domestic demand, increasingly important in an ever-closer global economy.
  • Tightening of Monetary Policy: Lower growth, government spending reduced through budget constraints.
  • Negative sentiment on Market Performance: Pessimism leads to increased saving and reduced spending.
  • Falling Asset Prices: Decline in consumer wealth and lower consumer spending.
  • Deflation: Deflation discourages spending and increases the real value of debt.
  • Oil Price Fluctuations: Lower oil price directly impacts countries with a high dependence on oil revenue.
  • Leadership: Regional factors specific to the Middle East were national strikes or changes in leadership.

Impact on Saudi Arabia

Oil price fluctuations have had a direct impact on the Middle East, specifically in Saudi Arabia, as the world’s largest producer and exporter of oil. The country has been able to scale up its production because of its high spare capacity of around 2 million barrels a day. 

SAUDI ARABIA’s continued dependence on oil [as its primary source of revenue] in the short term is potentially problematic. In the short-term, Saudi economy is vulnerable to shifts in oil prices, lowered demand, or disrupted production due to a number of possible factors, including regional [political] conflicts and the OPEC rebalancing oil-production quotas.

Impact on Industry

During an economic downturn, one may observe industries suffering from a number of potential factors. In essence, this would include: 

  • Fewer investments associated with general market uncertainty.
  • Reduced government expenditure as a result of reduced oil revenues, leading to fewer government subsidies/benefits given tightening on expenditure.
  • Higher costs of funding, a reduction in funding liquidity across the industry, impacts on interbank lending, leading to an increase in interest rates for borrowing. 
  • Increase in Small Medium Enterprise (SMEs) & Mid-Tier Corporate failures. Liquidity and cash flow issues became more prevalent in SMEs especially where tightening on credit terms may affect their liquidity and solvency. Cost Rationalisation results in  increased cost pressure, possibly resulting in reduced headcount of the workforce.

Impact on Consumer Lending 

During an economic downturn, there are a number of specific changes that would likely occur within consumer lending, this would include: 

  • Asset quality would potentially deteriorate, due to changes in the mix of new to bank customer and changes in institutional risk appetite (however, these could remain well-managed, owing to countercyclical buffers that SAMA has imposed in recent years). This would then lead on to further tightening of overall liquidity conditions, which would in turn lead to higher funding costs. 
  • Increased appetite for credit from higher risk segments.
  • Lower abundance of credit available in the market from which to profit. In turn, this could lead to higher capital requirements though increased NPL’s and provisions.  
  • Margin compression whereby costs rise at a faster rate than income.

And the Impact on Consumers?

Economic downturns directly impact consumers on a day-to-day level through factors which may include:

  • Fewer jobs available in the market, brought about by cost rationalisation and employer downsizing.
  • Lower overall job remuneration/lower disposable income whereby variable pay components and/or government subsidies/benefits are reduced.
  • Less overall available credit in the market for consumers.
  • Higher utility costs from higher living amenities.

Summary – Downturn Chain of Events:

These events, which are not exhaustive, start at a macro level flow through to the consumer.  Note that the time from the “Causal Factors” to the “Consumer Impact” is often quite lengthy, as such this lagged affect can sometimes lead to a false sense of how bad the downturn actually.

Many consumers will only reduce spending as a direct result on their disposable income; however this often leads to over-indebtedness and an increased appetite for credit to maintain existing expenditure and lifestyles.

Figure 1 below summarises the points discussed and shows how each event triggers the next.

How should Banks Prepare?

The main objective for banks during a downturn is to minimise the impact on losses.  Banks should quickly and carefully review and enhance strategies to prepare well in advance of such events and the end-to-end process must be well-thought out, managed, tested and revisited regularly:

  • Originations Management: Banks should enhance originations strategies and policies for new to bank customers including an assessment of scorecard cut-offs.   
  • Portfolio Management: banks should look to reduce risk and exposures of its existing customers. These customers could be managed with strategies such as credit line decreases or high risk performance alerts.  Growth activities (i.e. CLI’s) might need to be tempered and existing behavioural scorecards based strategies should potentially be re-aligned. 
  • Collections Management: Banks should enhance collection strategies and look to incorporate pre-delinquent strategies/accelerated treatments on specific “high risk” segments defined.

The Downturn Integrated Credit Risk Framework

The key management of risk in a downturn is for an action plan to be holistic and integrated.  For example, behavioural scorecard re-alignment will impact collections directly (specifically pre-delinquent actions) and a strong understanding of the downward impact is necessary to allow collections to plan capacity (potential higher inflow). 

Solutions for Retail Banks in the region

There are a number of solutions available for clients that can be considered in an economic downturn. These actions should be taken to constrain exposure and losses, whilst carefully considering the impact on customers. 

Essentially, there are three factors clients need to consider to ensure they are well prepared to weather the effects of a downturn:

  • Client Readiness: In the event of an economic downturn, ensuring Operations, Process, Information and Technology (“OPIT”) can support strategic changes efficiently and dynamically.
  • Integrated Credit Risk Strategies: Effective strategies have to be developed and executed throughout the credit life cycle.
  • Risk Mitigation Policies:  Ensure risk mitigation policies, strategies procedures are developed, well communicated and understood across all affected functions.

In summary, it is imperative for banks to identify its key success factors in preparing for a downturn. In general, these will include:

  • Speed.
  • Execution Strength.
  • Risk Mitigation Policy effectiveness.

It is important, whatever ‘solutions’ are recognised and implemented by the bank, that they utilise high quality internal and external data. This ensures a full and complete picture of a customer’s exposure and behaviours, and more importantly the associated impact that these strategic changes will have on the bank’s performance.