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    CBK Analyzes Financial Sector Stability, Presents Stress Test Results

    July 19, 2020

    CBK published the financial stability report, which assesses risks and vulnerabilities facing the financial system in Kuwait. The report also discusses the role of banks and their performance as financial intermediaries while shedding light on trends in credit distribution and deposit activity. The report uses the year-end data (December 2019) to analyze trends in the profitability and solvency of the banking system and assesses its ability to withstand internal and external shocks within different financial and economic stress scenarios. The report highlights that banking sector in Kuwait has entered this pandemic-driven crisis from a position of considerable strength. With robust capital adequacy, ample liquidity, substantial provisions, and the healthiest asset quality, the banking sector has been a part of the support mechanism for the impending economic recovery.

    The financial stability report also presents results of the stress test exercise on banks under a wide range of micro- and macro-economic scenarios. The stress test results reveal that, under a muted "U" shaped scenario, most banks were able to maintain a Capital Adequacy Ratio above the CBK’s minimum of 10.5% (after allowing for the temporary utilization of the 2.5% capital conservation buffer), with one bank breaching the Basel III minimum ratio (8.0%) by the end of 2020. Greater pressure on capital is expected during 2021, as moratoria expire and defaults materialize. It is worth noting that strong capital bases, abundant liquidity, and ample provisions of banks greatly influenced the stress test results. However, the resilience of the banking system would come under increased pressure in a severe "L" shaped scenario. Nevertheless, CBK is vigilantly monitoring these developments and stands ready to take any action required to ensure the resilience and stability of the banking sector. Overall, the stress test results suggest that most of the banks would maintain their capital adequacy ratio above the regulatory minimum.

    Going forward, it is expected that the banking sector will remain broadly stable, though the degree of resilience will largely hinge on the duration and severity of the crisis and differ across individual banks. Profitability of banks would come under pressure amid challenging economic conditions, compressed net interest income, and the need for greater provisions to cover potential deterioration in asset quality. Banks that choose to avail the capital conservation buffer would not be allowed to pay dividends, in line with the Basel recommendations. In terms of liquidity, levels are expected to remain comfortable and resumption in government debt issuance will offer banks additional opportunities to invest in risk-free government paper. To ease any potential pressure on banking sector liquidity, CBK has relaxed liquidity coverage ratio, net stable funding ratio, required liquidity ratio, and maturity ladder requirements since April 2020. Collectively, these measures will not only release additional liquidity for banks but also enable them to provide necessary credit to affected firms and individuals, thus restricting short-term liquidity problems from truing into solvency issues. It is critical that banks are able to see through the recession with their buffers largely preserved. While enormous financial savings and low public debt offer Kuwait some room to maneuver, the pandemic has intensified the need for economic diversification.

    However, without making tangible progress on requisite reforms, the country will remain vulnerable to oil price volatility, with its attendant risks to financial stability. It is hoped that the COVID-19-induced crisis would prompt a similar introspection at the national level and would pave the way to build a well-diversified, resilient, and sustainable economy going forward. A further detailed assessment of the impact of COVID-19 on financial institutions, local markets, and infrastructure is to be performed in the next time, as the recent changes in the financial soundness indicators of the banking system barely reflect the scale and severity of the crisis.

     

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    Keywords: Middle East and Africa, Kuwait, Banking, COVID-19, Financial Stability Report, Credit Risk, Market Risk, Liquidity Risk, Regulatory Capital, Basel, Stress Testing, CBK

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