GCC Islamic banks beat conventional peers for the second consecutive year

After trailing for five years, GCC banks are now more profitable than their counterparts.

The profitability of Islamic banks in the Gulf Cooperation Council (GCC) region will outpace that of their conventional peers for the second consecutive year in 2017 on the back of stronger margins and resilient cost of risk, says Moody's Investors Service in a report. Islamic banks became more profitable than their conventional counterparts in 2016 after trailing for five years.

"Islamic banks will be able to maintain their profitability in 2017, as lower funding costs will support their margins against a backdrop of rising interest rates, while improvements in their risk management and asset quality will further ease the pressure on their cost of risk," says Nitish Bhojnagarwala, Assistant Vice President -- Analyst at Moody's.

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Islamic banks will maintain stronger margins in 2017, primarily as a result of their low funding costs, which reflect their reliance on largely stable current and savings account balances. Islamic banks also tend to have higher asset yields, given their focus on retail and the real estate related lending.

Moody's expects that Islamic banks will retain a margin advantage of about 40 basis points over conventional banks in 2017. Islamic banks' net profit margins are analogous to conventional banks' net interest margins.

"The cost of risk for Islamic banks has converged with the conventional peers as they diversify away from real estate lending towards other sectors and tighten their risk management practices. In the past, higher impairment charges on loans and investments have dampened Islamic banks' profitability" adds Mr. Bhojnagarwala.

"Conventional banks will continue to beat Islamic peers in terms of cost efficiency" explains Mr. Bhojnagarwala. Islamic banks' have higher cost base because they are younger and more focused on retail customer segments. This means higher levels of investment in branch network expansion and technology. Conventional banks in the GCC, in contrast, have already established their branch networks.