Kurdistan International Islamic Bank – Ratings Affirmed

(MENAFN- Capital Intelligence Ltd) Capital Intelligence Ratings (CI Ratings or CI) today announced that it has affirmed Kurdistan International Islamic Bank for investment and Development’s (KIB) Long-Term Foreign Currency Rating (LT FCR) and Short-Term Foreign Currency Rating (ST FCR) of ‘B-’ and ‘B’, respectively. The LT FCR Outlook is Stable. CI Ratings has also affirmed KIB’s Bank Standalone Rating (BSR) of ‘b-’ with a Stable Outlook, Core financial Strength (CFS) of ‘bb-’, and Extraordinary Support Level (ESL) of Uncertain.

At the same time, CI has affirmed KIB’s Long- and Short-Term Ratings on the Iraq National Scale of ‘iqBBB’ and ‘iqA3’, respectively, with a Stable Outlook. These are supported and constrained by the same factors as the CFS as outlined below.

CI considers the likelihood of sufficient and timely official support being made available to KIB in the event of financial distress to be uncertain and, consequently, does not incorporate such support into the Bank’s LT FCR. Moreover, even if the government may be willing to provide extraordinary support in case of need, its financial capacity to do so is limited as indicated by our internal assessment of Iraq sovereign credit risk.

The Bank’s BSR and – since ESL is Uncertain – LT FCR are therefore derived from a CFS rating of ‘bb-’ and the constraints imposed by the Operating Environment Risk Anchor (OPERA) of ‘c+’. The CFS is supported by a solid capital base, including low balance sheet leverage, very high liquidity and strong customer deposit mobilising capability, particularly in the Kurdistan Regional Government (KRG) territory. The relatively granular customer deposit base, reflecting a significant retail component, also supports the CFS. The principal CFS constraints are KIB’s increased credit risk profile amid a difficult operating environment (due to volatile oil prices and Covid-19), the large asset concentrations and relatively small balance sheet, and still low profitability (despite a mild rebound in 2020). The rather weak regulatory and supervisory framework (although improving) also constrains the CFS.

The OPERA is at a level indicative of a high level of risk. This reflects the volatility of the economy and underlying structural and fiscal weaknesses, as well as significant socioeconomic imbalances and deficiencies in the country’s political and institutional frameworks. It also takes into account the challenges inherent in a banking sector that is small, underdeveloped, and dominated by financially weak state-owned banks. The latter elevates systemic risk in the banking sector. Although gradually improving, the quality of banking sector regulation and supervision is relatively low. Both the legal system and corporate governance standards are also comparatively weak.

KIB’s capital base is among the largest of the Iraqi private sector banks rated by CI. Meanwhile, balance sheet leverage remains at a conservative level, in common with almost all peer banks, reflecting the very limited lending opportunities in Iraq, as well as management’s cautious financing policy. In view of ongoing elevated credit risk in the economy, as well as geopolitical tensions, we consider the current business model concentrated and potentially vulnerable to event risk. These factors largely relate to the high concentration of assets seen in Central Bank of Iraq (CBI) balances (in common with peer banks), and the potential to transmit sovereign stress to KIB’s balance sheet in a distress situation. This is considered a major credit risk challenge.

Despite a satisfactory track record of servicing corporate, SME and retail customers, the difficult operating environment had produced precipitous falls in financing-related activity during much of the last decade. More recently, however, credit related activity has resumed growth, albeit from miniscule levels. Indeed, net financings equated to <1% of totals assets at end-2020 – one of the lowest proportions seen among Iraqi banks. Conversely, the balance sheet continues to display high levels of liquidity, notably in the form of cash and balances with the CBI and other banks.
 
In common with other Iraqi banks, KIB’s risk profile continues to be negatively affected by the difficult operating environment. This is compounded by the effects of volatile oil prices (impacting Iraq’s fiscal balances) and the Covid-19 pandemic. That said, CI considers management’s past de-risking initiatives in response to elevated credit and geopolitical risk judicious. However, these have come at the expense of significantly weakened profitability at both the operating and net levels – a key credit challenge.

KIB had been very profitable at both the operating and net levels prior to 2018, although income was heavily skewed towards non-financing income as is the case with peer banks. The latter reflects a miniscule financing portfolio alongside large non-remunerative balances with the CBI – the latter being a feature of all Iraqi banks. While operating income generation had been strong in the past, revenue streams remain undiversified and reliant on commissions from funds transfers and FX income. Despite the increase seen in 2020, KIB’s current low operating profitability provides limited risk absorption capacity, while modest bottom line profitability severely restricts internal capital generation. These risk factors, however, are currently not considered significant credit challenges given the solid equity base and its capacity to withstand unforeseen losses. Moreover, CI expects provision charges to continue to remain negligible over the medium-term given the exceptionally small financing portfolio.

KIB’s solid capitalisation remains a major credit strength in our opinion, particularly in view of the high probability of event risk in Iraq. The equity base remains large relative to total assets (44%), underscoring the fact that the Bank has yet to fully leverage the balance sheet. Equity has a very high Tier 1 component and provides a strong risk buffer. The ratings take into consideration the projected increase in leverage over time and, in turn, consequent decline in total CAR.

Liquidity has been consistently strong over the last four years, reflecting the dominance of cash and deposits placed with other banks and CBI. There remain very limited opportunities in which to profitably invest excess liquidity in the Iraqi banking system. KIB’s high liquidity firmly underpins the ratings. The emphasis given to safeguarding liquidity is of strategic importance in a banking system where the central bank is understood to perform lender of last resort function only in exceptional circumstances (at least for the private sector banks). Moreover, there is no real domestic interbank market to support banks’ potential short-term funding requirements. The bulk of liquidity remains deployed in deposits with other banks – in Iraq and to a lesser extent in the wider region. Counterparty concentration risk is however high.

Notwithstanding the recent strong expansion (albeit from a comparatively low base), customer deposit growth is considered vulnerable to volatility given fragile depositor confidence in Iraq and the high probability of event risk. KIB’s potential funding and liquidity risk is strongly mitigated by a significant pool of liquid assets. Also, a reasonably sized branch network supports customer deposit mobilisation. Moreover, in contrast with its peers, the Bank’s deposit funding base is relatively diversified by customer, reflecting a significant retail component. Government deposits have increased in recent years – albeit from a low base – and are deemed relatively stable, although authorities are likely to withdraw deposits in times of budgetary pressure.

Ongoing high concentrations in the asset base are partially a function of KIB’s limited business operation and small balance sheet. The large CBI balances – which equate to a high proportion of total equity – significantly expose KIB to sovereign risk. Notwithstanding the exceptionally small financing portfolio, the lending policy is deemed satisfactory with clear limits in place by sector and borrower. Looking ahead, CI expects management will resume lending as and when conditions on the ground improve.

Rating Outlook

The Outlook for the ratings is Stable, indicating that they are unlikely to change over the next 12 months. This reflects our view that despite ongoing challenges related to a difficult operating environment (brought on by volatile oil prices and Covid-19) and low profitability, we expect KIB to maintain strong capital and liquidity buffers to withstand a potential financial setback.

Rating Dynamics: Upside Scenario

We do not expect a change in the ratings unless there was a significant improvement in OPERA. This is currently seen as being unlikely within a 12-month timeframe.

Rating Dynamics: Downside Scenario

The ratings could be reduced by one notch over the next 12 months if KIB’s credit risk profile and/or OPERA deteriorate considerably beyond what is anticipated. The ratings could also be lowered by one notch should our internal assessment of Iraq’s sovereign credit risk deteriorates.


*A National Rating summarises the repayment risk of an entity relative to other entities within the same economy. It is not an absolute measurement of risk. National Ratings are not directly comparable across borders.


Contact

Primary Analyst: Morris Helal, Senior Credit Analyst; E-mail: morris.helal@ciratings.com
Secondary Analyst: Rory Keelan, Senior Credit Analyst
Committee Chairperson: Karti Inamdar, Senior Credit Analyst

About the Ratings

The credit ratings have been issued by Capital Intelligence Ratings Ltd, P.O. Box 53585, Limassol 3303, Cyprus.

The following information sources were used to prepare the credit ratings: public information and information provided by the rated entity. Financial data and metrics have been derived by CI from the rated entity’s financial statements for FY2016-20 and H1 2021. CI may also have relied upon non-public financial information provided by the rated entity and may also have used financial information from credible, independent third-party data providers. CI considers the quality of information available on the rated entity to be satisfactory for the purposes of assigning and maintaining credit ratings. CI does not audit or independently verify information received during the rating process.

The principal methodologies used to determine the ratings are the Bank Rating Methodology, dated 3 April 2019 (see and the National Scale Ratings Criteria for Iraq, dated 15 March 2020 (see Information on rating scales and definitions, the time horizon of rating outlooks, and the definition of default can be found at Historical performance data, including default rates, are available from a central repository established by ESMA (CEREP) at

This rating action follows a scheduled periodic (annual) review of the rated entity. International and National ratings on the entity were first released and last updated in September 2020. The ratings and rating outlook were disclosed to the rated entity prior to publication and were not amended following that disclosure. The ratings have been assigned or maintained at the request of the rated entity or a related third party.

Conditions of Use and General Limitations

The information contained in this publication including opinions, views, data, material and ratings may not be copied, distributed, altered or otherwise reproduced, in whole or in part, in any form or manner by any person except with the prior written consent of Capital Intelligence Ratings Ltd (hereinafter “CI”). All information contained herein has been obtained from sources believed to be accurate and reliable. However, because of the possibility of human or mechanical error or other factors by third parties, CI or others, the information is provided “as is” and CI and any third-party providers make no representations, guarantees or warranties whether express or implied regarding the accuracy or completeness of this information.
 
Without prejudice to the generality of the foregoing, CI and any third-party providers accept no responsibility or liability for any losses, errors or omissions, however caused, or for the results obtained from the use of this information. CI and any third-party providers do not accept any responsibility or liability for any damages, costs, expenses, legal fees or losses or any indirect or consequential loss or damage including, without limitation, loss of business and loss of profits, as a direct or indirect consequence of or in connection with or resulting from any use of this information.

Credit ratings and credit-related analysis issued by CI are current opinions as of the date of publication and not statements of fact. CI’s credit ratings provide a relative ranking of credit risk. They do not indicate a specific probability of default over any given time period. The ratings do not address the risk of loss due to risks other than credit risk, including, but not limited to, market risk and liquidity risk. CI’s ratings are not a recommendation to purchase, sell, or hold any security and do not comment as to market price or suitability of any security for a particular investor.

The information contained in this publication does not constitute investment or financial advice. As the ratings and analysis are opinions of CI they should be relied upon to a limited degree and users of this information should conduct their own risk assessment and due diligence before making any investment or other business decisions.

Copyright © Capital Intelligence Ratings Ltd 2021