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) rating 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.

The Bank’s BSR is derived from a CFS rating of ‘bb-’ and an Operating Environment Risk Anchor (OPERA) of ‘c+’. The latter is at a level indicative of a high degree of risk and is a key rating constraint for KIB, as well as all other Iraqi banks. The CFS is supported by the Bank’s strong capital base, including low balance sheet leverage, very high liquidity and effective customer deposit mobilising capability, particularly in the Kurdistan Regional Government (KRG) territory of Iraq. The relatively granular customer deposit base, reflecting a significant retail component, also supports the rating. The principal CFS constraints are KIB’s high credit risk profile due to Iraq’s difficult operating environment, as well as geopolitical and banking systemic risk, the large asset concentrations and relatively small balance sheet, and still weak profitability at all levels. The weak regulatory and supervisory framework (while improving) also constrains the CFS. Although KIB (along with many other Iraqi banks) is currently banned from CBI’s USD auction (due to US sanctions), management inform they are able to access other hard currencies to fulfil their commitments.

CI considers the likelihood of sufficient and timely official extraordinary support being made available to KIB (and all other private sector banks) 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 were willing to provide extraordinary support in case of need, its financial capacity to do so is limited.

KIB’s capital base is among the largest in money terms of the rated Iraqi private sector banks, notwithstanding the small balance sheet size. Management follows a relatively cautious business strategy and financing policy. The risk aversion has so far served to safeguard the balance sheet by ensuring that good liquidity and capital buffers remain in place. However, in view of ongoing elevated credit risk in the banking system, we consider KIB’s current business model vulnerable to event and sovereign risk. This factor partially derives from the high concentration of assets seen in Central Bank of Iraq (CBI) balances and, in turn, their potential to transmit sovereign stress to KIB’s balance sheet in a distress situation. CBI balances alone equated to a little more than one-half of total equity in 2023, and we expect these concentrations to persist in the intermediate term. This is considered a credit challenge. A partial risk mitigating factor in this regard is that the Bank’s balance sheet leverage ratio of 46% remains at a conservative level, in common with most (but not all) peer banks.

Liquidity has been good over the last four years, reflecting the dominance of cash and deposits with other banks and the CBI. However, in view of the concentration seen in CBI balances and bank placements this factor has the effect of elevating the Bank’s risk profile to some degree. The high liquidity reflects KIB’s risk aversion and is partially a corollary of the dearth of sound lending opportunities in the local market. Indeed, net financings were equivalent to less than 1% of total assets in 2023. The situation is compounded by the very limited avenues in which to profitably invest excess funds in the Iraqi banking system. The safeguarding of liquidity (specifically cash and bank placements) is of 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.

In contrast with many peer banks, KIB’s deposit funding base is relatively diversified by customer, reflecting the dominance of CASA balances. A reasonably sized branch network supports customer deposit mobilisation. That said, customer deposits are considered vulnerable to volatility given the fragile depositor confidence in Iraqi banks, alongside the high probability of event risk. Despite a recent decline, government deposits had grown in prior years, albeit from a low base. However, the authorities are likely to withdraw deposits in times of budgetary pressure. Potential funding and liquidity risks are deemed to be low and mitigated by a significant pool of liquid assets. We expect KIB to maintain liquidity metrics at current levels over the medium term.

KIB’s good capitalisation and leverage remain a credit strength, particularly in view of the high probability of event risk in Iraq. The equity base remains large relative to total assets, underscoring the fact that the Bank has yet to meaningfully leverage the balance sheet. Equity has a very high Tier 1 component and provides a good risk buffer. The current ratings take into consideration the projected increase in balance sheet leverage over time and, in turn, consequent decline in total CAR. Although internal capital generation is meagre (due to weak profitability), CI does not consider this to be a credit vulnerability at present given strong capitalisation. Furthermore, KIB is unlikely to need a fresh capital injection in the foreseeable future. The high headline total CAR (Basel II) is due to a very low risk weighted assets (RWA) density ratio (CBI balances are zero risk-weighted as per Central Bank regulations and the financing book is miniscule).

The Bank’s persistently weak profitability at both the operating and net levels is a credit challenge. Indeed, the negligible financing portfolio, alongside large non-remunerative balances with the CBI, significantly weighs down on operating income generation and profitability. Sources of revenue streams therefore remain very limited in scope, as is the case with most (but not all) Iraqi banks. This contributes to earnings volatility and undermines earnings strength. Furthermore, KIB’s operating income continues to be heavily skewed towards non-financing income (non-FI), reflecting meagre profit-earning assets. The current weak operating profitability provides very limited risk absorption capacity. However, this risk factor is partially mitigated by a good equity base and its capacity to withstand unforeseen losses. We also expect provision charges to continue to remain negligible over the medium term given the exceptionally small financing portfolio. Looking ahead, KIB’s ability to improve earnings strength largely hinges on its ability to generate higher levels of net financing income (NFI) and, to a lesser extent, non-FI.

Iraq’s OPERA is at a level indicative of a high degree of risk. The OPERA takes into account the volatility of the economy and underlying structural and fiscal weaknesses, as well as significant socio-economic imbalances and deficiencies in the country’s political and institutional frameworks. Although the Iraqi economy continued to recover moderately in 2023 from the economic fallout of the pandemic – buoyed by favourable oil prices − credit risk remains elevated. OPERA also reflects the challenges inherent in a banking sector that is small, underdeveloped, and dominated by financially weak state-owned banks. The latter elevate banking systemic risks. Both the legal system and corporate governance standards are also weak.

Rating Outlook

The Outlook for KIB’s ratings is Stable, indicating that they are unlikely to change over the next 12 months. This reflects our view that the Bank will maintain its current risk profile, including the concentrations in the balance sheet.

Rating Dynamics: Upside Scenario

We do not expect an upward change in the ratings and/or outlook unless OPERA improves. This is currently seen as being unlikely to change within a 12-month timeframe.

Rating Dynamics: Downside Scenario

While not our current expectation, KIB’s ratings could be reduced by one notch over the next 12 months in the event key credit metrics worsened significantly and should OPERA be revised downwards.

*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: ...
Secondary 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 FY2019-23. 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.

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