The largest banks in the Gulf Cooperation Council are set to earn more net interest income in 2023 as interest rates are likely to remain elevated for most of the year, according to industry observers.

Interest rates are expected to remain high through the year before slowly declining in the third or fourth quarter, meaning net interest margins (NIMs) will stay high, Martin Blechta, principal at Boston Consulting Group, told S&P Global Market Intelligence. NIM measures the amount of money banks earn from loan interest after deposit costs.

The currencies of Gulf Cooperation Council (GCC) countries are pegged to the US dollar, and officials at the US Federal Reserve have signaled they may hold rates steady at their upcoming June meeting before increasing them again later in 2023. A rate hike pause should not be interpreted as a signal that the regulator has reached the peak rate, The Wall Street Journal quoted Fed Governor Philip Jefferson as saying in a recent speech.

Four of the GCC's top five largest banks — Qatar National Bank QPSC, First Abu Dhabi Bank PJSC, Saudi National Bank and Emirates NBD Bank PJSC — posted year-over-year net interest income (NII) increases in the first quarter, according to Market Intelligence data. Meanwhile, Al Rajhi Banking & Investment Corp.'s NII slipped year over year. Collectively, the banks earned $8.33 billion of NII in the quarter, an increase of more than 22% year over year.

Banks benefit from most of the population having only current accounts, meaning banks do not pay interest on deposits in accordance with Islamic principles, according to Shoaib Khan, an assistant professor of finance at the University of Hail's Department of Economics and Finance in Saudi Arabia.

"So, the cost of capital for banks on deposits is almost zero," Khan told Market Intelligence.

– Access aggregate income statement for United Arab Emirates banks on S&P Capital IQ Pro. – Access aggregate income statement for Saudi banks on S&P Capital IQ Pro.

But while high interest rates might stifle lending growth, especially in the retail segment, corporate lending is still expected to increase, driven by government initiatives such as Saudi Arabia's Vision 2030 masterplan, Blechta said.

Banks' cost of risk, a measure of provisions taken for loan losses, is also expected to remain low, Andrea Gay, a partner at Boston Consulting Group, told Market Intelligence. High interest rates are mostly applied to new credit, and existing loans carry fixed rates, Gay said, adding that nonperforming loans (NPLs) are not expected to jump significantly, thanks to the good economic outlook in the GCC.

All five banks' NPL ratios were below 6% at the end of the first quarter, according to Market Intelligence data. Saudi bank Al Rajhi had the lowest NPL ratio of the five at 0.6%.

Profits at banks in the region will be higher in 2023, with NII driving revenue growth, Blechta said. Operating expenses and cost of risk are expected to remain low or stable throughout the year.

All five big banks posted net profits north of $1 billion in the quarter, with Dubai, United Arab Emirates-based Emirates NBD posting the highest at $1.64 billion, Market Intelligence data showed.