Geopolitical risk could see GCC banks require sovereign support

In the event of a sharp escalation in regional geopolitical tensions, the GCC banks may need sovereign support, according to S&P Global Ratings.

The ratings agency said yesterday despite tensions have increased between the US and Iran, it has not changed any bank or sovereign ratings or outlooks in the Gulf Cooperation Council (GCC). This is because, in its base case, it does not expect direct conflict between the US and Iran or their regional allies. Furthermore, S&P expects the Strait of Hormuz to remain open to the global oil trade. However, if the strait were blocked (even for a few days), or if there is a significant escalation in tensions that could affect Gulf countries, the potential related loss of investor confidence could weigh on the ratings of GCC banks and sovereigns.

On the potential implications for banks and sovereigns in the GCC in a hypothetical scenario, the global ratings agency assumes that 25 percent of total foreign interbank deposits and 40 percent of foreign customer deposits would leave the GCC countries. It also assumes in this hypothetical scenario that 30 percent of expat deposits would be transferred abroad–equivalent to an estimated 9 percent of total deposits for Qatar and the UAE and an estimated 3 percent of total deposits for the other countries. This ratio is lower than the rating agency’s assumption for nonresident customer deposits given the greater interest expatriates have in their host economies (including financial obligations and investments).

Although banks in the GCC generally place most of their money with highly rated counterparties, the S&P assumes that it would not be possible for them to liquidate all assets in a timely manner and they would not be available in full to plug the flight of liabilities. Therefore it applies 5 percent haircut on interbank deposits and 10 percent haircut on investment portfolios.

For most banking systems in the GCC, strong customer bases support their system-wide funding profiles. At year-end 2018, the loan-to-deposit ratio reached 99 percent on average for the six GCC countries. Moreover, about 52 percent of deposits came from retail customers and government-related entities (GRE) at the same date. Qatar had the biggest share of retail and GRE deposits at about 70 percent and Bahrain and Oman had the lowest at about 45 percent at year-end 2018.

Under the first hypothetical scenario, S&P would expect that most GCC countries would display strong resilience and would be able to finance outflows using their own internal sources or by liquidating their own external assets. S&P estimates Qatari and Saudi banks would require $17bn (9 percent of GDP) and $4bn (0.5 percent of GDP) of funding support from their governments respectively. Qatar’s position is explained by the substantial net external liabilities of its banks.

Under its second hypothetical scenario, which S&P views as highly unlikely to occur, all systems aside from Kuwait would have a funding gap and would require government or central bank support. Qatar would require almost $59bn (30 percent of GDP), Bahrain $4bn (10 percent of GDP), and Saudi Arabia almost $25bn (3 percent of GDP), while the other countries’ funding gaps would be smaller.

S&P assesses four of the six GCC governments as highly supportive of their banking systems. The ability to provide this support is underpinned by the substantial liquid assets available to GCC governments, aside from Bahrain and Oman, and their very strong track record of support in case of need. The most recent demonstration of this support was seen at the start of the Qatar boycott in 2017. This triggered outflows of $23bn but they were more than offset by an injection of $43bn (22 percent of GDP), by the government, related entities, and the Qatar Central Bank. Foreign deposits have since returned to pre-boycott levels.

Source from: The Peninsula