Will GCC banks shrug off the global banking meltdown?

Reuters/Faisal Al Nasser

• Gulf banks are less exposed to interest rate risks
• They also have limited exposure to the US
• GCC banks’ Islamic finance also provide a stable base

The effects of last month’s collapse of SVB and Signature Bank and the forced marriage of Credit Suisse and UBS are still reverberating across the world’s banks. 

Though the US Federal Reserve was quick to provide guarantees on both sides of the balance sheet, markets are still on edge. The question arises: how are GCC banks faring against this backdrop? The answer is that systemically they are relatively well insulated.

Let us remember that the problems stem from the raising of US interest rates from almost 0 percent to 4.75 percent, since January 2022. US interest rates are the reference point by which regulators and bankers around the world assess financial assets – and liabilities. After the 2008 financial crisis, rates were lowered to zero and remained there for an extended period of time before slowly climbing back – only for COVID to come and take them back to zero.

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Post-pandemic, creaking supply chains caused inflation, forcing the Fed to step in with one of the fastest interest rate rises in history. As bonds have an inverse value relationship to interest rates, the new hike triggered a steep fall in bonds and their related portfolios. This move set off an asset-liability mismatch for banks like SVB and Signature and ultimately caused their demise.

When it comes to the GCC, there is a regulatory angle at play here. In the US, lenders need not take mark-to-market losses to earnings or capital ratios, while in Europe and the GCC banks are mandated to pass them through earnings. So in the US, there is an element of suspense before the bad news breaks. 

We need to ask two further questions: how much worse will the global banking crisis get? And how will that affect GCC banks?

If we look at contagion, so far, only small banks have been affected and it is widely believed to be non-systemic. The Fed has said that it is ready to support banks with liquidity or short term funding. 

However, opinions differ widely since many banks have enjoyed cost-free deposit flows and it is possible that deposit growth has not matched loan growth. They bought risk-free treasury bonds at low long-term yields. Now, a steep rise in yields has slashed the value of US government bonds. 

A recent academic study found that the market value of assets in the US banking system is $2 trillion lower than suggested by their book value. “Recent declines in bank asset values have significantly increased the fragility of the US banking system to uninsured depositor runs,” said the Stanford University paper. 

Therefore, the problem could certainly get worse before it gets better.

Back in the GCC, banks boast total assets of around $3 trillion and collective profits have surpassed pre-pandemic levels, climbing 28 percent to $44 billion in 2022. Here, asset growth has historically correlated with oil prices rather than Fed rate hikes directly; higher interest rates are generally taken to signal dwindling demand for crude oil. 

With this in mind, it is worth exploring five points:

Asset-liability balance: The core of the problem with the global banking crisis stems from a mismatch between the tenor of assets and liabilities. Banks like SVB used short term deposits to invest in long-duration bonds. 

However, GCC banks do well on this score as local regulations minimise this kind of mismatch. Banks in the region are also not providers of long term capital to industry, so they do not run this risk. 

Nature of loans: We also need to examine banks’ loan books in terms of fixed rate loans vs. variable rate loans. During periods of ultra-low interest rates, if banks have lent at fixed rates, then they may face negative net interest margins when deposit rates climb steeply. 

This risk is potentially reduced if loans are contracted on a more variable basis.

Mortgage lending: Apart from investing in long-dated treasuries, US banks also have significant exposure to mortgage lending. Mortgage assets lose value as rates rise and this causes asset-liability mismatch. 

Looking at Gulf banks, mortgage lending is a fairly new activity and mainly active in Saudi Arabia and the UAE, so there is limited regional exposure.

Depositor behaviour: In the case of SVB, mainly depositors were uninsured. So there was an incentive to run as they sensed trouble.

However, in the GCC, given the strong regulatory oversight and backing, depositors are less likely to press the panic button. Therefore, the region’s banks are less likely to be forced into a fire sale of their investments.

Islamic finance: Islamic banks in the region enjoy low-cost funding and asset-backed investments. Both add to stability in times of crisis. 

Saudi National Bank was exposed to the fire sale of Credit Suisse and has suffered a substantial loss. But according to S&P Global, GCC banks have so far engaged in limited lending activity in the US, and most of their US assets are in high credit quality instruments or with the Federal Reserve Bank. 

The average exposure of Gulf banks to US assets stood at 4.6 percent of total banking assets and 2.3 percent percent of total liabilities at the end of 2022, said S&P.

GCC banks primarily depend on retail deposits, with less of a focus on wholesale finance. This trend is not likely to change any time soon. What’s more, GCC banks are known to be historically supportive and responsive during economically precarious times, such as the global pandemic for example.

In conclusion, assuming Fed rates remain below six percent, Gulf banks are likely to see another year of sluggish credit growth but stronger deposit growth. 

On the whole, the region’s banks appear reasonably insulated from the global banking crisis seeping through. They also tend towards ultra-careful regulatory oversight, which provides insulation from the global banking crisis. 

M R Raghu is CEO of Marmore Mena Intelligence (Kuwait Finance Centre)