Israel war tests GCC regional bank resilience 

Reuters

The Israel-Hamas conflict is another test for GCC financial institutions but in our assessment, regional banks will maintain their resilience in adverse circumstances – as they have historically done.

The Gulf countries are insulated in many ways. They are supported by continuing oil revenues, a currency peg with the US dollar, high profits, strong capitalisation and consistent deposit growth. 

At the sovereign level, oil revenues set the direction of the economy and GCC banks calibrate their business model to suit the macro.

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Any conflict, especially if it spreads in the region, may trigger oil price shocks as did the Iraqi invasion of Kuwait of 1990, the Arab oil embargo of 1973, the Iranian revolution in 1979, or the Iran-Iraq war of 1980 to 1982, to name a few. 

In all these instances, oil price spikes ranged between a low of 20 percent to a high of 100 percent. However, in the current episode, oil price and stock market reaction have been notably muted.

Analysts ascribe many reasons to this, including the falling intensity of global oil output – the contribution of oil to overall economic growth. While this may be true, fossil fuels in general remain the dominant source of energy supply globally, especially when it comes to transport. 

Hence, any major disruption to the oil supply is likely to trigger an upshot in oil prices. Remember, nearly 20 percent of world oil supplies pass through the Strait of Hormuz – the only passage from the Persian Gulf to the open ocean.

While price spikes may be positive for the GCC in an immediate financial sense, the wider upshot of regional conflict offers little reason to celebrate.

This could have serious consequences for GCC banks. Among other factors, the most important are funding and liquidity.

On 14 November S&P, the ratings agency, published the results of a stress test in which it estimated external funding outflow of $220 billion from banks, or 30 percent of the cumulative external liabilities for the GCC, Egypt and Jordan.

From a funding perspective, GCC banks rely on deposits and borrowing. Deposits have grown solidly by a compound 8 percent over the last five years.

In many GCC countries, such as Qatar, Saudi Arabia and UAE, the government share in deposits has been strong, ranging from 18 percent to 33 percent. In the past, Gulf governments have always backed their banks in cases of calls for liquidity.

The borrowing aspect is trickier. GCC banks tap both domestic as well external bonds as major sources of funding.

All GCC banks, with the exception of Saudi Arabia, have external borrowings ranging from a high of 99 percent in the UAE to 36 percent in Oman.

UAE banks are in a comfortable net external asset position and have also been accumulating local deposits over the past 15 months amid muted lending growth. 

GCC-wide external borrowings are mostly denominated in the US dollar, a currency to which the economies (except Kuwait) are pegged. Foreign exchange risk is therefore limited. 

But, in terms of maturity profile, Bahraini banks appear vulnerable as 26 percent of their external borrowings mature in 2024, followed by another 33 percent in 2025. 

Similarly, 12.5 percent of Qatar's borrowings are coming up for maturity in 2024 though only 2.3 percent are due in 2025. The UAE will encounter a roll-over maturity of 12.3 percent in 2024 and almost an equal amount in 2025. If the fighting continues into 2024 and 2025, these roll-over obligations will face a higher risk premium.

Trouble outside the GCC

GCC banks are also exposed via their branches in troubled geographies. While the banks are mostly inward looking to the point where even intra-GCC presence is rare (meaning, say, Omani banks in Saudi Arabia or vice-versa), many of them have ventured into geographies such as Turkey, Egypt and Pakistan.

In October, Marmore published GCC Banks – Moving Beyond Borders, in which we found that there are 745 GCC bank branches in Egypt. However, branch exposure to Jordan (134), Syria (38) and Palestine (15) is limited. 

If the Israel-Hamas conflict spreads, the economic fallout is likely to be considerable.

If supply disruption is in the region of 4 to 6 million barrels a day, this would imply an oil price in the range of $120-140/barrel, based on World Bank’s estimates. If disruption is upwards of 8 million barrels a day, then one could envisage an oil price spike of above $150/barrel. 

However, the GCC economies and banks have sufficient buffers to withstand such shocks. 

During earlier episodes where there were outflows of external funding, governments and government-related entities pumped in deposits. Now, consistently high Tier-1 ratios – essentially fully paid-up equity – provide additional comfort.

Also, given the importance of financial sector stability, GCC governments have been notably proactive in terms of their support to the local banking system. If the situation deteriorates this time should be no different. 

However, being resilient does not mean there will be no cost. Higher risk premiums, tighter net interest margins and lower profitability are all likely should a worst-case scenario materialise.

MR Raghu is CEO of Marmore Mena Intelligence, a research subsidiary of Kuwait Financial Centre (Markaz)