The question that has been playing in the minds of investors over the past few weeks is the likelihood of an escalation in the US-Iran tensions, and how that would impact financial institutions and governments in GCC countries.
Countless reports have been published on the probability of a military conflict between the two, with some asserting that it is highly likely in the near future and others suggesting that it is something that both countries would prefer to avoid.
S&P Global Ratings has recently conducted an analysis assessing which country’s banking system would suffer the most under severe circumstances. Speaking to Banker Middle East, Timucin Engin, Senior Director at S&P Global Ratings said, “Tensions between the US and Iran, though increasing, have not prompted any changes to ratings or outlooks on corporate or infrastructure issuers we rate in the GCC.
This is because, under our base-case scenario, we do not expect direct military conflict between the two countries or their regional allies, and we believe that the Strait of Hormuz will remain open to the global oil trade. That said, heightened geopolitical risk is not necessarily supportive for the investor sentiment, which is important for the region’s real estate markets.”
As in most parts of the world, the banking sector in each GCC state is inevitably a cornerstone of a country’s economy. Rising geopolitical risk may result in a confidence shock on these banking systems. Consequentially, a relatively high proportion of expat deposits is expected to leave the system—a large portion of the funding profiles of banks in the GCC.
Engin explained, “If the strait were blocked (even for a few days), or if there is a significant escalation in tensions between allies of either the US or Iran that could affect Gulf countries, the potential related loss of investor confidence could weigh on the ratings of GCC banks. In such a scenario we may see significant capital outflows, as well as lower liquidity becoming available for the region’s corporates.”
The funding profiles of most banking systems in the GCC is supported by strong customer bases. At the end of 2018, the loan-to-deposit ratio reached 99 per cent on average for the six GCC countries, with approximately 52 per cent of deposits coming from retail customers and government-related entities (GRE).
S&P also estimated that expat deposits account for about 30 per cent of total domestic deposits in Qatar and the UAE. This ratio is higher than its estimate for other GCC countries (10 per cent), due to the larger percentage of expatriates in these two states.
Another notable feature of the GCC banking system is that except for Qatar and to a lesser extent Bahrain, total external debt is relatively limited. According to the rating agency, three out of the six countries are in net external asset positions (Kuwait, Saudi Arabia and UAE) ranging from about 20 per cent of systemwide loans for Kuwait to about four per cent for the UAE at year-end 2018.
“In addition, a prolonged period of heightened geopolitical risk in the region could have revenue implications for the tourism and retail industries,” said Engin.
Banking systems in GCC countries are believed to be able to absorb foreign funding outflows without government support in a situation where geopolitical stresses are manageable.
However, under more severe circumstances, S&P expects potential funding gaps in all banking systems apart from Kuwait’s, with Qatari and Bahraini banks requiring the most support as a proportion of GDP. Most GCC governments possess sufficient liquid assets and foreign exchange reserves to support banks, but such support could weigh on some sovereigns’ fiscal and external profiles.
Four of the six GCC governments is highly supportive of their banking systems. Apart from Bahrain and Oman, the ability to provide this support is underpinned by the substantial liquid assets available to GCC governments.
According to estimates from the rating agency, authorities possess sufficient resources to support their banks under the hypothetical stress scenarios. However, deploying these assets would be a drain on government assets and could weigh on sovereign fiscal and external assessments, putting downward pressure on the ratings.
Governments could also move to shore up confidence in banks by deploying funds in addition to any potential shortfall, further pressuring liquid assets.