Funding risk is a prominent topic among investors in Gulf banks, particularly as we transition from cheap and abundant liquidity to a more restrictive environment. Major central banks have made it clear that interest rates will be higher for longer, meaning liquidity will be scarcer and more expensive. Can this affect Gulf banks?
Qatari banks’: Lower but potentially more volatile external funding
Qatari banks have the highest recourse to external funding among GCC banks. The system’s loan-to-deposit ratio reached 124% on March 31, 2023, which resulted in an overall funding gap (total domestic loans minus total resident deposits) of $112.4 billion, equivalent to almost two times the public sector deposits. Although Qatari banks benefit from geographical funding diversification, some of these external sources are less stable. As of March 31, 2023, the equivalent of almost two-thirds of the domestic funding gap was covered by capital markets and due to branches and head offices, while the remainder was covered by interbank deposits, which is potentially more volatile. The contribution from this source has also increased over the past 15 months, reaching Qatar riyal (QAR) 217.5 billion on March 31, 2023, compared with QAR164 billion at year-end 2021. However, we see the Qatari authorities as highly supportive of their banking system. This is evidenced by a strong track record in providing such support and is a mitigating factor. Amid scarcer and more expensive global liquidity, it is likely that Qatari banks will continue mobilizing domestic resources to meet future growth. However, it is unlikely the latter will materially pick up until a major new investment program is implemented by the government.
Read: Can GCC banks weather funding risks?
Saudi and Kuwait banks in a net external asset position
Although there has been some liquidity pressure in Saudi Arabia, the central bank is likely to continue to intervene when needed to ease the situation. The banking system is also expected to divest mortgages to create space for the financing of Vision 2030 projects, with capital markets a potential alternative – although at a higher cost. Over the past 12-24 months, many Saudi banks have established their sukuk or bond programs to tap the market when the opportunity arises. Saudi and Kuwaiti banks remain in a net external asset position and therefore have room to attract foreign funding. Moreover, the Saudi riyal’s peg to the U.S. dollar and the relative stability of the Kuwaiti dinar exchange rate, thanks to its peg to a basket of currencies, means that even if this flow is recycled locally, foreign currency risks are likely to remain in check. We note that Saudi banks’ gross foreign liabilities almost doubled over the past five years, but their net asset positions remained stable.
UAE banks demonstrate strong funding metrics
UAE banks are in a comfortable net external asset position. Their loan-to-deposit ratios are among the strongest in the region. Banks in the UAE have been accumulating local deposits over the past 15 months amid muted lending growth and acceleration of lending is not expected, so UAE banks’ funding profiles should continue to strengthen. One potential downside risk for UAE banks is the country’s expatriate-dominated population. This means deposits could be prone to higher volatility during extreme shocks, although they have mostly been stable through past tensions. Moreover, the country is considered a safe haven and tends to benefit from geopolitical instability in the region and beyond via an uptick in local deposits. It is also probable that federal authorities would be highly supportive of the banking system if needed.
The availability of a well-functioning domestic debt capital market can make a significant difference for a banking sector’s funding opportunities. In terms of relative stability, funding sourced from the domestic debt capital market tends to be more stable than cross-border funds, but less stable than core customer deposits. Having a broad and deep local debt capital market can therefore help a banking system reduce its dependence on external funding and ease concentration and maturity mismatches. In Saudi Arabia, for example, the presence of a broad and deep capital market could support the implementation of Vision 2030 projects, as the banking system alone probably won’t have sufficient capacity. We have already seen regional governments issue local-currency-denominated bonds or sukuk to help build a local yield curve, notably in Saudi Arabia or more recently in the UAE with the federal government’s sukuk issuances. Local capital markets could also help mobilize resources to finance diversification away from oil and the transition to greener economies.
This Op-Ed was written by Dr. Mohamed Damak, senior director and head of islamic finance at S&P Global Ratings
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