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Credit FAQ: Why Most GCC Banks Can Manage Contagion Risk From SVB

This report does not constitute a rating action.

Substantial volatility of bank equity prices across the globe, including in the Gulf Corporation Council (GCC), has followed the failure of U.S.-based Silicon Valley Bank (SVB) and Signature Bank (SB). U.S. authorities took action to reduce contagion risk, protecting all deposits at SVB and Signature Bank (see "The Fed's Plan For U.S. Banks Should Reduce Contagion Risk," published March 13, 2023). Here, S&P Global Ratings responds to the main questions from investors on the potential impact of these developments on rated GCC banks.

Frequently Asked Questions

What is rated GCC banks total exposure to the U.S.?

On average, banks we rate in GCC had exposure of 4.6% of assets and 2.3% of liabilities at year-end 2022, reflecting exposure ranging from zero to 22% and 11.4%, respectively (see chart 1). Five of the 19 banks we rate in the region have more than 5% of their assets in the U.S., while four had more than 5% of liabilities to counterparties in the U.S. Generally, GCC banks would have limited lending activity in the U.S. and most of their assets there would be in high-credit quality instruments or with the U.S. Federal Reserve Bank.

Chart 1

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How much unrealized losses have banks accumulated, and are they manageable?

Revaluation reserves for rated GCC banks averaged negative 2.6% of total equity at year-end 2022. For banks with the highest unrealized losses, this ratio was still only -10.9% (see chart 2). The slightly positive outcome of up to 1.9% for a handful of banks stemmed mainly from hedging exposure against interest rate volatility. We understand most of these hedges are cleared through central counterparties and hence see limited risk regarding their effectiveness.

It is also important to mention that not all unrealized losses relate to exposures in the U.S. Rather, they are associated with banks' overall investments, including instruments in the GCC whose fair value declined as the region's central banks increased their rates. GCC banks' U.S. portfolios have contributed to unrealized losses, but the overall amount appears manageable, in our view.

Chart 2

image

If these unrealized losses crystallize, would that change your view on banks' capitalization?

In light of the banks' good funding and liquidity profiles and expected government support in case of need, the chance of GCC banks having to sell meaningful volumes of investment securities appears limited. Nevertheless, if they did, and all unrealized losses crystallized, the impact would be on profitability rather than on capitalization for the majority of rated banks, in our view. For one bank, we anticipate some losses. All else equal, GCC banks would need to use only about 24.9% of their 2022 net income, on average, to absorb the estimated revaluation losses (see chart 3).

Chart 3

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Based on our most recent calculation of rated banks' risk-adjusted capital (RAC)--as of yearend 2022 for some banks and year-end 2021 for others--we do not foresee a change in our assessment of capital and earnings. We base our calculations on the banks' unrealized losses as of year-end 2022, which therefore exclude a potential increase of these losses in the future or additional losses caused by further episodes of market volatility. Capitalization is one of the main factors supporting our GCC bank ratings. The average RAC ratio for rated banks stood at 11.1%--based on ratios at year-end 2022, where available, and 2021 otherwise--and would decline by only 30 basis points on average to 10.8% if unrealized losses were to crystallize (see chart 4).

Chart 4

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To what extent do Gulf banks rely on external funding and do you see that as a source of risk?

We see funding as a relative strength for most GCC banking systems. Core customer deposits are GCC banks' main funding source and we do not foresee this changing in the next few years. Deposits have displayed a high degree of stability through numerous shocks (see "Why GCC Banking Systems Are Resilient To Geopolitical Stress Scenarios," published June 22, 2022). Lending growth has outpaced customer deposits over the past few years in Saudi Arabia, leading to liquidity pressure that reportedly prompted the country's central bank (SAMA) to inject liquidity last year. We expect SAMA to continue intervening whenever needed, since the Saudi banking system is one of the main pillars in implementing the country's Vision 2030 plan and the overall financing of Saudi Arabia's economy.

The use of wholesale funding sources remains relatively limited and is unlikely to change any time soon. The only exception is Qatar's banking system, which still carries a significant amount of net external debt (see chart 5). In our view, Qatar's banking system is unlikely to expand much in 2023, implying a lower need for external funding. Moreover, Qatar's central bank has tightened regulations to curb the use of external funding, and we have seen an $14.2 billion decline (down about 7.3%) in external funding for the 12 months to Jan. 31, 2023. During that period, nonresident customer deposits also dropped by $23.2 billion, albeit partly compensated by a $12.2 billion increase in interbank deposits, which in our view could be much more volatile than nonresident customer deposits. An increase in resident deposits of $23.2 billion (up 12.3%)--41.5% from the public sector and 58.5% from the private sector--offset the decline in nonresident funds. We also consider that the Qatari government has a strong capacity, willingness, and track record of providing support to the banking sector if needed.

Chart 5

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Banks in Bahrain and Oman continue to display a moderate external debt position. We do not foresee any major refinancing risk, however, barring a liquidity freeze on the international capital markets. Banks in the United Arab Emirates (UAE), Kuwait, and Saudi Arabia remain in a net asset position, and we expect they can manage their balance sheets if the rollover rate of their gross external debt declines.

How do you view government support in the GCC?

Of the six governments in the GCC, we view Qatar, Kuwait, Saudi Arabia, and the UAE as highly supportive toward their respective banking systems. Consequently, we expect extraordinary support to be forthcoming to these banking systems in case of need. These countries have a strong track record of supporting their banking systems in times of stress. The most recent example dates back to 2017 when Qatar was boycotted by some of its neighbors. At that time, the banking system lost around $20 billion of external debt funding and received more than twice that amount from the government and government-related entities to make up for the decline. In the absence of local capital markets, governments are conscious that any disruption of their banking systems could have a significant impact on their economies. We classify Oman's and Bahrain's propensity to support their banking systems as uncertain because, in our view, these two countries would have limited capacity to intervene in the event of a systemwide shock.

Related Research

Primary Credit Analyst:Mohamed Damak, Dubai + 97143727153;
mohamed.damak@spglobal.com
Secondary Contacts:Dhruv Roy, Dubai + 971(0)56 413 3480;
dhruv.roy@spglobal.com
Benjamin J Young, Dubai +971 4 372 7191;
benjamin.young@spglobal.com
Additional Contact:Financial Institutions EMEA;
Financial_Institutions_EMEA_Mailbox@spglobal.com

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