Political disruption tends to trigger investor risk aversion, prompting a rise in funding costs or possibly capital outflows from banking systems in higher-risk markets--even when events are unrelated to them. However, banks in the Gulf Cooperation Council (GCC) have remained remarkably stable and the largest funding item--private domestic deposits--has increased year-on-year over the past three decades despite a series of disruptive regional events, including Yemeni civil wars, the Arab Spring uprisings, the Iraq War, Qatar boycott, and several Houthi missile attacks. Only the 1990 Gulf war led to a decline in private sector domestic deposits and, while external funding has proven less stable, related withdrawals have only been temporary.

While the nature of the threat or shock--for example whether there is a direct physical threat--is clearly important, S&P Global Ratings thinks various factors explain the historical resilience of GCC bank funding. Notably, large outward remittances have reduced the stock of potentially less stable deposits and confidence boosting actions by public sector entities have helped reduce domestic funding volatility during shocks. Meanwhile, corporate activity and consistent population growth have also underpinned deposit expansion and offset outflows. Even though some vulnerabilities are on the rise, including continued external funding growth, a potentially increasing proportion of expatriate deposits, and reduced coverage from potentially supportive sovereign assets to funding bases, our hypothetical stress scenarios show that GCC banks can withstand substantial external funding outflows without additional support.

Bank Deposits Have Been Resilient To Geopolitical Tensions

GCC banking systems have proven resilient to disruptive events in past decades. Although some regional shocks prompted external and domestic deposit outflows, banks generally remained secure. Indeed, deposits in the GCC's banking system have continued to expand and remained remarkably stable through substantial political instability, including the Arab Spring, financial crises, wars, boycotts, and missile strikes. Only the 1990 Gulf War interrupted this trend. Although these events have strained liquidity, funding of a similar size to the withdrawals returned within a year. Even foreign liabilities lent into the domestic GCC financial systems proved only temporarily vulnerable to geopolitical shocks (see charts 1, 2, and 3).

Chart 1

Charts 2 and 3

The 1990 Gulf War Prompted An Outflow Of Regional Deposits, Although They Quickly Returned

Only one extreme disruption scenario--the invasion of Kuwait by Iraq in August 1990--prompted the movement of banks' domestic deposit bases, but it did so throughout the region.

Excluding Kuwait because its banking system was closed, an average of 22% of total deposits were withdrawn from banks in the United Arab Emirates (UAE), Saudi Arabia, and Qatar as a result (see table 1 and appendix).

Table 1

External funding into the GCC has traditionally been quite limited. We generally expect domestic deposits to be more stable because they form the working capital and savings of residents. Nevertheless, the stock of gross financial sector external liabilities increased substantially over the past few decades, and now comprises just under $550 billion (see chart 1). On average, banks in the GCC comprise about one-third of their economies' total external liabilities, with Oman and Saudi Arabian banks contributing under 10% to total liabilities and Qatari and Kuwaiti banks over 40%. The UAE, Kuwaiti and Saudi Arabian banking systems are in modest net external asset positions, while Oman's banks are small net debtors. Bahrain's retail banks and the Qatari banking system are in a more material net external debt position (see chart 4).

A further source of confidence in the deposit stability of these banking systems--and their sovereigns--is the presence of significant external fiscal assets and central bank reserves. In all the GCC countries, except Bahrain and Oman, governments are in large net asset positions (see chart 4). Similarly, with the exception of Bahrain and Oman, we also view regional governments as highly supportive of their banking systems and would expect them to draw upon some of these net assets to provide financial support if needed.

Chart 4

Four Factors Explain The Historical Resilience Of GCC Bank Deposits

How have GCC banking systems preserved deposit stability and maintained trend growth despite numerous geopolitical shocks? We see four major contributing factors:

Expatriates dominate the population, but not bank accounts:  High structural remittances out of the region have limited the accumulation of potentially more confidence-sensitive funding in the regional deposit base. Although foreign residents comprise about 90% of the populations in Qatar and Dubai, they represent a far smaller percentage of retail deposits. In Qatar, for example, only about 20% of retail deposits are from nonnationals. Although detailed data on depositor nationality is relatively sparse, we expect this proportion to be slightly larger in the UAE, given the availability to nonnationals of longer-term mortgages, savings products, and, more recently, a relaxation of the rules on foreign company ownership and visa status. In contrast, we expect nonnational retail deposits in Kuwait and Saudi Arabia represent less than 20% of the total because incentives for retaining out-of-contract migrant labor are less common.

Chart 5

Nonnational deposits in GCC banking systems have been limited because migration to the Gulf is spurred by economic opportunity and the majority of expatriates are typically low earners that send the lion's share of their wages home to support their families. However, the extent of remittances indicates that higher earners have also saved and invested outside of the GCC, since residence is usually tied to employment and domestic investment opportunities have been fairly limited. Behaviorally, we view this type of deposit as likely to be more confidence sensitive and mobile amid geopolitical shocks. Over the past decade, measures to encourage middle- and high-income expatriates to maintain their savings locally have increased, through the offering of mortgage products and more recently the relaxation of some residency rules. Although remittances from the region expanded alongside the population until 2014-2015 when oil prices corrected, they have since remained relatively stable at about $130 billion per year (see chart 6). The UAE is an exception in that outward remittances have continued to increase, given a significant portion of the population resides in Dubai, whose economy is not directly oil driven. Since then, regional populations and domestic retail deposits have continued to increase while remittances have remained steady, which could imply expatriates now account for a larger portion of domestic deposits. Deposits from GCC citizens will also continue to rise as populations expand, and more recently pandemic-related savings increased, but the previously mentioned factors could mean the proportion of potentially more confidence-sensitive domestic deposits is increasing (see chart 7).

Chart 6

Chart 7

Oil revenue has supported public spending and, in turn, long-term corporate development and population growth:  Ambitious hydrocarbon-backed economic development policies have pulled vast amounts of expatriate labor to the region and incentivized corporate expansion, which has supported deposit growth.

Governments have spent heavily on regional infrastructure. Most expatriates are construction workers, who are often unbanked and generally remit salaries to their home countries. However, the high-end infrastructure they have built has helped to attract multinational corporates and their higher skilled, paid, and more bankable labor force, thereby boosting consumption. Until recently, regional laws frequently required majority national ownership of foreign companies, enabling the retention and re-investment of corporate profits within the country. This has promoted the development of large, often family-owned, holding companies with significant local working capital and treasury operations. Over 2001-2016, corporate deposits increased faster than retail deposits in Qatar and the UAE (see chart 8). Since then, retail deposits in both of these markets have expanded more quickly, likely in part because lower oil prices have affected corporate growth but potentially also due to incentives designed to retain high-earning expatriate wealth starting to bear fruit.

Chart 8

Service sector and downstream developments have also promoted the creation of small and midsize enterprises and are helping develop a local skill base, attracting companies to the region. In addition, generous social security schemes for citizens and the trickle-down of public funds into developing private sectors have continued.

Depositors from higher-risk countries add to stability:  Where expats come from matters. The stability of most GCC banking systems has led them to be seen as safe havens for savings, investments, and business development from less stable countries in the wider Middle East and sub-continental Asia. Relative wealth levels between home and host countries are also an important factor in deposit stability because lower-paid migrants tend to be structural remitters, while higher-paid workers might have the flexibility to choose an investment destination and are increasingly the target of policies aimed to retain wealth by the host. The growth of the latter could increase deposit instability, but can also be an important funding item if linked to longer-term incentives.

Wealthy public sectors also support bank deposit stability:  In the GCC, income from the sale of oil and gas underpins public sector deposit growth, which is generally routed through national oil and gas companies.

Chart 9

The sale of these hydrocarbons has generated huge revenue for regional governments, facilitating the development of some of the world's largest sovereign wealth funds (see chart 4), which have continued to earn returns during periods of low prices. Public sector entities maintain significant local balances (see chart 9) to service their operations but also to demonstrate their support for individual banks and--more generally--financial sector development, even through periods of low oil prices, economic stress, and most recently at the start of the pandemic.

Probably the clearest example of GCC government support to a banking system during a geopolitical shock was following the 2017 boycott of Qatar by a group of Arab countries, including Bahrain, Saudi Arabia, and the UAE. Significant government and government-related entity (GRE) deposits were brought back to Qatar to offset nonresident outflows and bolster confidence (see chart 10 and Appendix).

Chart 10

Stress Tests Show GCC Banks Are Resilient To External Funding Outflows

As well as examining how GCC banking systems have performed during geopolitical disruption, we also assessed their potential vulnerabilities to future external funding outflows. To do so, we took a closer look at the external assets and liabilities of banks in Qatar, Saudi Arabia, Kuwait, and the UAE under various stress scenarios.

We first assessed banks' overall capacity to cover their external liabilities (including interbank deposits, customer deposits, and capital market instruments) using their stock of external assets. To account for the potential illiquidity of some of these assets, we used haircuts ranging from 0% for cash to 100% for other assets, since the nature of these was not disclosed. We used a 15% haircut for interbank deposits because GCC banks tend to place their money with creditworthy foreign banks. We also used a 50% haircut on banks' lending portfolios, where they exist, since we assumed banks would have to fire-sell some of these loans to generate liquidity under stress conditions.

Table 2

The results show that Saudi and Kuwaiti banks have the highest and full coverage of external liabilities by external assets, even under our stressed conditions. UAE banks also enjoy a strong coverage ratio of about 92% at Sept. 30, 2021, which is underpinned by their net asset position (see chart 4). In contrast, Qatari banks have the lowest external debt coverage of about 35% at Dec. 31, 2021. This is because they have been rapidly building external debt and recycling the money into local projects. As a result, we have observed a significant increase in the Qatari banking system's net external debt over the past five years and an increase in risks. However, some of these funds have long-term economic interests in Qatar and the government was extremely supportive of its banking system during the boycott led by its neighbors.

Chart 11

To analyze the vulnerability to outflows by type of instrument, we stressed banks' external liquidity under different scenarios. We assumed 20% of market instruments are maturing and not rolled over. For interbank deposits and nonresident deposits, we also applied an incremental stress test increasing the value of the outflow ratio progressively. The results show the amount of liquid assets remaining on the banking system's balance sheet. Under these calculations, Saudi Arabia, Kuwait, and the UAE again withstood an up to 100% withdrawal of interbank deposits and nonresident deposits, owing to their net external asset positions. UAE banks also benefit from having a large portion of their external debt in long-term capital market instruments where our outflow assumption is fixed at 20%.

The story is different for Qatari banks, which can sustain a much more limited, but still significant, percentage of interbank and nonresident deposit outflows and may also require government support. For example, based on our assumptions, Qatari banks would require about $18.4 billion of support to weather a 50% drop in nonresident and interbank deposits. Assuming a much higher stress scenario leading to a complete outflow of interbank and nonresident deposits (and the banks losing all access to their foreign assets) the required support sharply increases to about $80 billion.

Table 3

This exercise indicates that banks in the region's largest economies would likely remain resilient to external funding outflows, mostly from their own resources before turning to sovereign support.

As deposit bases continue to expand faster than government assets--and potentially more vulnerable characteristics increase as a proportion of total deposits--authorities' ability to deploy sufficient assets to offset a major outflow (which we do not expect) could be tested. That said, we expect regional governments to remain highly supportive of their banking systems.

Appendix

Case Study 1: The 1990 Gulf War

The withdrawal of external liabilities from the Gulf region started at the beginning of 1990, mainly from Saudi Arabia, but also from the UAE. This was mostly in the form of interbank lines (see charts 2 and 3). Domestic deposits reduced sharply following the invasion, with 15% and 21% of Saudi and UAE private sector deposits withdrawn from peak to trough. However, interbank lines returned before year-end 1990, with Kuwait still under occupation. Annual figures show only a limited change in the domestic deposit base; while private sector funds left, they also returned.

Unsurprisingly, the physical invasion quickly harmed Kuwait's financial system: 90% of foreign liabilities at end-second-quarter 1990 were interbank deposits and the majority exited the country prior to or just after the invasion. Domestic deposits were trapped and, given the extent of destruction, most loans became nonperforming. Nevertheless, the recovery was quick. At the end of the occupation, the authorities relaunched the Kuwaiti dinar and restored bank balances to their preinvasion amounts. The government assumed private sector debt equivalent to nearly twice its annual peacetime revenue (average 1987-1988 to 1989-1990), which accounted for nearly two-thirds of the entire stock of domestic credit.

The domestic deposit stock in Kuwait has continued to expand, with some periods of more circumspect growth occurring alongside heightened political risk. However, these were not material to overall trends (see chart 12).

Chart 12

Case study 2: The Arab Spring and Bahraini offshore banks

The presence of the Saudi and UAE militaries in Manama during the 2011 uprising accelerated fund outflows from Bahrain's established offshore banking system (mainly a booking center for international banks)--a trend that started during the financial crisis. The immediate effect on Bahrain's economy and domestic banking system was relatively limited but the country's population dipped slightly in the same year and domestic deposits with offshore banks decreased. This episode illustrates the potential sensitivity of some business operations to geopolitical stress.

Chart 13

Case study 3: The 2017 Qatar boycott

In June 2017, a group of Arab nations, including Saudi Arabia, the UAE, and Bahrain, imposed a boycott of Qatar, severing all economic and financial ties. Relations between the bloc members had been tense following previous diplomatic disagreements but the severity and speed of the action was unexpected.

It triggered outflows of some $20 billion over 2017. The initial outflows mainly related to the boycotting GCC nations, which had exposure to Qatar. However, for the most part, we understand that deposits were withdrawn upon maturity, rather than early and with a penalty. The sector's resilience during this period is likely because of banks' fundamental strengths but also the rapid deployment of state funds to offset outflows, with $40 billion injected by the government, GREs, and Central Bank of Qatar that is yet to be withdrawn. Interbank deposits started returning by October and nonresident deposits by year-end 2017 and continued to increase until first-quarter 2022, when new regulations on foreign liabilities were introduced. This build-up indicates vulnerability to future shocks but also reflects a degree of confidence that the authorities would be available to protect banks, if needed.

Chart 14

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