Funding risk is a prominent topic among investors in GCC 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. This could significantly affect banking systems in emerging markets. In this article, S&P Global Ratings responds to key questions from investors on the vulnerability of Gulf Cooperation Council (GCC) banks to funding risk and mitigating factors.

Frequently Asked Questions

How do you assess the funding profiles of Qatari banks?

Qatari banks have the highest recourse to external funding among GCC banks. The system's loan to deposit ratio reached 124% at March 31, 2023, or 152% at the same date if we factor only resident deposits and loans. This 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 (see chart 1).

Chart 1

Although Qatari banks benefit from geographical funding diversification, some of these external sources are less stable. At 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 we see as potentially more volatile. We also note that the contribution from this source has increased over the past 15 months, reaching Qatari riyal (QAR) 217.5 billion at March 31, 2023, compared with QAR164 billion at year-end 2021 (see chart 2). Our view that the Qatari authorities are highly supportive of their banking system and the strong track record in providing such support are mitigating factors. For example, in 2017, when neighboring countries started a boycott of Qatar, the banking system lost about $20 billion of external funding. This was more than compensated by twice that amount in the form of government and related entity deposits. Amid scarcer and more expensive global liquidity, we expect Qatari banks to continue mobilizing domestic resources to meet future growth. However, we do not expect the latter to materially pick up until a major new investment program is implemented by the government.

Chart 2

How do you compare the funding profiles of Saudi and Kuwaiti banks?

Saudi Arabia and Kuwait are the two GCC banking systems where we see low funding risk. As part of our Banking Industry Country Risk Assessment (BICRA), we assess systemwide funding to determine the industry risk score for a domestic banking sector. Our assessments of systemwide funding for the six GCC countries are summarized in table 1.

Table 1

Core customer deposits dominate the funding profiles of banks in these two systems. Moreover, these deposits have proved resilient and stable amid different episodes of geopolitical instability or oil price declines. A portion are from the national governments and their related entities--20% in Kuwait and 30% in Saudi Arabia. In Kuwait, the loan to deposit ratio reached 96.9% at March 31, 2023, and in Saudi Arabia it barely exceeded 100% at the same date.

Chart 3

Although we have observed some liquidity pressure in Saudi Arabia, in our view, the central bank will continue to intervene when needed to ease the situation. We also expect to see the banking system 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--mean 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.

Chart 4

What is your view on United Arab Emirates (UAE) banks' funding profiles after the recent increase in deposits?

UAE banks are in a comfortable net external asset position and their loan to deposit ratios are among the strongest in the region. Banks have been accumulating local deposits over the past 15 months amid muted lending growth (see chart 5). We do not expect an acceleration of lending, so UAE banks' funding profiles should continue to strengthen. One potential downside risk for 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. We also expect that the federal authorities would be highly supportive of the banking system, if needed.

Chart 5

Absent local growth, banks have increasingly deployed their assets outside the country, resulting in a strong net asset position of about 23% of domestic lending. Related risks are mitigated by banks' relatively conservative approach toward foreign asset deployment. We also expect this position to moderate in the future should lending growth pick up again.

How do you see the funding profiles of Bahraini banks given the large wholesale banking sector?

Bahrain's retail banks (onshore banks) have large and expanding net external liabilities. At March 31, 2023, they reached 26% of total domestic lending (see chart 6). We note that 60% of the foreign liabilities are interbank and 60% are sourced from the GCC (see chart 7). Given the ownership structures of some Bahraini retail banks, we assume that a portion of this external funding is from foreign parents. We also assume that external funding will remain stable under our base-case scenario.

Chart 6

Chart 7

Bahraini retail banks' loan to deposit ratios have been consistently below 80% for the past five years. Therefore, in our view, local deposits and a significant portion of external liabilities are recycled into government and local central bank exposures. At March 31, 2023, these exposures represented almost one-quarter of retail banks' balance sheets.

The other peculiarity of the Bahraini banking system stems from the large wholesale sector. However, we see the risk of disruption to retail banks as relatively limited. Wholesale banks' domestic activity represented about 15% of total assets and remained stable over the past few years. At March 31, 2023, about half of this exposure comprised interbank transactions-wholesale banks' lending to local retail or wholesale banks--and another one-quarter was direct lending to the Bahraini private sector. Exposure to the government represented about 15% of total local assets at the same date. Furthermore, about 78% of these exposures were financed using local sources, meaning that the overall domestic net contribution from wholesale banks to the local economy stood at $4.2 billion, or about 4% of the retail banking system's size.

Do you see any significant risk in the external funding of Omani banks?

At March 31, 2023, the system's loan to deposit ratio was 110%, resulting in some recourse to external funding. Positively, such recourse remains relatively limited with the banking system's net external debt position representing 3.7% of total lending on the same date. We note that about one-third of total deposits come from the government and its related entities (see chart 8). We have observed the relative stability of these funds over the past few years but, in our view, this dependency could result in some pressure on the banking system, particularly in periods of low oil prices.

Chart 8

What could boost your systemwide funding assessments of the GCC banking sectors?

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, since we think that the banking system alone won't have sufficient capacity. Saudi banks can also benefit from being able to securitize part of their mortgage books to free up their balance sheets and reduce maturity mismatches. We've 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.

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