Key Takeaways
- The latest war between Hamas and Israel heightens global geopolitical risks with potential adverse implications for investor confidence and external funding flows.
- While not underestimating the severity of the human tragedy, we assume the conflict remains largely limited to Israel and Gaza and does not trigger external funding outflows or pressure banking sectors in the Middle East and North Africa.
- However, there may be scenarios where the conflict widens, leading more risk-averse investors to withdraw funds from the region.
- In our hypothetical stress test of banking systems in the GCC, along with Egypt and Jordan, external funding outflows could reach $220 billion, or about 30% of the tested systems' cumulative external liabilities, although most can cope by liquidating their external assets.
The latest Israel-Hamas war has brought investor risk perceptions of the Middle East, including regional banks, back into focus. The situation is rapidly evolving, with uncertain outcomes. However, currently S&P Global Ratings believes that the economic and credit impacts are likely to be contained to Israel and its neighboring countries.
Against this backdrop, we have designed a hypothetical stress test to quantify the resilience of some rated Middle Eastern banking systems--including those in the Gulf Cooperation Council (GCC) countries, Jordan, and Egypt--to external funding outflows. For this, we use assumptions on the liquidity of external assets and outflows of external liabilities based on the most recent numbers published by regional central banks.
Under our standardized assumptions, external funding outflows could reach about $220 billion, or about 30% of the tested systems' cumulative external liabilities. However, banks have sufficient external liquidity to cover these outflows in most cases.
Based purely on the quantitative results, Qatar, Egypt, and to a much lesser extent Jordan, display an external funding deficit. For Egypt, this relates to the recent build-up of external debt in the banking system. For Jordan, it is due to banks' activities in the Palestinian territories, which could prove resilient in the current context because any unexpected escalation may prompt more Palestinians to transfer their money to Jordan. For Qatar, it is due to the banking system's significant external debt and a shift in composition toward interbank deposits, although we note the strong track record of government support.
While other systems look resilient, it is important to note that this depends on the capacity to liquidate their external assets abroad in a timely fashion and with manageable haircuts.
Why Were Some Countries Excluded?
We have excluded Tunisia and Morocco's banking systems from our sample due to the limited external debt of these systems, which are dominated by nonresident deposits from nationals. We have also excluded Turkiye's banking system, despite its significant external debt, because of our view that the system is more sensitive to domestic events and investor confidence has been tested several times over the past five years. Moreover, a substantial portion of Turkish banks' foreign-currency-denominated assets are placed with the central bank.
Our Adverse Scenario Of External Funding Outflows
Under our base-case scenario, we assume that the war will remain centered in Israel and Gaza, but there are risks that it spreads. If there is a wider regional escalation (for example, through proxy conflicts), investors' risk perception of the Middle East may prompt some confidence-sensitive funds to leave, as seen during previous stress.
We note that banking system external debt has increased in some sample countries over the past few years. However, in most cases, this external debt was recycled into external assets, leaving the system in a net external asset position. Bahrain, Oman, Qatar, Egypt, and Jordan have recycled some external debt into domestic assets, such as lending to the local economy or investments in local assets. For Egypt, in particular, this shift is very recent (see charts 1 and 2).
Chart 1
Chart 2
To assess the potential implications of the recent escalation of geopolitical risk, we have examined the impact of external funding outflows under the following assumptions:
- Outflows of external liabilities: A 50% outflow of interbank liabilities because these are generally more volatile than nonresident deposits--except for those due to banks' head offices and branches, for which we used an outflow rate of 20%. For nonresident deposits, an outflow of 30%. Furthermore, for capital market liabilities, an outflow rate of 10%, since these are mainly medium- to long-term instruments. No outflows in other liabilities. Where the breakdown of liabilities was not granular, an outflow of 50%, which was the case for Egypt and Jordan.
To fund these outflows, banks will have to liquidate their external assets. In a stressed environment, such liquidation could result in lower valuations for these assets, with our assumptions below:
- Liquidation of external assets: A haircut of 10% on interbank deposits--20% for those due to head offices and branches since we assume that banks will keep some liquidity there. Regional banks tend to place their money with highly rated institutions. A haircut of 20% on investment portfolios abroad, typically held for liquidity management and mostly fixed-income instruments with good credit quality. Furthermore, a 100% haircut on loans to nonresidents and other assets, which we assume will be much more difficult to liquidate in a stress scenario. We applied these haircuts because we assume that banks may incur some reduction in the value of their assets if they want to liquidate them prematurely.
Our overall assumptions are summarized in the table below.
Table 1
| Hypothetical stress test assumptions | ||||||
|---|---|---|---|---|---|---|
| Cash | Due from banks | Due from branches abroad | Investments | Loans to nonresident | Other assets | |
| Asset haircuts | 0% | 10% | 20% | 20% | 100% | 100% |
| Nonresident deposits | Due to nonresident banks | Due to head offices and branches | Debt | Others | ||
| Outflows | 30% | 50% | 20% | 10% | 0% | |
Most Systems Can Absorb Outflows By Liquidating External Assets
The results of this hypothetical scenario suggest potential external funding outflows of about $220 billion from the region, or about 30% of the selected systems' cumulative external liabilities (see chart 3). These are concentrated mainly in Qatar and the United Arab Emirates (UAE), followed by the offshore banking sector in Bahrain, because of the significant gross external debt of these countries (see chart 4). For the remaining systems, our assumed external funding outflows range from a limited $3.5 billion for Oman to a manageable $22.1 billion in Saudi Arabia.
Chart 3
Chart 4
Most banking systems can manage these outflows by liquidating their external assets, with only Qatar, Egypt, and Jordan facing deficits (see chart 5). We note that the amount for Jordan remains manageable at about $0.8 billion, or 5.4% of system external liabilities. We also believe the instability could lead to higher transfers to Jordan's banking system in the short term due to the presence of Jordanian banks in the Palestinian territories. Customer deposits with Jordanian bank branches operating in the Palestinian territories contributed 42.8% of Jordanian banks' external liabilities as of July 31, 2023.
For Egypt, the shortfall is mainly related to the recent buildup of external debt in the banking system. While for Qatar, the impact appears very manageable given the government's track record of support to banks. During the 2017 boycott by neighboring countries, when the banking system lost about $20 billion, it received double the amount in support from the Qatari government and its related entities. We note that the UAE stands out in terms of the external asset position accumulated by the banking system over the past few years.
Chart 5
One Scenario Among Many
These results show the resilience of most selected banking systems should Middle Eastern tensions escalate and hit investor confidence. However, it is important to note that this is just one hypothetical scenario and the situation could evolve in multiple directions. A higher level of outflows, an outflow of local liabilities, or lower liquidity of external assets could result in different outcomes. Also, our calculation excluded government intervention to inject foreign-currency-denominated resources and help the banking systems cope with outflows. Of the eight countries in our sample, we classify Kuwait, Qatar, Saudi Arabia, and the UAE as highly supportive toward their banking systems. This means we expect extraordinary support to be forthcoming should the need arise.
Related Research
- GCC Sovereign External Balance Sheets Remain Strong Despite Higher Banking Sector External Debt, Nov. 13, 2023
- War In The Middle East Compounds Global Geopolitical Risks, Oct. 18, 2023
- Banks In Major GCC Economies Remain Resilient To Less Supportive Operating Conditions, Sept. 12, 2023
- Where And How External Funding Stress Might Hit Emerging Market Banks, April 17, 2023
This report does not constitute a rating action.
| 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 |
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