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29 March 2024

GCC faces liquidity squeeze as European banks retreat: Moody’s

Published
By Staff

A decrease in lending from European banks to the Gulf Co-operation Council (GCC) region could lead to a short-term liquidity squeeze and, more likely, a longer-term structural shortfall, Moody’s Investors Service said in a new report published today.

Some banking systems in GCC countries could face funding gaps in the event of a sustained retrenchment by European banks from the region, Moody’s said.

Overall, European bank lending to the GCC region amounted to around $237 billion as of September 2011. Moody’s expects the likely deleveraging to result in a sustained reduction of lending to the GCC at a time when the region faces sizable funding requirements, with an estimated $1.8 trillion of capital investments underway or planned over the next 15 years.

The European banks’ retrenchment from the region has been prompted by the ongoing euro area debt crisis and their need to deleverage and build up capital buffers.

Although the economic reliance on European bank funding varies across the GCC, Moody’s says that in order to meet the gap resulting from an anticipated pullback by European banks, local GCC banks would need to grow as well as adjust their own funding structures. Asian banks are also likely to be a growing source of foreign funding.

The ratings agency believes that a short-term liquidity squeeze among GCC banks that would result from European banks’ retrenchment could in some cases be moderated through temporary liquidity support from governments, central banks as well as the GCC banks’ improved liquidity positions since the last ‘crunch’ in 2009.

However, GCC banks will also face longer-term structural funding shortfalls that would, in the agency’s view, be more difficult to address. The affected GCC countries would have to find new sources of funding to support future credit growth and economic development plans. Local banks would need to grow both in size and sophistication as well as undergo structural funding changes to meet this need.

Moody’s believes that Asian and, to a lesser extent, American banks could potentially fill some of the gap as their bank financing activities in the GCC represented only 1.9 and 2.3 per cent, respectively, of the region’s GDP as of September 2011.

Moreover, given the relatively low levels of government debt and relatively low cost, increased international sovereign borrowing is also a possibility, while the larger and more creditworthy corporates are likely to seek funding directly from the bond markets.

Moody’s has classified GCC banking systems into three categories of low, moderate and high vulnerability to European funding:

- LOW VULNERABILITY: With European bank financing equivalent to around 10 per cent of GDP, the economies of Saudi Arabia (rated Aa3, stable), Kuwait (Aa2, stable) and Oman (A1, stable) are not highly reliant on European funding and are the best positioned to withstand a sustained retrenchment.

- MODERATE VULNERABILTY: For Qatar (Aa2, stable) and the United Arab Emirates (UAE, Aa2, stable) European bank financing in the local economy is equivalent to a significant 25% of GDP. The short-term refinancing and investment needs in Qatar and the UAE can be handled by the respective governments. However, for Bahrain's (Baa1, negative) onshore retail banking sector, European financing is a much higher 75 per cent of GDP due to the sector’s size but the mitigant here is that the banks here (unlike those of Qatar and the UAE) show matched levels of foreign assets and liabilities. However, in the long term, a sustained withdrawal of foreign funding would be a structural issue for all three countries, necessitating a change in strategy and any gap would pressure the local economy without new sources of funds.

- HIGH VULNERABILITY: European funding accounts for around 40 per cent of the total $120 billion liabilities held by Bahraini offshore wholesale banks. A sustained outflow of funds would lead to a significant liquidity squeeze, a slowdown in business volumes in the short term and major structural challenges to offshore banks’ franchises in the long term.