How the diplomatic crisis in the Middle East will affect Qatari banks?
Following the Saudi Arabia-led alliance of Arab Muslim-mainly nations’ severing their ties with Doha last week, concerns over the massive impact on the Qatari banking system have been mounting.
On Wednesday, credit rating agency S&P Global Ratings lowered its long-term ratings on Qatar to ‘AA-‘ from ‘AA’. Moreover, it has placed all its ratings on the country negative on CreditWatch, which highlights the potential direction of a short- or long-term rating.
The agency said the move was because it considers Qatar’s creditworthiness to be vulnerable to a potential increase in domestic political risks, a spike in government debt, significantly higher contingent liabilities, and scarce external funding sources.
Following the sovereign rating action, we lowered our long-term rating on Qatar National Bank (QNB) to ‘A’ from ‘A+’ and put all our ratings on QNB, The Commercial Bank, Doha Bank, and Qatar Islamic Bank on CreditWatch negative. At present, we see numerous uncertainties regarding Qatar’s response to the group of governments’ measures, the extent of these measures, and how long they will stay in place. Amid this backdrop, investors are asking us about the potential implications for Qatari banks, S&P said.
Mohamed Damak, credit analyst, at S&P, discusses the possible consequences of the diplomatic breakdown:
What could be the immediate impact of recent developments on the Qatari banking system?
We believe the recent developments might result in an outflow of external funding for Qatari banks over the next few months, depending on how the situation evolves. In our opinion, the banks’ current liquidity profiles should help them absorb a moderate drop in external funding. Overall, Qatari banks’ net external debt totalled about $50 billion at the end of April 2017. We classify the authorities in Qatar as highly supportive toward the banking system and expect government support will be forthcoming in case of need. However, if the situation is not resolved relatively quickly, it might exert further pressure on banks’ credit quality. To capture these risks, we placed our ratings on the four Qatari banks on CreditWatch with negative implications.
How dependent is Qatar’s banking system on external debt?
We regard the Qatari banking system‘s reliance on external debt as a source of tail event risks in Qatar. External system-wide debt has risen sharply over the past few years, reaching QAR454.3bn (nearly $125bn) on April 30, 2017, with a significant portion coming from Europe and Asia. On the same date, banks had a net external debt position of QAR182bn (nearly $50 billion), representing 23.5 per cent of domestic loans compared with 13.2 per cent at year-end 2015. We understand that the average tenor of these funds is relatively short (less than one year). Over the same period, banks’ lending to government and government-related entities increased by a similar amount, and those funds were generally used to finance Qatar’s sizable ongoing infrastructure program.
What type of instruments make up banks’ external funding?
Qatari banks’ external funding structure is dominated by bank liabilities and non-resident deposits, which comprised 89 per cent of the banking system’s gross external debt on April 30, 2017. The Central Bank of Qatar’s data do not disclose the maturity of these liabilities, but we understand that most of them are relatively short term, typically less than 12 months. We also understand that a portion of the non-resident deposits are at longer tenors.
How much external funding comes from the GCC?
In tackling this question, we looked at the financials of the four banks we rate in Qatar, which collectively accounted for around 85 per cent of the banking system’s assets at year-end 2016. The geographic breakdown of liabilities (defined as due to banks, customer deposits, debt securities, and other borrowing) shows that the Gulf Cooperation Council (GCC) represented only around 8 per cent (QAR75bn or $20.6bn) of the total. While we understand that this figure includes funds from countries (Kuwait and Oman) that haven’t placed Qatar under sanctions, we take the view that these funds may theoretically also be withdrawn because of the recent events. It is important to mention that these numbers mask significant differences between the banks, however. For instance, among the rated banks, the least exposed to outflows from the GCC is Qatar National Bank, while the most exposed is Qatar Islamic Bank.
Have you done any scenario analysis and what are the results?
To assess the potential implication of the recent sanctions from GCC countries on Qatar, we examined two hypothetical scenarios. In both of them, the results show the rated Qatari banks to be in a decent position, on a stand-alone basis, to face a significant reduction of external funding.
Scenario 1: 100 per cent withdrawal of the GCC funds
The GCC authorities have not made a public statement on what depositors at Qatari banks should do with their money. In our first scenario, we take the conservative assumption that all of these deposits will be withdrawn when they mature. To assess Qatari banks’ ability to cope with this eventuality, we compared the volume of outflows with the banks’ liquidity positions at year-end 2016. Our results show that banks have the capacity to withstand such outflows, although one bank would likely have to use its investment securities portfolio to boost liquidity. Therefore, none of the banks would require external support in this scenario. We believe Qatari banks might decide to replace some of the GCC deposits with Qatari deposits. In fact, we observed that in the first four months of 2017, the drop in government and GRE deposits that occurred over the past two years started to reverse.
Scenario 2: Withdrawal of all GCC funds and 25 per cent of funds from other countries
Our second scenario is more severe. Even though no Western or Asian country has yet decided to impose sanctions on Qatar, we have tested Qatari banks’ resilience to the withdrawal of 25 per cent of deposits from other countries in addition to all attributable to the GCC. Again, our results show that banks have the capacity to withstand such a scenario, but in this case two banks may need to use their investment securities portfolio to do so. Even assuming a 20 per cent haircut on the value of those investment portfolios, the banks should be able to continue operating without requiring the intervention of the Central Bank of Qatar.
What could be the impact on Qatari bank ratings?
Although the results of our stress tests show that banks we rate in Qatar have sufficient liquidity to withstand some stress scenarios, the situation remains very fluid and could evolve in several directions. In particular, it is not yet clear how long the current situation will last or whether other countries might join the group that has imposed sanctions on Qatar. Another unknown is how investors and local expatriate depositors would react and whether there could be a higher outflow of deposits than in our hypothetical scenarios.
We’ve already captured these risks in our downgrade of Qatar National Bank and the placement of our ratings on the four banks on CreditWatch negative. A key factor, however, is that our long-term ratings on the banks include three notches of uplift for support, above the respective stand-alone credit profiles. This indicates that we expect the banks will receive some extraordinary government support if needed. Notwithstanding support expectations, should we observe a significant deterioration in Qatari banks’ funding or liquidity profiles, our ratings would come under pressure. We would consider Qatari banks’ creditworthiness to have weakened if the operating environment deteriorated, weighing on their financial profiles especially asset quality or capitalization.