Dubai: Some banking systems in the GCC could face funding gaps in the event of massive deleveraging and the consequent exit of European banks from funding in the region, Moody's analysts said yesterday.
Although the economic reliance on European bank funding varies across the GCC, Moody's says that a decrease in lending by European banks to the region could lead to a short-term liquidity squeeze and, more likely, a longer-term structural shortfall. In order to meet this gap, 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 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.
Overall, European bank lending to the GCC amounted to around $237 billion (Dh870.26 billion) as of September 2011.
Sustained reduction
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 under way or planned over the next 15 years.
"While the short-term effects of retrenchment can be moderated in most circumstances, we believe that the longer-term consequences are more difficult to address. Increased international government borrowing, as well as financing by local GCC and Asian banks will likely fill some of the gaps," said Khalid F. Howladar, vice-president - senior credit officer, Financial Institutions Group, Moody's Investors Services.
The rating agency said yesterday that the long-term structural funding shortfalls in the Gulf region caused by the potentially longer term absence of European institutions will be more difficult to address.
Three categories
Based on the vulnerability to the funding gaps, Moody's has categorised the Gulf banking systems into three categories. While Saudi Arabia, Oman and Kuwait fall into the low-vulnerability category with their reliance on European bank financing around 10 per cent of GDP, the UAE and Qatar face moderate levels of vulnerability according to Moody's assessment. In these two economies European bank financing is equivalent to a significant 25 per cent of GDP.
"We believe the short-term refinancing and investment needs in Qatar and the UAE can be handled by the respective governments and central banks who have demonstrated their ability and willingness to address the funding needs through direct support," Howladar said.
Around a third of international (or cross-border) financings to GCC economies (equivalent to $97 billion) are channelled via the local banking systems, with foreign banks placing deposits in local banks (in some cases local subsidiaries).
Refinancing risks
With the cash-strapped European banks looking to generate liquidity, local banks holding these deposits are likely to face withdrawals resulting in lower liquidity for regional institutions to lend.
The remaining two-thirds of international finance comprising $179 billion take the form of direct lending exposures to public sector entities ($24 billion) and to private corporates ($155 billion). The withdrawal of this foreign funding will raise refinancing risks for local corporates at a time when they face significant maturity redemptions.
To address the issue on a long-term basis, Moody's said, the region should look at improving the size and sophistication levels or local banks while diversifying the funding sources to Asian and US banks and increasingly using debt markets for long-term funds, where possible.
