Dubai: More than a month into economic and diplomatic sanctions imposed by its neighbouring countries, Qatar’s financial system is showing signs of further weakening as the impact bites both underlying macro-economic outlook and cost of funding, according to rating agencies, economists and analysts.

The ongoing dispute involving Qatar and a coalition of countries including three of its fellow GCC neighbours Saudi Arabia, UAE and Bahrain as well as some other mostly Arab nations including Egypt resulted in a series of measures such as severing diplomatic relations, closing land, sea and air links, and expelling Qatari nationals from their countries.

An immediate resolution of disputes appears unlikely as Qatar has rejected the list of 13 demands from the coalition countries as condition for removing these actions. Public exchanges between the various parties in recent weeks and previous periods of heightened tensions between Qatar and other GCC countries.

Arab states are angry over Qatar’s dismissal of their demands. Analysts do not rule out new sanctions when the meet in Bahrain.

“The Qatari banking sector is highly dependent on foreign funding (wholesale debt and deposits) with low operational relationships. Higher interbank rates suggest a significant reduction in available liquidity, which should increase cost of funds (CoF) and compress net interest margins (NIM), resulting in tighter credit standards and higher non-performing loans (NPL) formation,” said Jaap Meijer, Head of Research of Arqaam Capital.

Funding cost of banking sector has been increasing with Qatar interbank rates rising by 40 basis points (bps) during the first week after the embargo and bond spreads increasing as much as 105 bps for QNB’s 2018 debt instrument. Banking sector in the country as a whole relies on foreign markets for 43 per cent of its funding needs, with non-resident deposits making up 46 per cent, interbank 43 per cent and wholesale debt 11 per cent.

 Government support, as we have witnessed in the past crises, and QIA’s assets offer more than adequate buffer, especially if QIA were to provide direct loans to the banks.”

 - Jaap Meijer, Arqaam Capital

Among Qatari banks Qatar Islamic Bank (QIB) is the worst exposed to the GCC for funding, whilst Qatar National Bannk (QNB) is most dependent on foreign funding. In terms of GCC exposure, QIB has the highest share of funding coming from the GCC at 24 per cent, whilst QNB the least at 5 per cent, though it has the highest dependency on foreign funding at 57 per cent.

Analysts expect liquidity pressure to increase and bond spreads to widen. “We have increased CoF by 10b ps across the board to factor in the liquidity pressure and rating downgrades. We have also cut loan/deposit/asset growth forecast by 2 percentage points as liquidity constraints should curb growth, given the reliance on foreign funding,” said Janani Vamadeva, an analyst with Arqaam Capital.

Huge government reserves and support of sovereign wealth funds offer comfort in terms of systemic strength, however the current crisis is expected to take its toll on profitability and asset quality. Banks’ net foreign liabilities of $50 billion (Dh183.7 billion) are just about covered by Qatar Central Bank’s (QCB) international reserves of $34.4 billion and banks’ reserves $12.9 billion at QCB.

“Government support, as we have witnessed in the past crises and QIA’s assets offer more than adequate buffer, especially if QIA were to provide direct loans to the banks. Nonetheless, we are under weight on the Qatari banking sector as we expect profitability to continue to deteriorate as cost of funding increase and growth subsides until the political standoff ends,” said Meijer.

Factors such as a general decline in the operating environment, loss of business confidence of the non-oil private sector and external exposure of Qatari banks, particularly to the GCC and Mena [Middle East & North Africa] based customers could result in a spike in non-performing assets (NPAs) if the current crisis remains unresolved over a few months or more.

Data suggests Qatari banks have significant credit exposures to entities elsewhere in the GCC. A financial stability report published by the Central Bank of Qatar in 2015 put the GCC asset exposure of the banking system at 26.9 per cent of total assets and 15.9 per cent elsewhere in MENA.

“Adverse confidence effects on the private sector and tighter liquidity conditions in the banking system could amplify negative spillovers to the nonhydrocarbon sector,” said Garbis Iradian, Chief Economist of Institute of International Finance (IIF) Mena.