In this FAQ, S&P Global Ratings addresses questions from investors on the potential effects of climate transition risks on banks in the Gulf Cooperation Council (GCC) region. We think that these risks are complex, multidimensional, and nonlinear, and that they will evolve over a very long period. We reviewed rated GCC banks' exposures to sectors that are most vulnerable to climate transition risks, the banks' level of preparedness, and their status of climate risk reporting.
Frequently Asked Questions
How can climate transition risks affect GCC banks' overall creditworthiness?
Climate transition risks can increase banks' credit risk and losses. This is especially the case if banks are exposed to high-emitting industries and borrowers that are most vulnerable to the climate transition. Exposure to these high-emitting industries could also damage banks' reputation, deprive them from access to some funding sources, and increase funding costs. This could ultimately weaken their funding profiles if banks rely heavily on external funding.
Additionally, banks are exposed to legal risks--for example when financing high-emitting industries or dealing with greenwashing accusations--and potentially stricter global banking regulations, for instance if capital charges under Pillar 1 or Pillar 2 of the regulatory capital requirements increase significantly.
To what extent are GCC banks exposed to climate transition risks?
We assessed rated GCC banks' direct lending to economic sectors that are most directly exposed to the climate transition, including oil and gas, mining and quarrying, manufacturing, fossil fuel-fired power generation, and some public-sector lending. Based on GCC central banks' public disclosures, our analysis shows that GCC banks' direct lending exposures to these sectors stood at about 12% of total lending at year-end 2023 and remained stable over the past three years (see chart 1). This may be surprisingly low, given the importance of hydrocarbons in GCC economies, but it is worth noting that large national oil companies typically self-finance via joint ventures or access international capital markets. However, if international financing becomes restricted, oil companies may have to rely on local banks.
We note that many GCC economies rely on the recycling of oil revenues and the overall sentiment related to oil price dynamics. We therefore consider that the effect of oil and gas production and prices, as well as investors' and customers' appetite for carbon intensive sectors, is a long-term risk for GCC economies, sovereigns, and banking systems. However, we believe GCC sovereigns have certain competitive advantages, such as low extraction costs and the ability to increase production capacity. These will likely act as mitigating factors for GCC economies and banking sectors.
Chart 1
Since several GCC banks are government-owned, it is likely that they will have to continue supporting their respective governments' climate transition objectives. Indeed, all GCC countries, apart from Qatar, have already announced net-zero commitments (see table 1). These policy shifts highlight GCC countries' increasing focus on the energy transition.
Table 1
| GCC countries' net-zero commitments | ||||||||
|---|---|---|---|---|---|---|---|---|
| Country | Target date | Climate-related investment commitments | Renewables' contribution to electricity production | |||||
| Saudi Arabia | 2060 | $187 billion in climate action by 2030 | 50% by 2030 | |||||
| United Arab Emirates | 2050 | $163 billion in clean and renewable energy by 2050 | 50% by 2050 | |||||
| Bahrain | 2060 | N/A | 5% by 2025 | |||||
| Oman | 2050 | N/A | 30% by 2030 | |||||
| Kuwait | 2060 | N/A | 15% by 2030 | |||||
| N/A--Not available. Source: S&P Global Ratings. | ||||||||
We also note that GCC banks are trying to advance their relatively nascent sustainability programs by increasing their sustainable finance offerings to customers and contributing to government efforts to decarbonize local economies. However, we are yet to see bold regulatory actions in the region, including the introduction of climate stress testing or other measures to encourage banks to reduce climate transition risks.
How can climate transition affect GCC banks' exposure to credit, liquidity, and operational risks?
Credit risk: The materialization of climate transition risks means that banks could suffer from counterparties' deteriorating creditworthiness. That said, some of these risks will take a long time to materialize, which makes the consideration of loan maturities and banks' policy shifts even more important.
Liquidity risk: A loss of investor or depositor confidence can lead to outflows and reduce banks' liquidity. While this risk has not materialized yet, banks with a significant dependence on wholesale foreign funding may be more vulnerable than their peers. Over the past two years, GCC banks increased sustainable bond and sukuk issuances to mitigate this risk and attract new funding sources. Yet, sustainable bonds' contribution to total bond issuance in the GCC region remains small.
Sustainable Finance Is Still In The Early Stages
Sustainable debt issuance in the Middle East, dominated by banks and government-related entities in the UAE and Saudi Arabia, reached a record $23 billion in 2023. It has more than doubled since 2022, albeit from a low base--sustainable issuance in the Middle East contributes less than 3% to global issuance.
Legal risk: Operational risk is in check for now because of GCC economies' dependence on hydrocarbons and some large GCC banks' close relationships with their respective governments. However, legal risk could materialize over the medium term.
What are GCC banks doing in terms of climate risk reporting?
We reviewed 20 rated GCC banks' climate risk disclosures and noted the following:
- Only two-thirds of these banks published a materiality assessment, while only 30% consider environmental risk as a key risk.
- Only two banks--First Abu Dhabi Bank PJSC (FAB) and Abu Dhabi Commercial Bank PJSC (ADCB), both of which are based in the UAE--are members of the Net-Zero Banking Alliance (NZBA). FAB and ADCB are also the only banks that communicated publicly about a certain level of sustainable financings to be deployed by a predetermined deadline.
- 70% of rated GCC banks offer sustainability-labeled products.
- Only four banks communicated publicly that exclusion policies are part of their risk management framework. Also, to our knowledge, none of the banks in the region is in an advanced stage of implementing climate risk-adjusted loan pricing.
- Large banks' climate risk reporting and management is typically more advanced than small banks'.
Our main conclusion is that GCC banks' reporting on climate risks and, more generally, sustainability is still very much a work in progress (see chart 2).
Chart 2
What is your view on the challenges related to quantifying climate transition risks?
Based on our discussions with them, rated GCC banks' senior management teams consider the quantification of climate transition risks as a key challenge. For example, banks' difficulties with measuring scope 3 emissions come up regularly in our discussions. However, we note that banks and regulators are dedicating specific resources to tackle this challenge. Climate-related considerations are also part of banks' senior management key performance indicators, which could increase resources that are earmarked for the climate transition over the long term.
The challenge for regulators lies in the adaptation of stress tests and the use of a scenario that includes some mitigation measures to deal with climate change. We note that GCC regulators are still working on this.
FAB Leads The Way
In March 2023, FAB announced financed emissions reduction targets for oil and gas, aviation, and power generation sectors. Subsequently, FAB added more sectors, including agriculture, aluminum, cement, steel, and commercial real estate. Overall, the bank's reduction targets apply to approximately 90% of its corporate financed emissions. FAB is among the most advanced banks in the region in terms of quantifying and setting targets for financed emissions.
What challenges does the application of the UAE central bank's principles for the effective management of climate-related financial risks pose for UAE banks?
In our view, these principles, which the UAE central bank published in November 2023, are a step in the right direction. Yet, their application will require significant investments from UAE banks, as well as the incorporation of climate risks in capital and liquidity assessments and risk management frameworks. We note that some UAE banks have already integrated the environmental and social risk management (ESRM) in their risk management frameworks. For some of them, the ESRM contributed to decision-making processes, for example about whether to refrain from extending financing to counterparties with significant exposure to environmental or social risks.
The principles for the effective management of climate-related financial risks also require banks to run climate stress tests that are commensurate with their risk exposure and complexity. We think the implementation of these principles will be iterative and it will take time for them to leave a mark on UAE banks' strategy and exposure to climate risks.
Related Research
- GCC Banking Sector Outlook 2024: A Relative Bright Spot Among Emerging Markets, Jan. 31, 2024
- Islamic Finance's Role In The Climate Transition, Nov. 14, 2023
- Middle East Sustainable Bonds May Expand Further, Nov. 14, 2023
- Energy Transition: Competitive Advantages Shield GCC Sovereigns, March 8, 2023
This report does not constitute a rating action.
| Primary Credit Analyst: | Mohamed Damak, Dubai + 97143727153; mohamed.damak@spglobal.com |
| Secondary Contact: | Emmanuel F Volland, Paris + 33 14 420 6696; emmanuel.volland@spglobal.com |
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