The recent escalation of the war in the Middle East has increased the risk of broader regional ramifications for sovereigns' and banks' creditworthiness. Against this backdrop, we have created four stress scenarios to assess how the risk could evolve and how it could affect banks in GCC countries. In our view, the risk could materialize in the form of:

• Outflows of foreign funding, with non-resident investors exiting the GCC region as risks increase;
• Outflows of local funding, although we assume that this would materialize only in the case of severe stress, as seen during the Gulf War over 1990-1991; and
• A spike in default rates among banks' corporates and retail clients as the geopolitical instability affects regional economies.

To quantify the risk, we have used data on local and external funding that were published by central banks on June 30, 2024, and data on asset quality that were reported by the top 45 banks in the GCC region. Under our standardized assumptions, external funding outflows could reach about $221 billion, which translates into about 30% of the tested systems' cumulative external liabilities. That said, we think banks have sufficient external liquidity to cover these outflows in most cases. In the severe stress scenario, we assume a further $275 billion in deposit outflows from local private sector deposits. We think banks can cope with this, thanks to their liquid assets and--if these prove to be less liquid than we assume--support from central banks.

Under our asset quality deterioration scenarios, 13 of the top 45 banks in the GCC region will likely display losses under the high stress scenario, based on banks' annualized reported net income as of June 30, 2024. This number increases to 25 for the severe stress scenario, with cumulative losses reaching $24.6 billion.

Our Four Stress Scenarios

We have identified four possible stress scenarios for banking systems in the GCC region, depending on how the conflict evolves.

Table 1

To assess the potential implications of these scenarios, we have identified three channels of transmission for GCC banking systems.

Table 2

Most Banking Systems Can Absorb External Funding Outflows

The results of our hypothetical stress test (high and severe) suggest potential external funding outflows of about $221 billion from the region, or about 30% of the selected banking systems' cumulative external liabilities (see chart 1). These are concentrated in Qatar and the United Arab Emirates (UAE), followed by the offshore banking sector in Bahrain, because of the significant gross external debt of the banking systems in these countries (see chart 2). For the remaining banking systems, our assumed external funding outflows range from a limited $3.9 billion in Oman to a manageable $30 billion in Saudi Arabia.

Chart 1

Chart 2

Most banking systems can manage these outflows by liquidating their external assets, with only Qatar showing a negligible deficit (see chart 3). In our view, this deficit is very manageable, given the Qatari government's track record of supporting banks. During the 2017 boycott by neighboring countries, when Qatar's banking system lost about $20 billion, banks received double the amount in support from the Qatari government and its related entities. We note that the banking system in the UAE stands out in terms of external assets accumulated over the past few years.

Chart 3

Banks Can Handle Local Deposit Outflows

Based on our hypothetical stress test, domestic deposit outflows could reach up to $275 billion. Yet they are concentrated in the UAE and Saudi Arabia, both of which dominate the GCC banking systems due to their size (see chart 4). To meet these outflows, banks hold about $284 billion in cash or at their respective central banks.

Chart 4

Banks may need to liquidate some of their investment portfolios or park them at central banks against liquidity to ride out withdrawals. Overall, the risk appears manageable. After liquidating their investment books with our calibrated haircut, banks will still have about $264 billion that they can deploy.

The results of our hypothetical stress test show that most banking systems in our sample will be resilient if regional conflicts escalate and investor confidence declines. However, it is important to note that the potential outcomes of the current situation are hard to predict and will depend on the actual outflows and asset liquidity.

In our calculation, we excluded government intervention that could help banking systems cope with outflows. Of the six countries in our sample, we classify the governments of Kuwait, Qatar, Saudi Arabia, and the UAE as highly supportive toward their banking systems. This means we expect banks in these countries will receive extraordinary government support if necessary.

Asset Quality Deterioration Is The Key Risk

Under our hypothetical stress scenario--we tested for additional provisioning needs, all else being equal --13 of the top 45 banks in the GCC region will likely display losses under the high stress scenario, provided that the additional flow of NPLs is fully covered by provisions (see chart 5). These 13 banks will experience a cumulative loss of almost $3.3 billion under the same assumptions and using their reported annualized net incomes as of June 30, 2024.

Chart 5

The number of banks experiencing losses increases to 25 for the severe stress scenario, with a cumulative loss of $24.6 billion (see charts 6 and 7). We note, however, that regulators intervened through forbearance measures during previous shocks, enabling banking systems to absorb the potential impairments of loans over time. We expect regulators will proceed similarly in high or severe stress scenarios.

Chart 6

Chart 7

Related Research

• Widening Middle East Conflict Poses Risks For Regional Sovereign Ratings, Oct. 9, 2024
• Your Three Minutes In Banking: GCC Banks Are Well Positioned To Continue Their Strong Run, Sept. 4, 2024
• What A Regional Escalation Could Mean For MENA Banks' External Funding, Nov. 13, 2023