This report does not constitute a rating action.
The risk-adjusted capital (RAC) ratio is the primary metric used by S&P Global Ratings to assess the capital adequacy of issuers and it influences our analysis of the Gulf Cooperation Council (GCC)-based banks that we rate. The role that the RAC ratio plays in our analysis of credit quality, and the differences between the RAC ratio and the region's regulatory capital requirements, is thus a subject of interest.
Here S&P Global Ratings presents frequently asked questions from investors about the RAC ratio and our assessment of GCC banks’ capital adequacy.
Frequently Asked Questions
How do GCC banks compare with financial institutions in other regions in terms of capital adequacy?
We believe the GCC banking sector is generally well capitalized. The median regulatory Tier 1 capital ratio for rated GCC banks was 16.6% at year-end 2024, about 140 basis points (bps) higher than the ratio for the 115 Group 1 banks monitored by the Basel Institute (as of June 30, 2024). At the same time, the median RAC ratio for rated GCC banks at year-end 2024 was 11.3%, corresponding to strong capital and earnings score under our criteria and approximately 160 bps higher than our estimate for the top 200 rated global banks. We expect rated GCC banks' RAC ratio to remain stable over the next two to three years, supported by sound capital generation capacity, prudent capital management, and regulatory requirements. However, the variance is quite high across rated GCC banks, with RAC ratios ranging from just below 4% to over 15%.This largely reflects bank-specific, idiosyncratic factors.
Why do you use your own model and not regulatory ratios to assess a bank's capital?
We use our own RAC framework to evaluate the capital adequacy of banks and certain nonbank financial institutions because it is unaffected by differences in jurisdictional definitions of capital, the methods financial institutions use to define and calculate capital, and the approaches they adopt to calculate regulatory risk-weighted assets. Compliance with regulatory ratios is a starting point for assessing banks’ capital under our methodology for rating financial institutions. However, these regulatory ratios are not uniform and are influenced by jurisdiction-specific implementation and diverging macroprudential policies, which make them incomparable.
Why do you apply different risk weights to different asset classes and geographies?
We do this because we consider that the potential magnitude of banks’ unexpected credit losses typically varies between asset classes and countries. This variation is influenced by factors such as the sovereign rating, the country's economic structure and policy flexibility, the quality of lending and underwriting standards, and the extent of internal and external imbalances and protection for creditors. We assess the relative level of economic risk as part of our Banking Industry Country Risk Assessment (BICRA) and use this evaluation to determine risk weights for corporate and retail exposures in each jurisdiction.
Why are the risk weights you apply to sovereign exposures generally higher than those set by local regulators, which sometimes apply a zero-risk weight?
Regulators generally apply a zero percent risk weight to the domestic sovereign exposure as it is considered a risk-free asset in that specific jurisdiction. In our view, countries can (and do) default and banks may incur losses on their exposure to them. Therefore, in our risk adjusted capital framework, banks should set aside capital to cover this risk. The higher the rating on a country, the lower the risk that banks will incur unexpected losses relating to their sovereign exposure under our framework. For most GCC countries, effective risk weights are quite low given their relatively strong creditworthiness. The exception is Bahrain, where risk weights are higher, given the country’s lower rating. For some banks with sizeable exposures to sovereigns outside the GCC, particularly countries like Egypt or Turkiye, the density of risk-weighted assets can be material since the creditworthiness of these countries is lower than the average creditworthiness of GCC sovereigns.
What is your approach to assessing banks’ exposure to government-related entities (GREs)?
In general, we treat loans to GREs as corporate exposures, unless we consider there to be a credit substitution guarantee, or if we consider the creditworthiness of the entity to be similar to that of the sovereign, typically in the case of public sector entities as defined by local central banks. We may sometimes deviate from the regulatory treatment if we believe that the creditworthiness of these entities is materially different from the government’s.
How do you assess portfolios of assets funded by Islamic investment accounts?
Theoretically, Islamic banks have the option to require their profit-sharing investment account (PSIA) holders to absorb losses if the underlying assets of these deposits generate losses. In reality, to avoid that scenario, banks set aside additional provisions in the form of profit equalization reserves and investment risk reserves. Even if these are insufficient, banks generally avoid sharing losses with clients as this may lead to significant outflows of deposits and potential concerns over a bank's viability. In some jurisdictions, Bahrain for example, regulators reduce risk weights for exposures funded by PSIAs to reflect this theoretical capacity to absorb losses. We do not apply a similar adjustment, and this can sometimes result in significant differences between our RAC ratios and regulatory capital ratios.
What other critical factors do you consider when applying the RAC capital model to Islamic banks in the GCC?
In general, we take a substance-over-form approach. For instance, we may consider Mudarabah exposures to be equity rather than debt if these instruments have equity-like features, such as the ability to absorb losses. We typically treat Additional Tier 1 capital instruments, which are often based on Mudarabah principals, as equity instruments.
How do you risk weight mortgage loans in Saudi Arabia?
We believe that mortgages in Saudi Arabia do not bear significantly lower credit risk than unsecured retail exposures. This is because banks can be reluctant to repossess collateral from Saudi nationals. To our knowledge, there have been only a few cases of property repossession, and typically only after lengthy legal proceedings. Conversely, most retail loans are secured by wage assignment. We also understand that off-plan mortgage lending in Saudi Arabia is becoming a key growth driver for banks. We therefore risk weight mortgages using the same risk weight as unsecured retail exposures in Saudi Arabia.
Related Criteria
- Banking Industry Country Risk Assessment Methodology And Assumptions, Dec. 9, 2021
- Financial Institutions Rating Methodology, Dec. 9, 2021
Related Research
- Islamic Finance 2025-2026: Resilient Growth Amid Upcoming Headwinds, April 17, 2025
- GCC GRE Ratings Benefit From Government Support, Feb. 17, 2025
- GCC Banking Sector Outlook 2025: Profitability And Asset Quality Boost Resilience, Nov. 13, 2024
External Research
- Basel III Monitoring Report March 2025, BIS, https://www.bis.org/bcbs/publ/d592.pdf
| Primary Contact: | Roman Rybalkin, CFA, Dubai 971-0-50-106-1739; roman.rybalkin@spglobal.com |
| Secondary Contacts: | Mohamed Damak, Dubai 97143727153; mohamed.damak@spglobal.com |
| Tatjana Lescova, Dubai 97143727151; tatjana.lescova@spglobal.com |
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