US downgrade threat to Gulf borrowing costs

Financial Fallout: Banks in the Gulf may find themselves in a tough position following the downgrade of the US's credit rating by Standard and Poor's, analysts say.

Financial companies in the Gulf face the risk of rising borrowing costs after Standard & Poor's downgrading of the US's credit rating.

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The move is raising fresh concern about regional institutions' large holdings of the country's debt.

While no official figures exist on how much US debt Gulf players hold, businesses and governments in the region are thought to have many billions of dollars of US treasuries in their coffers.

Few observers expect GCC institutions to liquidate those holdings any time soon, but the downgrade has brought a new element of risk to some of the world's safest and most heavily traded assets.

"The downgrade does make US Treasury bonds less attractive, but selling them off in the short term might in fact be counterproductive because of lack of immediately obvious alternatives and the fact that the amounts held are very large indeed," said Ghanem Nuseibeh, a partner at Cornerstone Global Associates and senior analyst with Political Capital. "However, this will be a wake-up alarm for the GCC to start seriously looking at alternatives in the medium to long term."

Banks in Saudi Arabia are big holders of US treasuries, said Jaap Meijer, an analyst at AlembicHCin Dubai. Saudi's Arab National Bank has 11 per cent of its assets in US holdings, while the figure is 8 per cent for Samba Financial Group and 6 per cent for Riyad Bank. Nearly all of that money was almost certainly in Treasury bonds, he said. "For the Saudi banks, it's one of the few ways to invest in risk-free assets," he said, adding banks in the kingdom have low loan-to-deposit ratios, giving them a lot of cash to invest in safe assets such as treasuries. "They also have US dollar deposits, so they want to match that with dollar holdings," Mr Meijer said.

Many banks have rules prohibiting investment in debt with a less-than-sterling rating, but Mr Meijer and other analysts said the US's ranking was not yet low enough to breach those limits and trigger automatic selling.

Regional banks would probably be affected by the move, said Raj Madha, an analyst at Rasmala Investment Bank in Dubai, but it was too early to assess the precise nature of the impact. In any event, he said the strain was likely to be light.

"Banks in the Middle East could be impacted through their investment portfolios, through interbank rates, through funding costs, and through various issues related to exchange rate expectations," Mr Madha said. "However, in each case the scale of the impact is likely to be small, and likely to be managed through the treasury departments of the banks."

But the effects of the downgrade on funding costs, or the interest rates banks pay to depositors and other banks when they borrow, could be especially pertinent in the UAE, Mr Meijer said. Among banks in the region, the UAE's are some of the most dependent on funding from foreign institutions, leaving them somewhat vulnerable to a rise in prevailing interest rates attached to those loans, he said. If international interbank borrowing rates go up, that could force the UAE's banks to charge higher rates to customers to preserve the interest rate margins from which they make profits. "UAE banks are reliant on external funding, so this might cause some disruption," Mr Meijer said.

And since interest rates for corporate and government borrowers are linked to US dollar rates, any revaluation on US government debt could mean debt refinancing in the Gulf becomes more expensive, economists at Emirates NBD said in a note to clients yesterday. When large debts near their maturities, companies and governments often look to pay for them by taking out new loans or selling new bonds, but the interest rates attached to them are determined by the market at the time of the refinancing.