Ali Noureddine
This article was translated from Arabic.
Risks associated with investments by Gulf countries in the American and European banking sectors are substantial, in large part due to the ongoing crises that these banks are currently experiencing. While losses are reportedly substantial, Gulf banks have sizable reserves that can shield them from the risk of bankruptcy.
Conversely, due to the challenges facing the global financial system, other nations’ banking and financial sectors, like those in Egypt, Tunisia, and Sudan, are predicted to experience more severe liquidity shortages.
The crisis of American and European banks began in 2022, following a challenging monetary and financial environment that the global financial system entered. As a result, a group of U.S. banks, including “Silicon Valley Bank,” filed for bankruptcy in 2023, marking the most significant bankruptcy in the U.S. since the global financial crisis of 2008. In Europe, the “Credit Suisse” crisis emerged, affecting one of Switzerland’s largest banks and the second-largest in Europe, raising concerns about the potential spread of the bankruptcy contagion among the world’s 30 largest banks.
Significant concerns have emerged about the potential impact of the ongoing events in the Arab region, particularly with regard to the resilience of Arab banking and financial systems and their susceptibility to the wave of bankruptcies affecting banks the West.
The degree to which Arab banking sectors are vulnerable to the same risks that recently put pressure on American and European banks is called into question. Naturally, depending on each Arab nation’s financial and monetary circumstances, the effects will differ.
The causes of the crisis
Understanding these risks is essential to determine whether or not Arab banks could be exposed to the same dangers that sparked the current banking crisis in Europe and the United States.
The banking crisis in the United States began in March 2022 when the Federal Reserve started steadily raising target interest rates. The target interest rate’s upper range increased over the course of the following year as a consequence of nine decisions by the Federal Reserve to raise interest rates in consecutive months, ranging from 0.25 per cent in March 2022 to 5 per cent in March 2023.
This represented a twenty-fold increase in the upper range of targeted interest rates, reflecting a stringent deflationary policy. The current U.S. interest rate is the highest it has been since the global financial crisis in 2008. The primary motivation for the Federal Reserve’s policy was an attempt to control inflation rates, which surged in the U.S. in May 2022 to their highest levels in 40 years.
In the European Union, the European Central Bank adopted a similar policy, resulting in its main interest rate reaching 3 per cent in March 2023, after having been negative (below zero) in July 2022. Central banks in Britain, Switzerland and other Western countries that influence financial markets also followed the same path. The primary goal in all of these cases was to control inflation.
It was expected that this deflationary policy would put immense pressure on the banking sector in the West. Banks must increase the interest they pay to depositors as money market interest rates rise in order to stop liquidity from flowing to the debt securities markets, where prices decline and returns rise sharply as interest rates rise. Raising the interest rate on deposits as a consequence burdens banks more and reduces their profits.
Banks will continue to lose some of their deposits even after interest rates on deposits are raised because investors often purchase government bonds when their prices decline as the return on investment is higher due to the minimal risk associated with these bonds in Western nations.
On the other hand, most banks hold long-term government bonds as strategic reserves, and when interest rates rise, the prices of these assets in the market fall. This is why banks will suffer significant losses as a result of the drop in bond prices when there is pressure on bank liquidity due to the loss of some deposits, as is the case at the moment. As a consequence of losing some of the value of their assets, banks experience gaps in their balance sheets.
This is not a hypothetical scenario, but rather precisely what happened in the case of Silicon Valley Bank. The lender suffered huge losses when it was forced to sell a portion of its debt securities portfolio to cover depositors’ withdrawals. Additionally, the bank had to increase the interest paid to depositors to prevent the outflow of funds to debt markets, which resulted in further losses. Consequently, SVB was unable to obtain the capital required to manage these losses, and depositors panicked, leading to the bank’s closure.
In the case of Credit Suisse, the confluence of deflationary policies, interest rate hikes and liquidity shortages resulting from the flight of deposits to debt markets intersected with the bank’s own crises related to its losses last year and the scandals it was embroiled in. This perfect storm led to a crisis that forced the sale of Credit Suisse to UBS, effectively ending the bank’s 167-year legacy.
Gulf losses resulting from the European and U.S. banking crisis
The crisis in European and American banks has caused substantial losses for Arab nations, especially those in the Gulf.
For instance, the National Bank of Saudi Arabia had previously owned 9.9 per cent of the shares of Credit Suisse before selling them to UBS at a lower price, resulting in losses of $1.17 billion. National Bank is owned by the Saudi Public Investment Fund, one of the most prominent sovereign funds in the Gulf. Furthermore, the Saudi Olayan Group was among the most affected by the failure and sale of Credit Suisse, with losses totaling approximately $3.91 billion from its shares in the Swiss bank.
Meanwhile, the Qatar Investment Authority, the sovereign fund of Qatar, suffered losses of around $3.44 billion after having increased the value of its holdings in Credit Suisse to approximately 7 per cent of the bank’s shares in January 2023.
Currently, Gulf banks and investment funds are concerned about potential further losses resulting from their investments in foreign banks. These losses may occur due to a long-term decline in the stock prices of European and American banks, or if another scenario like that of Credit Suisse were to happen in other major international banks. Over the past two years, Gulf investment funds and banks have increased their investments in Western banks to diversify their economy and benefit from the surpluses generated by rising oil prices.
However, Gulf banks themselves are also susceptible to the same pressures that Western banks face due to high interest rates and deflationary policies.
Since March 2022, the central banks of Qatar, Saudi Arabia, Bahrain, the United Arab Emirates, Kuwait and Oman have followed the Federal Reserve and the European Central Bank’s lead regarding interest rate trends by raising interest rates in the Gulf countries. The Gulf central banks implemented this measure to prevent liquidity from transferring from Gulf banks to Western banks.
The current developments will subject Gulf banks to the same high interest rate pressure as Western banks. As a result, Gulf banks will face challenges such as shrinking the value of some investment assets, including debt securities, in addition to the high cost of interest paid to depositors. Each time the Federal Reserve and Gulf central banks decided to increase interest rates, the stock prices of Gulf banks fell, and the Gulf stock exchanges as a whole experienced a downturn.
Despite the losses incurred by Gulf countries and banks due to the crisis of European and American banks, and the exposure of the Gulf financial system to the same problems resulting from high interest rates, it is unlikely that Gulf banks will be detrimentally affected by the collapses that occurred in the West.
Gulf banks are less likely to be affected by the scenario of bank closures or liquidations as seen in Credit Suisse or Silicon Valley Bank owing to their large liquid reserves of foreign currencies. The banking sector and investment funds in Gulf countries have taken substantial precautions to ensure that they can intervene swiftly and address any pressures that may affect the liquidity of Gulf commercial banks. Furthermore, the recent rise in oil prices has led to an increase in these reserves, further inflating the assets of Gulf investment funds.
Repercussions on troubled Arab economies
Currently, many Arab countries, such as Egypt, Tunisia and Sudan, are facing challenging economic conditions due to a shortage of foreign currency inflows into their financial systems. The global financial crisis and the tightening of liquidity and investment by foreign banks are expected to further decrease the inflow of hard currency, exacerbating their crises. Furthermore, the deflationary policies and interest rate hikes adopted by Western central banks may exacerbate the problem by absorbing liquidity from and restricting its flow to developing countries.
For a country like Lebanon, for example, might not be greatly impacted by these events because its banking system has already collapsed to the point where it cannot even attract new deposits or foreign currency transfers. But if financial crises in the West worsen, the Lebanese government may face challenges in obtaining much needed aid.
Investing countries must closely monitor the banking crisis in Europe and the United States. This will help them understand the potential impact on their local economies, and develop strategies to protect their banking and financial systems from external risks.
