Climate transition may lead to increased credit risk, losses for GCC banks

Climate transition can increase credit risks and losses for banks in the GCC region, especially in cases where lenders are exposed to high-emitting industries and borrowers that are most vulnerable to the climate transition, a leading global credit rating agency said.

Exposure to these high-emitting industries could also damage banks' reputation, deprive them from access to some funding sources, and increase funding costs and could ultimately weaken their funding profiles if banks rely heavily on external funding, says S&P Global Ratings in its report “GCC banks climate transition journey has only just begun.”

Climate-related considerations are becoming part of GCC banks' senior management key performance indicators, which could increase resources that are earmarked for the climate transition over the long term.

"After reviewing 20 rated GCC banks' climate risk disclosures, our main conclusion is that GCC banks' reporting on climate risks and, more generally, sustainability is still very much a work in progress," S&P Global Ratings credit analyst Mohamed Damak said. "Only two-thirds of the banks we reviewed published a materiality assessment, while only 30 per cent consider environmental risk as a key risk."

Analysts at S&P Global said banks are also 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.

“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 per cent of total lending at year-end 2023 and remained stable over the past three years,” they said.

Given the importance of hydrocarbons in GCC economies, the exposures may be surprisingly low, but it is worth noting that large national oil companies typically self-finance via joint ventures or access international capital markets, said the report. “However, if international financing becomes restricted, oil companies may have to rely on local banks.”

S&P analysts noted 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,” they said.

The report said that 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. These policy shifts highlight GCC countries' increasing focus on the energy transition.”

“The materialisation 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 materialise, which makes the consideration of loan maturities and banks' policy shifts even more important,” it said. On liquidity risk face by lender, the report noted that a loss of investor or depositor confidence can lead to outflows and reduce banks' liquidity. “While this risk has not materialised 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,” S&P report said.

• Business