Funding outflow of $220bn may hit Mena banks if Israel-Gaza war spreads, S&P says

Potential outflows from lenders in GCC, Jordan and Egypt are about 30% of aggregate external liabilities

Israel is continuing its military campaign in Gaza, leading to geopolitical uncertainty in the broader Mena region. AFP

Banks in the broader Middle East and North Africa region could see $220 billion of funding outflows if Israel-Gaza war spreads to the wider region, however, lenders are well positioned to cope with the stress, S&P Global Ratings has said.

The potential external funding outflows from financial institutions in the six-member economic bloc of GCC, Jordan and Egypt are about 30 per cent of the tested systems’ aggregate external liabilities, S&P said in its latest report on Monday.

Under the base case scenario, S&P assumes that the war will remain centred in Israel and Gaza, However, if there is a wider regional escalation including through proxy conflicts, investors' risk perception of the Middle East may prompt some confidence-sensitive funds to leave, as seen during previous stress.

“The latest war between Hamas and Israel heightens global geopolitical risks with potential adverse implications for investor confidence and external funding flows,” Mohamed Damak, S&P managing director for financial institutions ratings, and analysts Dhruv Roy and Benjamin Young wrote in the joint report.

“There may be scenarios where the conflict widens, leading more risk-averse investors to withdraw funds from the region.”

The Israel-Gaza war, which has become a major humanitarian crisis, has created further uncertainty for a global economy that is feeling the effects of stubborn inflation and high borrowing costs.

The war that broke out on October 7 could have serious consequences for the Mena economies if it escalates beyond the borders of the besieged Gaza enclave.

The continuing bombardment has already devastated the Gazan economy as Israel continues to attack the narrow strip. If the unabated military campaign continues, it risk the tensions to flare further in the broader region as death toll of innocent civilians continues to rise on daily basis.

Travel and tourism sectors, a vital source of foreign exchange and a key driver of economies in most oil-importing Mena countries, is likely to take the biggest hit.

S&P said although the regional banking system’s external debt level has increased in some countries over the past few years, in most markets, those liabilities were recycled into external assets.

The banking system is currently in a net external asset position, it said.

S&P’s hypothetical scenarios, in case of a broader conflict, assumes a 50 per cent outflow of interbank liabilities, an outflow of 30 per cent for external liabilities and a 10 per cent outflow rate for capital market liabilities – since these are mainly medium to long-term instruments.

Where the breakdown of liabilities was not granular, an outflow of 50 per cent, which was the case for Egypt and Jordan, S&P said.

“To fund these outflows, banks will have to liquidate their external assets,” S&P analysts said. “In a stressed environment, such liquidation could result in lower valuations for these assets, a potential haircut of 10 per cent on interbank deposits.

Lenders may have to take a 20 per cent loss on investment portfolios abroad and a “100 per cent haircut on loans to non-residents and other assets, which we assume will be much more difficult to liquidate in a stress scenario”, analysts said.

“We applied these haircuts because we assume that banks may incur some reduction in the value of their assets if they want to liquidate them prematurely.”

Despite the distress caused by the potential escalation of the conflict to other regional economies, most banking systems can manage the outflows, with only Qatar, Egypt, and Jordan facing deficits.

“For Egypt, the shortfall is mainly related to the recent build-up of external debt in the banking system. While for Qatar, the impact appears very manageable given the government's track record of support to banks.”