Finance

Assessing the Impacts of Climate Transition Risks on GCC Banks' Creditworthiness

As the world grapples with the challenges posed by climate change, the financial sector is not immune to its impacts. In particular, banks in the Gulf Cooperation Council (GCC) region face potential risks associated with the transition to a low-carbon economy. S&P Global Ratings has conducted an analysis to address some of the questions from investors concerning these climate transition risks and their potential effects on GCC banks. This news article delves into the various dimensions of these risks, their impacts on the creditworthiness of GCC banks, and the measures being undertaken to mitigate them.

Frequently Asked Questions (FAQs) Raised by Investors

Potential Repercussions of Climate Transition on Banks' Credit Profiles

Climate transition risks can significantly amplify credit risks and banking losses. This increase is predominantly evident among banks with considerable exposure to carbon-intensive industries most susceptible to the impacts of the climate transition. Financial institutions catering to these sectors could see their reputations tarnished, which might hinder access to certain funding avenues and drive up funding costs. Should banks lean heavily on external means for funding, such circumstances could substantially undermine their funding disposition.

Moreover, legal contingencies might arise from the financing of high-polluting industries or in situations pertaining to greenwashing allegations. The specter of stricter international banking regulations looms large, with the possibility of a considerable hike in capital charges as part of Pillars 1 and 2 of the regulatory capital requirements.

Extent of GCC Banks' Exposure to Climate Transition Risks

Our examination of the rated GCC banks' direct lending to sectors at the frontline of the climate transition, such as oil and gas, mining, utility providers relying on fossil fuels, manufacturing, and select public-sector lending, paints a complex picture. Despite the hydrocarbon-dependent nature of GCC economies, lending exposures to these high-risk sectors accounted for about 12% of total lending by the close of 2023 and have showcased stability over the past triennium. It's imperative to recognize that key national oil companies within the region often opt for self-financing or the global capital markets for their fiscal needs. That being said, local financial institutions may become a more relied upon source should international financing recede.

It's worth mentioning that the GCC region extensively recycles oil revenues, and the sentiment around oil prices and production plays a considerable role in shaping long-term risks for the banking system, economies, and sovereignty of the region. Nonetheless, the competitive edge enjoyed by GCC sovereigns lies in their low production costs and capability to scale up capacities, potentially serving as buffers for local economies and banking sectors.

In the light of the unfolding energy transition and the elaborated net-zero commitments of GCC countries, except Qatar, banks—predominantly those with government ownership—are anticipated to actively support their national climate objectives. These transformational policy shifts underscore a growing inclination towards energy transition within the GCC.

Chart 1: GCC Banks' Lending Exposures

GCC Banks' Commitment to Climate Goals

On the sustainability front, GCC banks are endeavoring to refine their nascent sustainability programs by expanding their sustainable finance products and reinforcing governmental initiatives aimed at decarbonizing the local economies. Despite these efforts, the region is yet to witness substantial regulatory strides, such as climate stress testing or persuasive measures to nudge banks toward lessening climate transition risks.

The GCC's Sustainable Finance Landscape

2023 marked a year where sustainable debt issuance in the Middle East reached a zenith, with a record-setting $23 billion mainly driven by banks and government-related bodies in the UAE and Saudi Arabia. Doubling since 2022, this figure of sustainable issuance contributed less than 3% to the global issuance, signalling that sustainable finance in the Middle East, albeit at an embryonic stage, is gaining momentum.

Sustainable Finance's Nascent Stage

The Varied Spectrum of Risks Influenced by Climate Transition

• Credit Risk: The materialization of climate transition could debilitate the creditworthiness of banks' counterparts. However, these risks might have protracted timelines for actualization, making loan maturities and alterations in banking policies crucial.

• Liquidity Risk: A wavering confidence among investors or a dip in depositor enthusiasm could precipitate liquidity shortages. Banks with a pronounced dependency on foreign wholesale funding find themselves particularly at risk. In response, there has been an uptick in sustainable bond and sukuk issuances over the past couple of years; nonetheless, these issuances still represent a scant portion of total bond issuances in the region.

Advancing Climate Risk Disclosures

A review of climate risk disclosures among 20 rated GCC banks highlights some intriguing findings:

• Two-thirds of these institutions have disclosed materiality assessments.

• 70% provide sustainability-labeled offerings.

• Barely 30% classify environmental risk as a principal risk concern.

• The only two members of the Net-Zero Banking Alliance (NZBA) from the region are First Abu Dhabi Bank PJSC (FAB) and Abu Dhabi Commercial Bank PJSC (ADCB), both UAE-based. These entities have also delineated sustainable financing targets within specific timelines.

• Merely four banks have openly indicated that they incorporate exclusion policies within their risk management frameworks. It appears that the region's banking sector is still distant from embracing climate risk-adjusted loan pricing.

Leading the Charge: FAB's Commitment

In an exemplary move, FAB took the initiative in March 2023 to announce financed emissions reduction targets across multiple sectors including agriculture, aviation, aluminum, cement, steel, power generation, and commercial real estate, covering almost 90% of its corporate financed emissions.

FAB's Progressive Climate Action

Navigating Quantification Challenges

Senior management across rated GCC banks express quantification of climate transition risks, such as scope 3 emissions, as a formidable challenge. Both banking personnel and regulators are allocating specialized resources to tackle this complication. Having climate-related considerations included as part of key performance indicators at the senior management level bodes well for the long-term emphasis on climate transition.

UAE Central Bank's Principles for Climate-Risk Management: A Stepping Stone

The principles introduced by the UAE central bank in November 2023 delineate a significant journey that banks must embark upon, necessitating substantial investments and a redefinition of risk management frameworks, particularly with regards to climate risks. Some banks have already integrated environmental and social risk management (ESRM) into their operations, influencing decisions about financing to entities with pronounced environmental or social risks.

The execution of these principles demands methodical climate stress tests that reflect banks' risk exposure and complexity. The iterative implementation of these principles over time will indubitably influence UAE banks' strategies and engagement with climate risks.

In Closing: Related Research and Analyst Contacts

To complement this discussion, several pertinent research pieces shed light on the evolving landscape:

• GCC Banking Sector Outlook
• Islamic Finance's Role In The Climate Transition
• Middle East Sustainable Bonds May Expand Further
• Energy Transition: Competitive Advantages Shield GCC Sovereigns

For inquiries, please reach out to the analysts:

Primary Credit Analyst: Mohamed Damak, Dubai: +97143727153, mohamed.damak@spglobal.com

Secondary Contact: Emmanuel Volland, Paris: +33144206696, emmanuel.volland@spglobal.com

It stands unequivocally that the navigation through the climate transition will be a layered and sustained one for GCC banks. The comprehensive insights drawn from S&P Global Ratings' research not only underline the nascent stages of adaptation but also spotlight the earnest attempts by leading entities to pioneer pathways towards sustainable finance and risk management within the region amidst a global environmental pivot.