How will the banking system be affected?

On June 5, 2017, a group of governments including Saudi Arabia, the UAE, Bahrain, Egypt, Libya, and Yemen, moved to cut diplomatic ties, trade, and transport links with Qatar. The measures to do this include a blockade of land, sea, and air access and the expulsion of Qatari officials, residents, and visitors from those countries.
S&P Global Ratings consequently lowered its long-term ratings on Qatar to 'AA-' from 'AA' and placed all its ratings on the country on CreditWatch negative. This was because the rating agency considers Qatar's creditworthiness to be vulnerable to a potential increase in domestic political risks, a spike in government debt, significantly higher contingent liabilities, and scarce external funding sources.
Following the sovereign rating action, the rating agency lowered its long-term rating on Qatar National Bank (QNB) to 'A' from 'A+' and put all its ratings on QNB, The Commercial Bank, Doha Bank, and Qatar Islamic Bank on CreditWatch negative. At present, it sees numerous uncertainties regarding Qatar's response to the group of government's measures, the extent of these measures, and how long they will stay in place. Amid this backdrop, investors are asking about the potential implications for Qatari banks
What could be the immediate impact of recent developments on the Qatari banking system?
S&P believes the recent developments might result in an outflow of external funding for Qatari banks over the next few months, depending on how the situation evolves. In its opinion, the banks' current liquidity profiles should help them absorb a moderate drop in external funding. Overall, Qatari banks' net external debt totaled about $50 billion at the end of April 2017. S&P classifies the authorities in Qatar as highly supportive toward the banking system and expect government support will be forthcoming in case of need. However, if the situation is not resolved relatively quickly, it might exert further pressure on banks' credit quality. To capture these risks, S&P placed its ratings on the four Qatari banks on CreditWatch with negative implications
What type of instruments makeup banks' external funding?
Qatari banks' external funding structure is dominated by bank liabilities and nonresident deposits, which comprised 89 per cebt of the banking system's gross external debt on April 30, 2017. The Central Bank of Qatar's data don't disclose the maturity of these liabilities, but we understand that most of them are relatively short-term, typically less than 12 months. S&P also understands that a portion of the non-resident deposits are at longer tenors. 
How dependent is Qatar's banking system on external debt?
S&P regards the Qatari banking system's reliance on external debt as a source of tail event risks in Qatar. External system-wide debt has risen sharply over the past few years, reaching QR454.3 billion (about $125 billion) on April 30, 2017, with a significant portion coming from Europe and Asia. On the same date, banks had a net external debt position of QR182 billion, representing 23.5 per cent of domestic loans compared with 13.2 per cent at year-end 2015. S&P understands that the average tenor of these funds is relatively short (less than one year). Over the same period, banks' lending to government and government-related entities increased by a similar amount, and those funds were generally used to finance Qatar's sizeable ongoing infrastructure programme.
 

source: Khaleejtimes

How much external funding comes from the GCC?

In tackling this question, S&P looked at the financials of the four banks it rates in Qatar, which collectively accounted for around 85 per cent of the banking system's assets at year-end 2016. The geographic breakdown of liabilities (defined as due to banks, customer deposits, debt securities, and other borrowing) shows that the GCC represented only around eight per cent (QR75 billion) of the total. While S&P understands that this figure includes funds from countries (Kuwait and Oman) that haven't placed Qatar under sanctions, it takes the view that these funds may theoretically also be withdrawn because of the recent events. It is important to mention that these numbers mask significant differences between the banks, however. For instance, among the rated banks, the least exposed to outflows from the GCC is Qatar National Bank, while the most exposed is Qatar Islamic Bank.

Has a scenario analysis been done? What are the results?

To assess the potential implication of the recent sanctions from GCC countries on Qatar, S&P examined two hypothetical scenarios. In both of them, the results show the rated Qatari banks to be in a decent position, on a stand-alone basis, to face a significant reduction of external funding:

Scenario 1: 100% withdrawal of the GCC funds: The GCC authorities have not made a public statement on what depositors at Qatari banks should do with their money. In the first scenario, S&P takes the conservative assumption that all of these deposits will be withdrawn when they mature. To assess Qatari banks' ability to cope with this eventuality, it compared the volume of outflows with the banks' liquidity positions at year-end 2016. The results show that banks have the capacity to withstand such outflows, although one bank would likely have to use its investment securities portfolio to boost liquidity. Therefore, none of the banks would require external support in this scenario. S&P believes Qatari banks might decide to replace some of the GCC deposits with Qatari deposits. In fact, S&P observed that in the first four months of 2017, the drop in government and GRE deposits that occurred over the past two years started to reverse.

Scenario 2: Withdrawal of all GCC funds and 25 per cent of funds from other countries: The second scenario is more severe. Even though no Western or Asian country has yet decided to impose sanctions on Qatar, S&P tested Qatari banks' resilience to the withdrawal of 25 per cent of deposits from other countries in addition to all attributable to the GCC. Again, the results show that banks have the capacity to withstand such a scenario, but in this case two banks may need to use their investment securities portfolio to do so. Even assuming a 20 per cent haircut on the value of those investment portfolios, the banks should be able to continue operating without requiring the intervention of the central bank.

What could be the impact on Qatari bank ratings?

Although the results of S&P's stress tests show that banks it rates in Qatar have sufficient liquidity to withstand some stress scenarios, the situation remains very fluid and could evolve in several directions. In particular, it is not yet clear how long the current situation will last or whether other countries might join the group that has imposed sanctions on Qatar. Another unknown is how investors and local expatriate depositors would react and whether there could be a higher outflow of deposits than in our hypothetical scenarios.

"We've already captured these risks in our downgrade of Qatar National Bank and the placement of our ratings on the four banks on CreditWatch negative. A key factor, however, is that our long-term ratings on the banks include three notches of uplift for support, above the respective stand-alone credit profiles," the rating agency said.

"This indicates that we expect the banks will receive some extraordinary government support if needed. Notwithstanding support expectations, should we observe a significant deterioration in Qatari banks' funding or liquidity profiles, our ratings would come under pressure. We would consider Qatari banks' creditworthiness to have weakened if the operating environment deteriorated, weighing on their financial profiles especially asset quality or capitalisation."