GCC banks adjust debt instruments

Gulf Cooperation Council banks will refrain from redeeming the hybrid capital instruments at the first call date for the next 12 to 24 months, owing to the increasing volatility, scarce liquidity and significant rise in the cost of capital, said S&P Global Ratings in its latest report. 

Hybrid capital refers to a perpetual or long-term debt instrument, the interest on which can be deferred so that the issuer has more room to maneuver in case of a financial crisis.

Rise of interest rates

Interest rates in the Gulf have been rising quickly as central banks matched course with the US in support of their currency pegs with the US dollar. “Liquidity is becoming scarcer and more expensive, even in the Gulf. Current market conditions mean banks that replace an existing hybrid capital instrument with a new one could incur a significant increase in their cost of capital,” said Mohamed Damak, primary credit analyst at S&P Global Ratings in Dubai, in the report. 

GCC hybrid instruments

Over the past decade, the GCC banks have shown a marked preference for conventional and Islamic hybrid capital instruments, resulting in their contribution to the total adjusted capital increasing from 2.3 percent at the end of 2011 to 13.5 percent as of Sept. 30, 2022.  While some banks have abstained from issuing hybrid instruments, others have almost a quarter of their TAC in hybrids. Most GCC banks have also issued only additional Tier 1 instruments, which absorb losses or conserve cash while operational.  

For instance, banks in the UAE and Bahrain issued a large portion of their AT1 instruments on the international capital market in hard currencies. In contrast, Saudi Arabia and Qatar focused on the local market, with issuance denominated in local currencies. Local investors, in this case, may include cash-rich governments and their related entities, which invested in providing support for banks while receiving a defined return. 

Qatar, Oman lead the trend 

“Both Islamic and conventional hybrid AT1 instruments allow issuers to suspend payments —periodic distributions for the Islamic instruments and coupons for the conventional instruments — without triggering a default, while the bank is still a going concern,” said Damak in the rating report.  With low-cost hybrid instruments no longer available, S&P Global expects more noncall decisions in the GCC, such as Qatari and Omani issuers choosing to refrain from redeeming hybrid instruments on the first call date over the past three years.

Meanwhile, Russian banks may start providing financial products based on the principles of Islamic banking as early as February 2023.