Could exposure to high-emitting sectors pose liquidity, legal risks to GCC lenders?

Climate transition poses a number of downside risks to GCC banks, especially to those with extensive exposure to high-emitting industries and borrowers, according to a recently-published FAQ by S&P Global Ratings.

In context: As we move closer to net-zero targets, lenders that have big blocks of clients in carbon-emitting sectors could start to see their access to finance get more expensive — and may face legal risks a bit further out.

Remember: The UAE aims to deliver on its net-zero target by 2050, with USD 163 bn in earmarked investments and 50% renewables energy-mix target for 2050. Meanwhile, Saudi Arabia wants renewables to account for 50% of its electricity production by 2030 with USD 187 bn in investments committed to climate action by 2030 and a 2060 net-zero target.

The methodology: The rating agency assessed the direct lending of rated GCC banks to the sectors most impacted by the transition to clean energy, including oil and gas, mining, quarrying, manufacturing, and fossil fuel-fired power generation sectors.

Direct lending to carbon-intensive players accounted for 12% of GCC banks’ overall loan book in 2023 — a rate that S&P calls “manageable” — and has remained basically unchanged for the past three years, the rating agency said citing disclosures by the region’s central banks. It’s important to note that state-owned oil giants typically self-finance via JVs and / or tap global debt markets for financing— explaining the low ratio.

Some lenders are at a higher risk than others: GCC banks that depend heavily on foreign funding have higher liquidity risk than others because a shift in investor appetite for lenders with exposure to carbon-emitting sectors could result in outflows of funds, squeezing local liquidity.

Diversification of financing sources: Regional banks have issued more sustainable bonds and sukuk over the past two years to mitigate against the risk of lower liquidity and unlock new sources of funding. Sustainable debt issuances led by Saudi and the UAE doubled y-o-y to USD 23 bn in 2023. Meanwhile, the Middle East accounts for a mere 3% of global sustainable issuances.

How regional lenders are faring in climate risk reporting: Only two thirds of the 20 reviewed GCC rated banks have published a materiality assessment, while only 30% consider environmental risk as a key risk. Only four of the assessed lenders have “communicated publicly that exclusion policies are part of their risk management framework,” S&P notes. Meanwhile, none of these lenders is in an advanced stage of implementing climate risk-adjusted loan pricing, while 70% of them offer sustainability-labeled products.

Two of the UAE’s banks are on the right track: First Abu Dhabi Bank and Abu Dhabi Commercial Bank are the only two banks in the region who are members of the net-zero banking alliance and who have communicated publicly about planned sustainable financings with a predetermined deadline, according to S&P Global. FAB is also classified to be among the most advanced banks in terms of quantifying targets for financed emissions.

More work on the regulatory front is required, including the incorporation of climate change into stress tests and scenarios that encompass mitigation measures. The Central Bank of the UAE’s principles for the effective management of climate-related financial risks are a “step in the right direction,” the agency said, adding that it will still require “significant investments” from UAE banks in order to be effective.