How did Islamic Gulf banks avoid liquidity and quality crises?
Moody’s Investors Service reported that Islamic banks in Gulf countries enjoy greater protection from the secondary repercussions of the ongoing Middle East conflict compared to their counterparts in several Asian Islamic finance markets. This resilience stems from the nature of their financing portfolios, which help mitigate the risk of asset quality deterioration, particularly in the retail and small and medium-sized enterprise (SME) sectors.
In an analytical report, the agency explained that retail financing at Gulf Islamic banks is strongly supported by salary transfers, especially for public sector employees, while SMEs represent a smaller share of their overall financing portfolios.
This structure gives these banks greater capacity to withstand pressures arising from rising living costs and energy prices, compared to markets more exposed to external shocks.
Conversely, Moody’s noted that Islamic banks in Bangladesh, Indonesia, and Pakistan face greater exposure to the conflict’s repercussions, while Malaysia holds a more balanced position. The variation in impact is linked to each economy’s reliance on energy imports from the Middle East, inflation levels, currency and interest rate movements, as well as the nature of banks’ portfolios and funding sources.
The agency expects that sustained high energy prices will keep inflation and interest rates at elevated levels, imposing pressure on economic growth and the ability of some borrowers to service their obligations.
Risks are more pronounced in Indonesia and Pakistan, where rising interest rates and living costs have increased pressure on households and small businesses.
Moody’s observed that the risk-sharing and asset-backed nature of Islamic financing has led Islamic banks in some Asian markets to focus more heavily on retail customers and SMEs. These sectors are directly affected by rising food and energy prices, declining disposable income, and reduced cash flows.
However, the presence of collateral and secured assets in a significant portion of Islamic retail financing, such as home and auto financing, limits potential losses in the event of default.
In Bangladesh, the picture differs due to Islamic banks’ higher exposure to large corporations, particularly in the manufacturing, ready-made garments, and textiles sectors, making them more sensitive to rising energy costs and weak global demand.
The agency also highlighted that the impact of interest rates on Islamic banks’ margins varies according to funding structures. Reliance on time deposits and fixed-return financing in some markets raises funding costs and slows the pass-through of rising interest rates to financing yields, while other markets demonstrate a faster ability to reprice balance sheet items.
Regarding liquidity, Moody’s noted that some Asian Islamic banks face pressure due to high financing-to-deposit ratios, particularly in Bangladesh and Malaysia, while liquidity remains more abundant in Pakistan. Gulf Islamic banks, meanwhile, benefit from a more stable domestic funding base and a financing portfolio structure that relatively dampens the transmission of shocks to asset quality.
The agency affirmed that capital adequacy levels in most Islamic markets, with the exception of Bangladesh, provide adequate buffers to absorb the conflict’s secondary repercussions. Asset quality, profitability, and liquidity will remain key factors in determining banks’ ability to maintain safety margins in the coming period.
