Thursday, 9 November 2017

Qatar Banking Sector - How to Measure the Net Foreign Assets Position

AA Absolutely Loves Quotes Like This Though It's Hard to Match "Live Your Life" 

This is the first of four planned posts on Qatari banks’ vulnerability to cross-border foreign currency exposure in light of the measures taken by Saudi Arabia, the UAE, Bahrain and Egypt (the GCC 3 +1). 
Before getting into a detailed discussion of the numbers, it’s important to ensure that we’re measuring cross-border foreign currency exposure vulnerability properly. 
Currently analysts and the press are focused on Qatari banks’ Net Foreign Assets (NFA) position as reported by the Qatar Central Bank (QCB).  It’s a “convenient” measure:  a single number available monthly.   But sadly reality is rarely, if ever, that neat. 
To be very clear, I don’t think there is a fault in the QCB’s NFA statistics, but rather that they give only a partial picture of Qatari banks’ positions and vulnerability.
The statistics are an aggregate of the separate foreign currency positions of all the banks operating in Qatar with non-resident counterparties.
What does that mean? 
  1. Net Positions Obscure Gross Positions: Assume a country whose banking sector is composed of only two banks, Bank A and Bank B.  Assume Bank A has borrowed local currency to fund foreign assets of some USD 55 billion and Bank B has borrowed foreign currency to fund local currency assets of USD 55 billion.  According to QCB’s valid methodology, NFA = 0, an apparently “happy” cross-border position.  But if foreign creditors cease lending to the country, Bank B needs to pay USD 55 billion to them. If it can’t, the central bank needs to step up unless one assumes the highly unlikely event that Bank A voluntarily liquidates its foreign assets and makes the resulting foreign currency available to Bank B.   The situation is even more complicated when as usual there are multiple banks in a country.  The net of all their individual positions obscures the position of each bank.  And it is the position of each bank that is critical to the ultimate demand for foreign currency on a country.
  2. Net Positions Obscure Exposure to Specific Creditors:  When assessing creditor flight, it’s important to know where the creditors are.  In the case of Qatar, creditors in the GCC 3 +1 are most likely to take “flight”.  Other creditors less so because the crisis is at present driven by political not economic/credit issues. If exposure to the GCC 3 +1 countries is large, then the potential funding gap from their withdrawal is large.  If not, the problem may be minor. 
  3. The standard NFA statistics implicitly assume that assets and liabilities are equally liquid. They “ignore” the fact that a bank’s basic business is maturity transformation – typically borrowing short and lending/investing long. On a contractual basis a good portion of assets (likely a majority) will almost certainly have maturities far in excess of liabilities.  If assets cannot be liquidated quickly because of contractual maturities, the central bank (here QCB) may have to provide additional foreign currency funding to “bridge” the maturity gap. That will be an immediate call upon the central bank’s foreign assets.  If the banks’ assets cannot be realized at par, the parent or central bank may have to provide additional funds to make up the shortfall from asset realization.  If, for example, Qatari banks hold their foreign assets in US Treasury Bills, realization at par is almost certain.  If they hold Dana Gas or GFH shares, less so, much less so.
What’s needed then is additional information on Qatari banks’ foreign currency exposure that supplements the QCB reported NFA position by factoring in the cross border foreign assets and liabilities of local Qatar banks that are not included in the NFA position, subtracting the position of overseas banks operating in Qatar (if their position is meaningful), disaggregating “net” positions into gross Foreign Assets (FA) and Foreign Liabilities (FL) by region (ideally country), and by individual Qatari bank, as well as understanding the liquidity of gross FA of individual banks.  That requires looking at the foreign asset classes the banks hold. 
We can derive some of this information from other data published by the QCB.
But we are still left with unanswered questions.
To answer those questions, we can turn to the fiscal year end consolidated financial reports of Qatari banks, though this method is admittedly imperfect. 
In the third post I’ll discuss the theoretical limitations as well as  practical constraints of using this method.  And why I chose this method as an analytical tool despite those drawbacks.  For example, not all Qatari banks provide a geographical allocation of assets and liabilities. Accounting standards do not require the provision of this data for “parent only” statements that would eliminate a key issue with using consolidated statements. That is Qatari parents have less direct access to the foreign assets of their overseas subsidiaries than to those of their foreign branches.  Also the parents are not legally liable for their subsidiaries' foreign liabilities absent having provided a guarantee. 
One final point. 
This exercise will result in estimates of Qatari banks’ vulnerability—hopefully more comprehensive than the NFA reported by QCB.  But note that both are estimates not “hard” numbers. Vulnerability is composed of two elements: structural position and market sentiment.  We can get a reasonable “fix” on the aggregate structural position, but not an exact number due to the absence of sufficiently detailed information. Pricing and timing of realization of assets remain uncertain and dependent on many factors.  Creditor sentiment—responsible for the “flight” in capital flight--is harder to specify than the structural position.  We  see creditor or market sentiment most clearly post-facto.    All these factors are uncertain and inter-react making this a complex system.  As such, it’s not capable of being modelled accurately.  Therefore, the final post will look at some scenarios to set a range of possibilities and hopefully spark some thinking by others as to how to refine the analysis.
The following three posts will detail the results of an analysis of:
  1. QCB data
  2. Data from individual Qatari banks’  audited annual consolidated financial statements
  3. Various FX exposure scenarios 
These posts will be typical-AA excessively-detailed journeys through the data.  To whet your appetite for the long journey that follows, three teasers.  Note that the consolidated financial statement data cited below is as of 31 December, the only time that banks are required to publish detailed risk management notes.
The Qatar banking sector’s estimated foreign asset and liability exposure to other GCC states (OGCC) is minor in the context of its total foreign asset (TFA) and total foreign liability (TFL) position as of 31 December 2016.
  1. Based on a sample of  7 Qatari banks consolidated financial statements, the base worst case exposure to other GCC states (OGCC)—assuming no realization of any FA held in OGCC—is estimated at some QAR 89 billion (the aggregate of all banks TFL  to OGCC) or some USD 24.5 billion. 
  2. If we assume that Qatari banks will be able to realize their FA at par value, and look only at those banks with a negative NFA, the exposure is QAR 31 billion equivalent to USD 8.5 billion. 
  3. If we take the aggregate position of all Qatari banks, the aggregate NFA is some QAR 18 billion or USD 4.9 billion.  For the reasons outlined above AA thinks this scenario is unlikely.
  4. While we are missing detailed data for four banks, it’s unlikely that they will dramatically change these amounts.  AlKhaliji Qatar has disclosed overseas subsidiaries with gross assets of QAR 8.9 billion (USD 2.4 billion), primarily in the UAE.  QIIB and IBQ do not appear to have foreign branches or operating subsidiaries overseas.  Qatar Development Bank, the missing fourth bank, doesn’t release financials but from the QCB data we can see that it is funded primarily with equity and has a positive NFA of some USD 84 million equivalent. 
  5. If we adjust the base worst case scenario for AlKhaliji's overseas subsidiaries' total assets of QAR 8 billion, the result is QAR 97 billion or USD 26.6 billion.   
An estimate of the Qatari banking sector’s aggregate NFA using individual bank consolidated financial reports results in a much lower aggregate NFA than QCB figures as of 31 December 2016. 
  1. As per consolidated financials, the aggregate NFA is some USD 25 billion equivalent versus USD 48 billion equivalent from QCB data as of 31 December 2016. 
  2. While the consolidated financial “result” is based on a sample and thus does not include all Qatari banks, I think it’s unlikely that the remaining banks could generate an additional negative NFA equaling USD 24 billion equivalent.  Why?  Because the total liabilities (foreign and domestic) of these banks ex-QDB equal QAR 112 billion (some USD 31 billion). It’s highly unlikely that they have foreign liabilities equal to 74% of total liabilities. As well there are likely to have some FA to offset their FL.  
Qatari banks with the aid of the Government of Qatar (GOQ) should be easily able to meet the challenge posed by the GCC 3 +1’s actions. 
  1. However, if the GCC 3 +1 can create a situation in which other foreign creditors withdraw funding support, the burden on the banks and the GOQ would be substantially higher.
  2. Using QCB data the worst case would be aggregate TFL of some USD 101 billion equivalent as of September 2017.  Consolidated financial report data after 31 December 2006 isn’t available for comparison.  But if we use the “spread” at 31 December 2016 between QCB’s computation of NFA and that derived from bank financial reports, the estimated consolidated finance report-derived NFA would be some USD 9 billion larger, i.e. USD 110 billion.          

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