The side effects of the tightening US credit markets show no sign of abating and dollar liquidity looks set to worsen. In addition, banks with exposure to sub-prime-related assets could be forced to write off more of their investments.

Raising dollar funding is becoming a major difficulty. Pricing for five-year dollar deposits has risen to about 50 basis points over the London interbank offered rate (Libor) from about 25 basis points over the past year.

“The premiums that most banks are paying for dollars have already doubled since last year,” says one Bahrain-based banker. “It is likely to go up further now.”

Banks in the UAE, Qatar and Saudi Arabia are most exposed to the problem as speculators target their currencies as the most likely to be revalued. “For short-term dollar funding, some UAE and Qatari banks can pay up to 1.5-2 per cent over Libor,” says a Qatar-based banker.

Many bankers in the region say that deal-flow will slow as debt prices rise in 2008.

Despite the liquidity crisis, which led to the collapse of the US' Bear Stearns in mid-March, regional institutions Gulf International Bank (GIB) and Gulf Investment Corporation (GIC) have defended their exposure to the crisis.

However, GIC says it could be forced to make further provisions, on top of the $250m in 2007.

“We have taken whatever provisions were necessary,” says Hisham al-Razzuqi, chief executive officer of GIC. “In fact, we have done a bit more than we needed at 31 December, but if there is any further decline we will need to take it.”

He insists the bank is well capitalised. “There is no need for us to raise capital,” he says.

In contrast, GIB wrote off its investments in structured products down to zero, making provisions of $960m. “The speed of deterioration has been unprecedented,” says Khaled al-Fayez, chief executive officer at GIB.