Borrowers in the GCC are facing a sharp rise in the cost of credit in the coming years, one of the region’s leading economists has warned.

Speaking to MEED, the chief economist at Saudi Arabia’s Banque Saudi Fransi, John Sfakianakis, warns that the tightening of liquidity in response to the more stringent capital ratios banks are required to have under the new Basel III regulations will drive up the cost of capital to corporate and retail borrowers in the Gulf.

Global regulators agreed on 12 September to introduce sweeping reforms to the rules governing financial institutions that requires banks to more than triple their Tier 1 capital ratios by 2019.

“Banks will have to pass on some of the added costs to the end users and therefore the cost of capital will increase and spreads will widen,” says Sfakianakis. “The economic costs will be felt most by the consumer and corporates, especially in the UAE, where liquidity is still quite tight.”

Tier 1 or “high-quality” capital consists of equity or retained earnings. Starting 2013, banks will need a Tier 1 ratio of at least 3.5 per cent, up from the current 2 per cent. The requirements get tougher each year until 2019 when the ratio will be raised to 7 per cent.

These regulations are aimed at ensuring banks hold sufficient capital to withstand shocks in order to avoid a repeat of banks having to bail out undercapitalised lenders during an economic slowdown.  

However, reduced lending to corporates and consumers will inevitably feed through into the broader economy, affecting its rate of recovery.

“Revival of bank credit will be a key determinant of economic recovery,” says a regional economist. “If banks are having to rein in lending in order to raise extra capital, then of course this will have a knock-on effect on the economy.”

Basel III is expected to have the least impact on Saudi banks, which have the highest capital adequacy ratios today in the Gulf region, with an average loan-to-deposit (LDR) of 81 per cent.

“Sama has often been criticised by other regulators for demanding high buffer ratios and low rates of leverage, but this conservatism has clearly paid off,” says Sfakianakis.