Moody’s Investors Service has changed the outlook on Qatar’s banking system to negative from stable due to continued funding pressure faced by the lenders and weakening conditions they are operating in.

The change in outlook also underlines the potential weakness in the government of Qatar’s capacity to support the banks in the gas-rich Arab state, if the need arises. The change also reflects an expectation of how bank creditworthiness will evolve over the next 12 to18 months, Moody’s said in its ‘Banking System Outlook – Qatar’ report.

“Qatari banks’ reliance on confidence-sensitive external funding has increased in recent years due to a significant decline in oil-related revenues” said Nitish Bhojnagarwala, a vice president at Moody’s. “This leaves them vulnerable to shifts in investor sentiment.”

Qatar, the world’s top liquefied natural gas exporter, is facing an economic blockade since 5 June, after Saudi Arabia, the UAE, Bahrain and their North African ally Egypt chose to sever transport and diplomatic links with Doha. The quartet accuses Qatar of financing terrorism and meddling in their internal affairs. Qatar has denied the allegations.

Regional efforts at mediation, led by Kuwait, and attempts by the US, the UK and Turkey have so far failed to break the deadlock, which is mounting pressure on Qatar’s economy and its financial system.

The US-based Moody’s expects Qatar’s GDP growth to slow to 2.4 per cent in 2017 from exceptionally high rates of around 13.3 per cent during the 2006-2014 period. However, despite a slowdown, the growth remains the highest in the GCC, driven by high levels of government spending in preparation for the FIFA World Cup in 2022. Domestic credit growth in the country is also expected to slow to the 5 per cent to 7 percent range for 2017 and 2018, down from 15 per cent in 2015.

Moody’s expects asset quality in the financial system to dip slightly. “We expect system-wide problem loans to increase to around 2.2 per cent of gross loans by 2018, up from 1.7 per cent as of December 2016,” Bhojnagarwala said, adding that despite this increase, the non-performing loan (NPL) ratio will remain among the lowest in the GCC heading into 2018.

Capitalisation will continue to remain strong, providing Qatari banks with substantial cushions to absorb losses. However, a prolonged regional dispute could trigger outflows of foreign deposits and other external funding, which represents around 36 per cent of total banking system liabilities as of May 2017.

“Against this backdrop, Qatari banks’ profitability will likely decline, with return-on-assets declining to around 0.4 per cent for 2017, from 1.6 per cent in 2016, driven by increases in funding and provisioning costs,” Bhojnagarwala said