Qatar's currency came under pressure on Tuesday as Gulf Arab commercial banks started holding off on business with Qatari banks because of a diplomatic rift in the region.
Banking sources said some banks from Saudi Arabia, the United Arab Emirates and Bahrain delayed letters of credit and other deals with Qatari banks after their governments cut diplomatic ties and transport links with Doha on Monday, accusing Qatar of backing terrorism.
Saudi Arabia's central bank advised banks in the kingdom not to trade with Qatari banks in Qatari riyals, the sources told Reuters. The central bank did not respond to a request for comment.
Qatar has dismissed the terrorism charge and welcomed a Kuwaiti mediation effort. Doha, the world's biggest liquefied natural gas exporter, says it has enough reserves to support its banks and its riyal currency, which is pegged to the dollar.
Qatari banks have been borrowing abroad to fund their activities. Their foreign liabilities ballooned to 451 billion riyals ($124 billion) in March from 310 billion riyals at the end of 2015, central bank data shows.
So any extended disruption to their ties with foreign banks could potentially threaten a funding crunch for some Qatari banks. Banks from the UAE, Europe and elsewhere have been lending to Qatari institutions.
Gulf banking sources, who declined to be named because of political sensitivities, said Saudi Arabian, UAE and Bahraini banks were postponing deals until they received guidance from their central banks on how to handle Qatar.
"We will not take action without central bank guidance, but it is wise to evaluate what you give to Qatari clients and hold off until there is further clarity," said a UAE banker, adding that trade finance had stalled for the time being.
The sources said the UAE and Bahraini central banks had asked banks under their supervision to report their exposure to Qatari banks. The UAE and Bahraini central banks did not reply to requests for comment.
With an estimated $335 billion of assets in its sovereign wealth fund and its gas exports earning billions of dollars every month, Qatar has enough financial power to protect its banks.
"We are watching the financial sector very closely. If the market needs liquidity, the central bank will definitely provide liquidity," a Qatari central bank official told Reuters.
Nevertheless, losing some of their foreign business links could be uncomfortable for Qatari banks because they have been expanding their loans faster than other banks in the six-nation Gulf Cooperation Council. To fund this, they have been seeking loans and deposits from the rest of the GCC.
Among large banks, Doha Bank and Qatar Islamic Bank (QIB) are the most exposed to GCC deposits, with QIB obtaining a quarter of its deposits from the GCC, said Olivier Panis, analyst at Moody's Investors Service.
"We need to look into the maturity of those deposits but if they're short-term deposits, this could expose the banks rapidly to reduced confidence from GCC institutions," he said.
Doha Bank and QIB did not respond to requests for comment.
Because of such worries, the Qatari riyal fell in the spot market on Tuesday to 3.6470 against the U.S. dollar, its lowest level since June 2016, although it later rebounded to 3.6405, almost equal to its official peg of 3.64.
It also fell slightly in the one-year forwards market, where traders bet on rates 12 months from now.
The riyal's drop "is based on speculation," the Qatari central bank official said, adding Doha had a "huge cushion" of foreign currency to support the riyal if necessary.
A commercial banker in fellow GCC state Kuwait, which did not sever diplomatic ties with Qatar, said on Tuesday that business with Qatari institutions was continuing as normal.
But there were signs that Qatar's financial ties might be damaged well beyond the Gulf. Some Sri Lankan banks stopped buying Qatari riyals, saying counterpart banks in Singapore had advised them not to accept the currency.
In Egypt, which also cut diplomatic and transport ties with Qatar, some banks resumed dealing in Qatari riyals after halting trade on Monday, but others appeared to be continuing to limit transactions with Doha.
Banks reducing their business with Qatar could lose out financially, but the damage looks likely to be relatively minor.
Panis at Moody's estimated under 2 percent of Saudi banking sector assets were related to Qatar and the figure was around 5 percent for Bahrain, while the UAE's exposure was also small.