Prolonged Gulf conflict may erode lenders' credit quality, UOB Kay Hian warns

Disruptions have left highly leveraged borrowers in major industries in distress.

Continuing conflict in the Middle East could gradually weaken the asset quality of Singapore banks as sustained disruption to energy markets and shipping routes stresses leveraged borrowers, UOB Kay Hian said.

Iran has escalated the conflict by targeting American bases, commercial shipping routes and regional allies. The Strait of Hormuz carries roughly one-fifth of global oil supplies, and sustained disruption to shipping has triggered higher oil prices and inflationary pressures. Iran's use of drones and missiles has forced the United States to expend costly defensive systems, creating what UOB Kay Hian called an expensive war of attrition that the country may find increasingly difficult to exit.

For banks, the transmission is indirect. Sustained disruptions to energy markets and shipping routes could keep energy prices elevated and dampen business investment, leaving highly leveraged borrowers in the transportation, logistics and aviation sectors financially stressed.

Companies exposed to supply chain disruptions or higher operating expenses may face refinancing challenges. Exposure to the transportation, storage and communications sector stands at 7.4% for DBS Group Holdings, 7.4% for Oversea-Chinese Banking Corp and 5.5% for United Overseas Bank.

Credit metrics remain sound for now. DBS reported non-performing loan formation of $126m in the first quarter of 2026 and $155m in the second, with an NPL ratio of 1% and loan-loss coverage of 130%. OCBC recorded non-performing loan (NPL) formation of $123m and $300m across the same quarters, holding the lowest NPL ratio at 0.9% and the highest loan-loss coverage at 163%.

Separately, the brokerage expects government bond yields to stay elevated, citing resilient economic growth bolstered by the investment cycle for AI and still-elevated inflation. Elevated energy prices caused by the Middle East conflict are also adding upward pressure on yields.

The yield on 10-year Singapore government bonds has risen 25 basis points year to date to 2.37%. UOB Kay Hian described that increase as mild compared with the United States, where the 10-year treasury yield rose 52 basis points to 4.69%, and Japan, where the 10-year government bond yield rose 78 basis points to 2.85%.

Domestic conditions remain comparatively firm. Non-oil domestic exports rose 24% year on year in July 2026, driven by a 112% surge in the electronics sector and supported by robust global demand for AI-related products. Core inflation was 1.6% in June.

DBS and OCBC share prices have risen 35% and 56%, respectively, whilst United Overseas Bank has gained 15%.

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