The role of GCC banks in promoting regional economic growth

For as long as people have existed, banking has existed, even in its most non-descript form. Prior to the first currencies being minted, merchants granting grain loans to farmers and traders transporting goods through various cities were touted as the first prototypes of banks.

The first proper bank too was no more than a series of vaults for people to store valuables in. Since then, banking worldwide has graduated from bullions in a vault to a plethora of financial products and offerings for consumers and corporate entities, nurtured and propelled by ingenuity, innovation and digitalisation.

GCC’s banking landscape
The GCC’s banking landscape is as diverse as it is sheer. On the heels of regulatory reforms, customer-centric approaches, consolidation, technological investments and omni-channel
approaches, the regional ecosystem in recent years has exploded.

There are more than 70 listed banks across six GCC countries; Qatar National Bank remains the biggest lender in the GCC by assets – which total $262bn – followed by the UAE’s First Abu Dhabi Bank ($227bn), according to data published by Bloomberg in July.

In recent years, the Gulf’s banking sector has shown resilience, recording formidable growth in terms of assets and profitability, despite political and economic headwinds. GCC banks recorded an increase of 16.9 per cent in net profits in 2019, totaling $36.5bn, while total assets went up by 12.8 per cent to $2.3 trillion, a KPMG report, summarising the performance
of select 55 GCC-based listed banks for the year-ended December 31, 2019, revealed.

Meanwhile, bank share prices trended upwards with an average increase of 9.5 per cent over 2019, it found.

Islamic banks in the GCC have also maintained sound asset quality and hold encouraging profitability indicators, funding profiles, and capitalisation.

The 2019 Islamic Banking Index by Emirates Islamic bank, which polled more than 900 respondents with a UAE bank account and a minimum monthly income of Dhs5,000, revealed that 60 per cent had at least one Shari’a compliant product, up from 55 per cent in 2018. Meanwhile, non-Muslim respondents’ interest in Islamic products also grew since 2018, including a 9 per cent increase in Islamic current accounts, and a 6 per cent hike in Islamic savings accounts.

“The UAE headed into 2020 with renewed confidence. However, the twin effects of the Covid-19 pandemic, leading to the postponement of Expo 2020 and the collapse of crude oil
prices have caused substantial economic disruption in the UAE and across the oil-rich Gulf,” says Matthew Escritt, partner, Banking at Pinsent Masons Middle East.

“As the region moves beyond the acute phase of the crisis and takes tentative steps to reopen, it is clear that the region’s banks will be front and centre in that recovery. Strong capital
buffers together with recent consolidation in the sector have meant that the UAE’s banks are better placed than financial institutions elsewhere to come through this crisis.”

The ‘Covid’ effect
The Covid-19 pandemic has dealt a strong blow to the regional and global banking sector. Although the fallout of the outbreak in the region was mitigated by the quick measures taken –
including government support – the impact was felt along the length and breadth of the regional banking ecosystem.

GCC banks’ share prices, which had trended upwards in 2019, witnessed an average decline of 18.9 per cent between December 31, 2019 and April 30, 2020, the KPMG report noted.

“The global banking sector has faced a number of challenges as a result of subdued economic activities due to the twin shocks of falling oil prices and the impact of the Covid- 19. In the GCC, the extent to which the banking sector will be impacted is likely to be country related; if you look at the two largest economies in the GCC, it is likely that the
impact in the UAE is
more compared to Saudi Arabia. One indicator that is followed is the NPL (non-performing loans) ratio. This ratio – for the 10 largest banks in both countries stood, at the end of Q1 2020, at 5.2 per cent for UAE compared to 1.9 per cent for Saudi Arabia,” says
Asad Ahmed, managing director and head of Financial Services ME, Alvarez & Marsal.

To offset the economic onslaught brought on by the pandemic the UAE Central Bank launched the Targeted Economic Support Scheme in March this year, which included Dhs50bn of zero-interest, collateralised loans for UAE-based banks and allowed for Dhs50bn funds to be freed up from banks’ capital buffers.

Earlier this year, the Saudi Arabian Monetary Authority also boosted liquidity in the market by injecting SAR50bn ($13.3bn) into the banking sector.

“The global nature of this crisis has provided an opportunity for transformative change in the sector as banks rethink all aspects of their business and operations not only to ensure their survival, but also to allow them to emerge from the crisis stronger and more resilient than before,” notes
Escritt at Pinsent Masons Middle East.

“From a retail perspective, the transition towards an online service model and cashless transactions can be expected to accelerate. Banks will also be looking to cut costs substantially
and this will require a comprehensive assessment of all bank operations as they respond to lasting social and economic changes accelerated by the pandemic. New working practices
will also cause many banks to reconsider the size of their real estate footprints, branch network and ATM distribution.”

Similarly, the Islamic finance industry is also expected to witness low-to-mid-single-digit growth in 2020-2021, after 11.4 per cent growth in 2019 supported by a strong sukuk market performance.

However, the Covid-19 pandemic offers an opportunity for more integrated and transformative growth within the sector, with a higher degree of standardisation and meaningful adoption of financial technology, S&P Global Ratings suggests.

Merging strengths
The virus outbreak and the crash in oil prices has also had implications for banks’ core operating models in the region, pertaining to employees, customers, and subsequently, their bottom lines. Many regional institutions have paused to reassess their long-term viability plans, further underpinning a recent consolidation trend that had been gaining ground.

The consolidation wave had begun in the GCC a few years ago, even as lenders faced pressure from technological innovation, the need for stronger corporate governance and increased costs.

The pandemic may accelerate this trend. The possible merger of Saudi’s National Commercial Bank (NCB) with Samba Financial Group may well be a step in that direction.

The merger, which will result in the formation of a combined entity with reportedly $213bn in assets, will not only create the kingdom’s largest lender – and the third largest in the GCC by assets – but also potentially stir a next wave of mergers and acquisitions.

“It [the merger] could create the largest bank in Saudi Arabia, which would help the government implement Vision 2030. A bigger bank means a bigger capacity to finance the economy and to underwrite bigger loans,” notes Dr Mohamed Damak, senior director, Financial Sector lead, Middle East and Africa at S&P Global Ratings.

“This merger is similar to what we’ve seen in other Gulf countries, with government institutions the biggest shareholders in both entities. That should help the transaction succeed.
However, in our view, Saudi isn’t the primary Gulf market for further bank M&A – that’s the UAE, which is fragmented and overbanked.

“With Covid-19 and its negative impact on banking sector profitability, we might see a second wave of mergers that won’t be driven by common shareholders re-organising their assets, but instead based on a purely economic rationale,” he explains.

Ahmed at Alvarez & Marsal, adds: “The merger of National Commercial Bank with Samba Financial Group will continue the consolidation trend that is happening within the GCC. The
amalgamation will allow customers and businesses alike to reap the benefits of larger banks being scaled up and this efficiency being passed on to customers in the form of improved
turnaround and lower overall costs.

“We believe that rising competition, reduced lending opportunities, along with an increased focus towards digitisation will continue to drive theconsolidation agenda.”

The Gulf banking ecosystem has witnessed a notable consolidation phase in the years prior to the virus outbreak. In 2007, UAE-based Emirates Bank International and National Bank
of Dubai merged to form Emirates NBD, followed by National Bank of Abu Dhabi and First Gulf Bank, which combined to create First Abu Dhabi Bank in 2017. Last year, Abu Dhabi
Commercial Bank merged with Union National Bank and the combined entity acquired Al Hilal Bank.

Regionally, in 2019, International Bank of Qatar and Barwa Bank also merged, and so did Saudi Arabia’s Alawwal Bank and Saudi British Bank.

“Even before the Covid-19 pandemic, the region had seen significant bank consolidation with around 20 banks with assets worth an estimated $1 trillion negotiating mergers. The
Emirates leads in terms of both volume and value with the highest number of mergers. With tougher market conditions and a more competitive retail environment, it seems likely
there will be further consolidation amongst the region’s financial institutions in the future,” says Escritt at Pinsent Masons Middle East.

As regional banks navigate through the current crisis, adopting several measures to deliver top-line growth, the industry looks set to see several major changes – including further consolidation in the market – which may well see the emergence of a robust and leaner banking landscape.