The GCC has enjoyed vigorous growth in the banking sector, with the exception of Saudi Arabia that suffered the aftershocks of the 2006 downturn in its stock market. These profits have been driven by record high oil prices across the region, better regulation practices (e.g. Basel II), financial diversification, and nationalization.
Basel II acts as an internationally standardized regulatory accord to manage credit risk, improve transparency, and strengthen the overall stability of financial systems. The GCC’s recent implementation of Basel II will alter how banks lend money, and to which countries they lend it to. With this standard on their backs, banks will have to invest abundantly to upgrade their IT systems and consultancy fees in order to comply with the new regiments. Basel II compliance will also encourage banks to liberalize their policies, be more transparent with their balance sheets and to manage their risks more effectively.
Floating on crude
With crude oil pushing $130 per barrel, the Gulf is awash with liquidity. Such an overflow of liquidity means customers have more money to place in banks, thus driving their desire for better services. The soaring liquidity has bred inflation. Inflation rates across the GCC are high, with Qatar hitting a record of 14.81% in March of 2007. Finishing in second place is the UAE, with inflation rates expected to reach up to 12% in 2008. Oman ranked third with inflation rocketing to 11.5% in 2007, but it is expected to come down this year. Inflation in Kuwait also soared from 4.4% in 2007 and is anticipated to climb to 6.6% in 2008. Saudi Arabia falls right behind Kuwait, with probable inflation of 6% this year, up from 4% last year. With the lowest rate across the GCC, Bahrain’s inflation is expected to rise to a mere 4.5% this year, up from 3% in 2007.
The high liquidity and resulting inflation plaguing the GCC has lead to renewed talk about severing ties with the ailing American greenback. While Kuwait removed its dollar peg in May 2007, it remains the only Gulf country to have done so. The move came as a surprise as most analysts had expected a more unified approach to the issue, especially with the idea of a joint GCC currency still being floated. It appears that the de-pegging has had two effects on the Kuwaiti economy. First, it has helped to curb inflation somewhat, although rising real estate prices have done much to cancel the effect. Second, the move has cut into Kuwait’s oil profits by $2.9 billion in 2007, according to a study by Aljoman Centre for Economic Consultancy. Apparently, the loss resulted from reduced oil income calculated in dollars. This development may make it even more difficult for the rest of the GCC countries to de-peg their currencies before the anticipated joint currency in 2010.
GCC top 10 banks in assets
Index of economic freedom 2008
Banking penetration GCC
*Excluding Bahrain due to non-comparable data
Diversification necessary
Other issues in the GCC banking sector include the need for diversification. Most of the Gulf countries practice heavy-handed protectionism. For example, the UAE levies 20% tax on profits for foreign owned banks, but local banks pay nothing. This has understandably limited foreign direct investment and limited the market. Other countries, like Oman, have opened their doors to foreign financial institutions, driving up standards and pushing the economy forward. Furthermore, nationalization has been and will continue to be an issue. Countries like Saudi Arabia are working hard to qualify and employ their indigenous human resources in the banking sector. Perhaps moves like this will not only benefit the sector, but ultimately help to solve social woes as well.
Having avoided the rest of the world’s economic downturn and the resulting credit crunch, and by slowing tackling their own homegrown challenges, the GCC’s banking industry is poised to continue make strong profits on the back of record high oil prices. The region’s financiers are certainly smiling… all the way to the bank.
