GCC

Private equity – Fat times thin quick

by Executive Staff
written by Executive Staff

Unlike buying a few shares in a public company, private equity (PE) investment is a commitment that cannot be taken lightly. That is perhaps why most experts believe some two-thirds of institutional PE investors are on the sidelines waiting for better days. Who can blame them? Just like any other asset class in the region, PE is still licking its wounds after the beating that it took from the public markets, not to mention the de-leveraging costs that PE firms and portfolio companies across the region continue to shoulder as they brace themselves for a dismal year to come. Accordingly, it’s little wonder that most institutional investors who are willing to deploy money would rather consider more liquid investment options than further investment in PE, even at current market valuations.

“The nature of the private equity funds, reputed for their long term investment horizon, is not an attractive attribute for today’s investors who value liquidity,” says Rami Bazzi, senior executive officer at Injazat Capital.

The ensuing atmosphere in the region has become one of understanding between firms and limited partners (LPs) about capital commitments that were expected to be called over the past six months or in the foreseeable future.

“We told our LPs in November [2008] ‘be comfortable and relax… we are not going to be making any capital calls before we talk to you first because we don’t want to put you in an embarrassing situation of making a capital call that you can’t meet,’” says Ammar Al Khudairy, managing director & CEO of Amwal Al Khaleej Investment Co. Ironically, much of the stress on PE firms to make capital calls and on LPs to meet them has been lifted due to the systemic effects of the economic downturn.

“LPs would have defaulted initially [had capital been called], but deal making has reduced considerably considering the situation with LPs. At the same time, PE funds would not want to be at risk of signing a deal for which the funding may not come through thus jeopardizing the entire fund itself,” says Tamer Bazzari, deputy CEO of Rasmala.

To call or not to call

Nonetheless, it has already been around six months since this ‘period of understanding’ began. Since then, most PE firms have managed to hold off on making capital calls, but others have had no choice but to make that untimely call.

“At least one group has told us in January that they had frozen investment and made a capital call and only came up with 90 percent of the call. With regards to the other 10 percent, the investor just said ‘we can’t do it,’” says Benjamin Newland, partner at King and Spalding, a multinational law firm that consults in the regional PE market. The phenomenon of defaulting is indicative of a wider problem in the PE sector.

“There is going to be a ‘point of pain’ going forward for the PE industry, which is LPs being unable to fulfill their capital call obligations because of their own liquidity issues,” says Yahya Jalil, senior executive officer and head of private equity at The National Investor.

Robert Hall, head of transaction services Middle East & South Asia at KPMG, adds that “some LPs will continue to provide cash and there will be others who will refuse to make further capital calls and legal action will be taken against those.”

Having to deal with the liquidity issues of LPs is undoubtedly going to be a battle that will be waged until the end of this downturn. Nevertheless, PE firms will have to make nice with LPs whether they like it or not because, at the end of the day, firms will have to coax them into investing in an intrinsically illiquid sector at a time when cash is king.

“In an asset allocation waterfall where fixed income instruments receive most of the money… PE happens to be at the end of the asset allocation priority. Very clearly, not many LPs want to take additional risk in order to generate additional returns, when normal levels of return… are at risk,” says Bazzari. “Investors are seeking liquid investments to enable them to re-allocate when needed, a luxury private equity investments do not normally provide,” he continues.

Even institutional investors that have already committed to the PE sector will by default commit less money to the sector. “If a family conglomerate or a large institution has a target allocation for PE which is eight to 10 percent, and the value of their public portfolio shrinks, that eight to 10 percent will also shrink into a smaller base for PE with much fewer dollars [sic],” says Jalil.

In reality the current gap between the interests of general partners (GPs) and LPs was a long time in the making and despite the fact that there will be much friction in the next cycle, this is not necessarily a bad thing. PE in the region has to some extent been a victim of its own success, especially in the last three years. According to research conducted by Zawya Private Equity Monitor (ZPEM) and the Gulf Venture Capital Association (GVCA) of the total investments made in the PE sector over the last decade, approximately 86 percent were made in the last three years (2006 to 2008), with approximately 39 percent and 27 percent made in 2007 and 2008, respectively. While 27 percent in 2008 is still an admirable figure in terms of growth, it is symptomatic of a downward trend that is now manifesting itself in the industry.

Private equity activity in the MENA region has declined in 2008, both in total size and in number — 31 percent and 22 percent, respectively — according to ZPEM and the GVCA. Growing at such break-neck speeds — a CAGR of 48 percent in the past three years — has resulted in GPs charging almost exorbitant management fees and carrying commissions, while LPs were fishing for multiples that were out of sync with what the market could sustain in the medium to long term.

But as investment appetite has all but dried up, GPs are realizing that they can no longer afford to maintain a predominately opportunistic attitude towards their investors.

“Investors and LPs will be looking for a greater level of alignment of interests which will come in several respects. LPs will require GPs to have more ‘skill in the game’ and more of their own money alongside that of LPs, not just to be asset managers but also to have principle investments,” says Hisham El-Khazindar, managing director and co-founder of Citadel Capital. “There is going to be some pressure on management fees, particularly for the larger funds, as investors ask for the management fees to come down and harder return on investment (ROI) hurdles before PE firms are allowed to carry.”

As far as carries are concerned, the more intertwined the interests of funds and investors become, the less this becomes an issue.

“I don’t think anyone will be negotiating carries now because everyone realizes that there is a full alignment of interests,” says Al Khudairy. In the second quater of 2009 the PE industry will have to reconcile with the idea that unless mutual interests converge, many GPs could find themselves looking for a new profession.

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Executive Insights

Should investors enter the dragon or greet the elephant?

by Rehan Syed
written by Rehan Syed

As global investors we face a dilemma — whether to make the next round of investment in the once solid developed markets or always fragile but promising emerging markets. Conventional wisdom argues that developed nations historically lead the emerging world out of recessions. Is this time any different? While a return to economic stability in the developed world is a prerequisite, the burden of driving growth will fall more than ever on the shoulders of the big new emerging markets of the ‘dragon’ China and the ‘elephant’ India. In the next few years, China will likely overtake Japan to become the world’s second largest economy.

A rare and unpredictable year for China

While ‘tiger’ often suffixes China, and ox metaphors are du jour, our edgier ‘dragon’ underscores the unpredictability of 2009’s economic outcome, pivoting around a heroic fiscal stimulus plan and China’s large collateral impact on other emerging markets. A feared Chinese hard landing, defined as sub five percent real GDP growth, will no doubt have a ripple effect, since over half of Chinese trade is with other emerging markets. Another reason to be edgy on China this year is potential social unrest since 20 million migrant workers are estimated to have lost jobs in the current crisis, often returning to villages where their land has been repossessed for development. Also, China faces a rare triple anniversary of controversies, notably the 10th anniversary of Falun Gong’s banning, the 20th of the Tiananmen uprising and the 50th of the Tibetan uprising, including the Dalai Lama’s escape to India. While less melodramatic, this year will also be eventful for India given its much-anticipated mid-year national election.

Weak outlooks?

In 2009 we expect China and India will grow about 5.5 percent and five percent, respectively, which is more pessimistic than the current consensus view of 7.7 percent and six percent. This is still well ahead of world GDP, which is likely to shrink one percent in 2009, thus partially offsetting the US and EU drag of about -2.5 percent in 2009, before rebounding to 2.5 percent in 2010. The stated government growth targets for 2009 are lofty at eight percent for China and seven percent for India, both unrealistic and with more downside risk for India.
In the past year, the equity markets of both have crashed and are now at historical valuation lows. While global stocks, as measured by the MSCI World index, were down a stiff 42 percent in 2008, India swooned 52 percent, China A-Shares crashed 65 percent and China H-shares were off a relatively better 51 percent. Year to date, China A- shares are up strongly but H-shares are about flat and India is down seven percent. Both Indian and Chinese H- Share markets trade at almost trough valuations with price- earnings ratios below 10 times.

From these depressed valuation levels, which of the two will fare better in the recession and eventual recovery, China or India? Beyond the obvious disparity of centralized vs. federalized governance structure, there are critical differences between the two — in terms of domestic consumer spending, exposure to the overstretched US consumer, foreign exchange reserves, trade balance, fiscal deficit and, most importantly, the degree of stimulus spending. The interplay of these is important but difficult to forecast and complexity is compounded by the lack of transparency, especially in oft-murky Chinese statistics.

Recent data is dreadful, but more so for China

After an exceptional run of nine to 10 percent real GDP growth for the past quarter century, which peaked at 13 percent growth in 2007, Chinese growth is sputtering. The major reasons for this are exhaustion of the export driven growth model compounded by a credit crunch, which squeezed trade finance, tail-off in capital investment, inventory destocking and a continuation of the real estate slump. Other metrics that confirm this steep fall in economic activity include electricity consumption, a reliable proxy for industrial production, which was -4 percent in recent months versus 12 to 15 percent growth in recent years, far worse than in the prior downturns of 1998 and 2001. This decline is partly due to inventory destocking, but could have been worse had it not been for improved inventory management, which has resulted in inventory stock of 35 to 40 percent of GDP versus well above 50 percent in prior downturns. Finally, export growth, which was running at 20 percent or more in recent years, is down about 25 percent this year and would have been worse had China not diversified away from the US, which was over 30 percent of exports a year ago and is now below 20 percent.

On the other hand, India has also slowed from a peak of 9.5 percent real GDP growth in 2007 to 5.5 percent, with exports down 15 percent in recent months. However, it is less pressured than China because of its less cyclical economic structure, with much heavier services mix and less export dependence on the US and EU. India’s exports are less cyclical, since services are about 35 percent of exports and least-cyclical IT services are 40 to 45 percent of service exports. Finally, Indian exports, which have tripled in the past five years, are now more competitive due to a sharp 25 percent recent fall in the currency relative to both US dollars and China’s yen. While China might be tempted to dangerously devalue as they did in 1994, they will be held back by political pressure from its vital trade partner, the US. In fact, we are likely to see continued appreciation if growth rebounds, albeit at a reduced pace versus the past three years.

Stimulus is far greater in China and could rise

China has launched a more aggressive stimulus policy than India and most other emerging markets. While it has grandiosely announced plans to spend $586 billion over two years, which equates to seven percent of GDP per year, some analysts have tarred it as an inflated plan that includes a rehash of previously committed spending. Even if the real spend is only half that figure, it still exceeds India’s paltry one percent of GDP. The equity markets have already priced in these announcements but we expect there could be more stimulus to come from China since the current announcements result in a deficit of ‘only’ 2.6 percent in 2009, lower than India’s — and America’s — elephantine annual fiscal deficit of about 10 percent. If GDP growth disappoints, we expect additional stimulus deficit spending in China, exceeding the governments’ current goal of limiting it to three percent of GDP. Given India’s already-high deficit, it has very limited room for additional stimulus, hence the higher downside risk.

Key structural differences will endure

As the table [on the previous page] shows, there are vast differences between the two countries’ economic attributes, which hint at continued growth opportunities well past the current turmoil. China is poor with GDP per capita of about $3,300 and about one third of its 1.4 billion population living on less than $2 per day, while India is worse off with GDP per capita of about $1,000 and over two thirds of its 1.2 billion people get by on a $2 daily budget. India’s population density is substantially higher and getting worse with an annual growth of 1.2 percent per year, double China’s 0.6 percent per year. Over the next couple of decades, this will result in a gray China and a youthful India, a demographic dividend that will translate into productivity only if India improves its lagging primary education system, especially in the rural areas where the bulk of the population resides. Finally, India is less cyclical because its GDP is about two-thirds domestic consumer spending driven, versus only about a third for China. China’s core challenge in the near future is to shift the economy from being manufacturing and export driven to being more like India, with higher services and domestic consumption.

Average into China now, await lower Indian entry point

Waiting for a turn in macroeconomic data is too late since equity markets will attempt to lead by about six months. In China, while news flow might worsen in the next month or two, some early indicators point to the fiscal stimulus working, such as bank loan growth, which is up strongly recently. While one statistic does not make a trend, oversold markets could result in large upside moves. We favor the H-share route given they trade at a wide discount to A-shares and have better transparency in these murky times. Since bottom picking seldom works, we advocate averaging in over the next six months, accumulating on dips and accelerating if the HSCEI index retests October lows of 5,000, especially if you have at least a five-year horizon to mitigate market risk. If you think that is an awfully long horizon, keep in mind that once-emerging Japan equities still trade 75 percent below their 1989 peak. Also, diversify and allocate your portfolio wisely, since Chinese equities are only about seven percent global stock market capitalization and India’s even less at two percent.

With India, saunter slowly like the elephant, and start to build positions in the mid-to-late second quarter around the national elections, which will likely have major impact on investor sentiment. During the last major election of 2004, an unfavorable outcome resulted in a 20 percent market drop within two months and we would buy into any similar dislocation. Since fiscal pump priming is limited by the deficit-laden nature of the budget and the high 72 percent debt to GDP ratio, a favorable election outcome will be defined as a stable reformist government given the fractious political landscape. Such stability is key to macroeconomic reform, especially financial services reform and privatization of inefficient national assets, which are critical to unlock economic potential.
Borrowing from a former president of the US — the country where this recession began — the Chinese use two brush strokes to write the word ‘crisis’: one brush stroke stands for danger, the other for opportunity. In this crisis, be aware of the danger, but recognize the opportunity, as a lot of negative news is being priced into the markets.
Rehan Syed is the head of portfolio management at the ABN AMRO Private Bank in Dubai. The opinions expressed here are personal and not necessarily those of his employer

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Finance

UAE – Dubai bails

by Executive Staff
written by Executive Staff

Earlier this year when Abu Dhabi capitalized five of its own banks, panic spread throughout the Dubai banking sector. Waiting with baited breath, bankers in the ailing emirate anticipated action by the federal or local government to rescue Dubai’s banking sector. Finally, at the end of February, the Dubai government issued a $20 billion long-term bond program, selling the first half of the bond to the UAE Central Bank (CBUAE). Central Bank Governor Sultan Nasser Bin Al Suwaidi said he hopes to bridge the banking sector’s reported $30 billion gap between bank deposits and loans and beef-up the advances- to-deposit ratio in collaboration with the Ministry of Finance. While many referred to this bond program as a ‘bailout,’ the government labeled the move a ‘stimulus plan’ for the banking sector and economy as a whole. More important, however, is the message the Dubai sovereign sent out via this latest initiative: Dubai is just as capable as its sibling emirates. Economy minister Sultan Bin Saeed Al Mansouri said he believes that the government’s latest measures should be adequate to hold up the UAE economy for the next nine months.

Road to recovery
Since the global financial turmoil began ravaging the UAE economy in the fourth quarter of 2008, many steps have been taken to ease market pressures and boost liquidity, beginning with the central bank’s $32.67 billion emergency funding facilities, followed by Abu Dhabi’s capital injection of $4.4 billion into five of its banks and now with the latest Dubai sovereign’s $20 billion bond issuance. Raj Madha, director of equity research at EFG- Hermes in Dubai, says after the Abu Dhabi bank capitalizations, “the Dubai banks were a little left out in the cold. This [bond issuance] goes some way to addressing that imbalance.”
Moody’s Middle East analyst John Tofarides reiterates the program’s benefits stating: “the banks indirectly benefit from this bond issue as federal support helps to recoup confidence in the system.” The bond issuance “alleviates potential pressures to Dubai banks for taking up loans that cannot be internationally financed as a result of dried market funding conditions,” he adds.
Robert Thursfield, director in the financial institutions group at Fitch Ratings UAE, notes it is “unclear how much, if any, of the [bond] will be used to support the banks. If some is allocated to the banking sector, then a recapitalization as per the one in Abu Dhabi could occur.” While the picture is still murky as to what the direct implications will be on Dubai banks, these days any action is good action.
Last month, Al Suwaidi emphasized the need for banks and other financial institutions to pay off their outstanding international debts, “with 100 percent reliance on local funding… At the moment, the UAE banking system is localizing liabilities of banks; that is, getting rid of foreign inter-bank deposits. Also, it is repaying syndicated loans, medium-term notes and European commercial paper to reduce risk of non-renewal of such liabilities at the wrong time.”
Inter-bank rates have been slashed across the GCC, with Madha noting that “lower inter-bank rates give headroom for profitability pricing risk.” EFG-Hermes data suggests, continues Madha, that three-month inter-bank rates “fell to a low of 1.88 percent. I think the greater issue is the perceived levels of risk — and these are still high — given pressure on labor markets, tourism, financial services and construction.”
To aid the recovery, the central bank also plans to cut interest rates by the second quarter of this year. Al Suwaidi mentioned that the CBUAE intended to ostracize the country’s banking sector from the global arena in order to protect the system against any ensuing international crises, but he insisted this would not include any rumored actions related to de-pegging the dirham from the US dollar.
Despite the latest moves by the federal and local sovereign entities, renowned ratings agency Standard & Poor’s recently announced plans to review numerous institutions for downgrade across Dubai, including four Dubai-based banks. The rationale behind the downgrade is due to the continued deterioration in the Dubai real estate market and its serious effects on local banks, as well as the overall weakening economy. The banks nominated for ratings review are Mashreqbank, Dubai Islamic Bank, as well as Emirates Bank International and National Bank of Dubai — now collectively known as Emirates NBD — due to residual debt prior to their merger.
Experts and business leaders alike find the new bond program a positive development for Dubai banks. Moreover it is “a step towards avoiding any unpleasant surprises,” says Tofarides. Thursfield trusts that this year “will be very challenging for the banks” and is confident that “the challenges will persist into 2010.” With tightened liquidity, delinquencies on loan portfolios, systemic risks, depleting deposits and much more, banks in the UAE undoubtedly have a grueling year ahead of them.

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Executive Insights

The future is online

by Gabriel Chahine & Jayant Bhargava
written by Gabriel Chahine & Jayant Bhargava

Reading newspapers, watching television and listening to the radio may no longer be preferred options for consuming media. Mobile handsets and computers are gaining importance as means to access mass media, especially with younger audiences. Media usage has fragmented and many more advertising platforms now exist. New media will gather a 19 percent share of global advertising by 2011. These platforms enable a greater precision in targeting and accountability, while allowing for interactivity and innovation. During the current economic climate, new media has a clear advantage.

This has profound implications for traditional media players. Their distribution channels are controlled by a new breed of competitors. The Internet gorillas dominate online traffic, whereas telecommunication companies control the touch-points with mobile media consumers. New formats, such as paid search, dominated by Internet players are eating into their bread and butter. The new media game involves a dynamic, complex and interconnected ecosystem in which ad agencies, telecommunications, media, Internet and technology players depend on one another to thrive. But it is also a brutal competitive arena, rapidly distinguishing winners from losers.

In the MENA region, the game is just beginning. New media accounts for less than two percent of ad spend. Unlike developed countries, delivering content over mobile forms the primary new media revenue source. Low Internet penetration, availability of digital Arabic content and advertising capabilities remain key challenges. Consumers are displaying similar preferences as those in developed countries. Young people make up a relatively high percentage of the population. Overall, the regional new media market is fertile with leaders yet to be established.

Are the rules still the same?

As always, consumers define the rules. The consumer today has more control and choice. Consumption is no longer passive. Consumption is becoming a norm. So yes, the rules are changing. This is transforming the recipe for building a successful digital media brand. The challenge is not limited to real-time consumption of content. Editors need to engage in two-way communication allowing user participation. Building a digital community within the context of a brand is essential. Ability to leverage technology and develop partnerships is more important than ever.

The youth segment rarely uses traditional platforms. Hearst, recognizing this trend, transformed Elle Girl into an online-only brand. Other segments — such as leisure male, female socialites and professionals — are expected to follow suit, more so when today’s youth transition into these segments. For now it is crucial to leverage the loyalty of traditional assets to create equity on digital platforms, before users choose a different digital brand for the same content needs. Marketers are demanding new models of interactions with agencies. The traditional models lack the required speed-to-market and ability to create a dialogue with consumers. A recent cross-industry study in the US confirmed that advertisers believe closer and more collaborative partnerships with media companies will be important to their marketing initiatives.

Media companies have the opportunity to take on responsibilities that were once the exclusive preserve of ad agencies. Ninety-one percent of media companies surveyed already provide some kind of advertising service such as campaign development and branded content creation.

In the US, newspapers took 127 years to reach $20 billion in ad revenues; online media have garnered that amount in just 13 years. Regionally, advertising investment per user is two dollars, compared with $59 in the US or the global average of $27. Regional offerings are suboptimal and do not cover the wide spectrum of needs. Popular local sites lack qualities essential for advertisers. The successful traditional brands are not well represented on digital platforms. International players are not focusing on the region, yet they dominate the traffic, although not by intent or design. Today’s opportunities may well be taken and guarded by the time the market becomes lucrative. Fortunately, paid search is not expected to be the primary format. A targeted local offering has the potential to not only capture a prominent share but also to play a critical role in creating the market.

What strategies are media players adopting?

Take existing assets online — it is key to enable users to consume and participate with their favorite content at the time of their convenience and in the form they prefer.

Build new media brands — new media provides an efficient way to target segments not covered by traditional formats. It also enables companies to aggregate content from existing titles to provide a differentiated experience. For instance, Conde Nast created menstyle.com by combining GQ and Details magazines.

Build a digital content business — new media provides a unique platform to monetize the long tail. The large libraries, which do not find a place on TV grids or magazine pages, can be monetized easily.

Build a media portal — media players could integrate traffic-generating applications, like e-mail and marketplace, into their content propositions. To illustrate, the strategic merger of Time Warner with AOL accelerated the digital transformation of Time Warner. Today, AOL is syndicating content not only from Time Warner, but also from other media sources.

Who will win the ‘New Media’ game?

Each player has established a sweet spot along the digital value chain and is devising strategies to lead the game. Business models are constantly evolving and their sustainability is yet to be established. Relative values of traffic generation and aggregation, content and customer intelligence will be key in defining the leader. But one thing is certain, no player can win alone. Collaboration is king. The ability to forge the right partnership at the right terms and at the right time will define the winner.

Gabriel Chahine is partner and Jayant Bhargava senior associate at Booz & Company

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Finance

Global economic crisis – A six-month tally of woe

by Executive Staff
written by Executive Staff

In October 2008, Alan Greenspan, the 1987 to 2006 chairman of the US Federal Reserve, testified before congressional leaders in Washington saying “I was shocked when the system broke down, my ideology and model that I always believed in proved me wrong.” He hastened to add that, “the crisis will pass” and that the then proposed $700 billion rescue package “is adequate to serve the needs.” In December 2008, he went on to say that “the global stock market value wiped out this year is $30 trillion, but human nature being what it is, we can count on a market reversal within six months to a year.”

Six months into the crisis, economic reality defies Mr. Greenspan’s assessments and predictions. The lost value in stocks has reached $50 trillion — nearly double his estimate and almost as much as last year’s world global output that is estimated to be $55 trillion.
In the meantime, the initial US rescue package was augmented by one trillion dollars this February, making the current US operation to save its economy more than 10 times bigger in real terms than the Marshall Plan of the late 1940s, which helped the European continent recover from a devastating war by increasing industrial production by 35 percent and restoring agricultural production to its pre-war levels in just four years.

A crisis like no other
This time it may take longer than four years for the world economy to get back to what it was before the crisis, as expectations for recovery are deteriorating by the day. Last November, the International Monetary Fund (IMF) predicted a slow down of the global output growth rate to two percent in 2009, from an average annual growth of five percent in the preceding years. In January, it revised this estimate to “possibly negative.” In economics, it is customary to qualify pessimistic expectations. Last December, the World Bank forecast a positive global growth of one percent, but in March that was revised to negative growth of possibly “up to two percent.” The Bank also expects that as a result of the crisis, global poverty will increase by 100 million, while the International Labor Organization foresees an increase in global unemployment by 50 million.
The ideology that Mr. Greenspan referred to is by now well known. It was practiced in its purest form, especially by the US and the UK. Since 1979, the year President Ronald Reagan was elected in the US and Margaret Thatcher in the UK. It was based on three pillars:
First, too much faith in unregulated markets — and there is a fundamental difference between ‘free markets’ and ‘markets’. Second, too much reliance on interest rates alone to manage the whole economy — at the expense of sensible fiscal policy, especially in the area of social services. Third, too much of a belief that central banks can and should avoid recessions happening on the watch of the government of the day — in defiance of the expected independence of central banks. This led to excessive leverage (debt creation) by financial institutions and unrealistic borrowing by households for housing (mortgages) and current consumption (read: credit cards).
Of course, elected politicians in democracies cannot have it their way unless the electorate is on their side. Both the UK and US have unquestionable democratic processes and educated voters in democracies tend to follow — with spasmodic deviations — what they believe is best for their own interests. The rhetoric that followed the so-called ‘neoconservative’ ideological revolution since the 1980s did just that: it used an array of populist arguments that made the majority of the electorate believe that free markets can best serve their interests and that economic insecurity can become a thing of the past.
Policies supporting this ideology followed suit. Firstly, shares of privatized companies in the UK were offered at low prices and appealed both to the short- sighted and the long-sighted. The short-sighted bought shares to make a quick profit by reselling them. The long- sighted bought them to start building a bigger nest egg as it was felt that returns on investments in stock markets were bound to increase fast.
Second, by offering subprime mortgages that have a high risk of default — one of the culprits of the crisis — house ownership increased (good for the citizens), corporate profits boomed, especially in the construction sector and the financial markets (good for economic growth), while the pressure on governments to fund low- cost social housing decreased (good for the public debt). What could be more appealing than this ‘triple win’?
Third, recommendations for securing the financial stability of the elderly overstated the growth and security of financial investments. Voters were aware that they had smaller families than their parents and that there would be fewer future workers to support their own pensions. In the meantime, they were facing increasing payroll taxes in the form of pension contributions, requirements for staying on longer at work and decreasing levels of pensions. Privately funded pensions based on returns on individual savings accounts invested in financial markets were marketed as another winning alternative and as a fair one. They were expected to provide higher pensions due to the then state-provided social insurance. And their ideological appeal was significant: those who earned and saved more would have a bigger pension than those who earned less — those with less were assumed to be lazy rather than unfortunate.

The model of greed
The rhetoric included many other arguments, but let’s mention just one more. In an interconnected, globalized economy it does not make much difference who saves and who consumes as long as the whole thing balances out. In such a world, over-spending by consumers in some countries — such as the US and the UK — can be the antidote to the thriftiness of other countries, notably China.
All in all, it was an ideology based on what is now widely termed as ‘greed’, though the word seems to be equally, and incorrectly, used both for workers and households who justifiably aspire to a better life in the already high income economies, as well as for financial executives and the 1,300 billionaires that have been created in the last couple of decades. In the words of economist Paul Krugman, the most recent Nobel laureate, it was the ideology of “private good, public bad” that prevented the development of sensible regulation for the expanding financial sector. Lack of regulation created asset inflation over time, which was deflated instantly after the onset of the crisis. The total 2008 financial losses were 40 percent for UK’s FTSE, 45 percent for the European FTSEurofirst, 42 percent for Japan’s Nikkei, 48 percent for Hong Kong’s Hang Seng, 39 percent for the New York’s S&P and 65 percent for China’s stock market.
None of this is surprising. Many people talked about the looming crisis, but strong arguments are not always enough to overcome strong political powers. Some of those in power did listen. For example, during the East Asian financial crisis in 1997, the prescribed rescue packages were criticized for being too based on ideological thinking — some called it the ‘Washington Consensus’. They said it put too much emphasis on fiscal austerity, raising interest rates and privatization. Furthermore, they said, “let the banks fail.” Today, Western economies follow the opposite track. Their recovery plan is based on expansionary fiscal policies, low interest rates and rescuing private companies and banks.
Similarly, soon after the 1997 crisis, the aforementioned Krugman became one of the many critics of the risk management model that replaced the role of regulation in the financial markets and eventually, and predictably, failed to ensure that the inrush of capital created in the financial markets was prudently invested. In 1999, Peter Warburton, a UK economist, published a 350- page book that focused on how the central banks were imperiling the world’s economy. The book’s message is obvious from its title, “Debt and Delusion.” In 2001, Joseph Stiglitz, a US economist who got a 2001 Nobel Prize, explicitly advised the Bank of Iceland what it had to do to avoid becoming the “champion victim” of the crisis. As recently as 2006, Nuriel Roubini, another US economist, earned a similarly unenviable title, “the prophet of doom,” after a lecture he delivered to an uninterested IMF, the international organization in charge of overseeing the global financial system.
Despite the warnings, the ideology crossed political boundaries. The Labor Party in the UK, referred to as “New Labor” after it took power over from the successive conservative administrations between 1979 and 1997, pledged to decrease child poverty by half to 1.7 million children by 2010 and to eradicate it by 2020. It is now estimated that 2.3 million children will still be in poverty in 2010, a discrepancy of 35 percent from the stated target, due to a financing gap of $6.15 billion a year. Let’s put these numbers in context. First, without any new policies to help low-income families — a likely scenario amidst the current crisis — child poverty could rise to 3.1 million by 2020, a number similar to the number of poor children in 1999 when the pledge was made. Second, the Royal Bank of Scotland paid nearly $5.87 billion in bonuses in 2007 and posted $35 billion losses in 2008, the largest corporate loss in the history of the UK. Third, the value of employees’ private pension funds dropped by nearly a third from $810 billion to $579 billion between October 2007 and October 2008. In the US, $2 trillion was wiped out in equity value from 401(k) and individual retirement accounts in the two months following the start of the crisis, nearly half the holdings in those plans.
The time has come to listen. This is already happening. In February, the new US administration under President Barack Obama added $1 trillion to what Mr. Greenspan thought was adequate to rescue the economy. Whether this will be sufficient, and how it will be spent in practice remains to be seen. For example, the faltering American Insurance Group (AIG), once the leading insurer in the world, is to receive $170 billion in rescue funds, but still faces hazards in its $1.6 trillion portfolio of complex derivatives.
This month, British Prime Minister Gordon Brown declared that he takes “full responsibility” for his role in the banking failures that led to the global recession. In the meantime, housing waiting lists have reached record levels, having increased by 55 percent compared to five years ago and they are expected to double by 2011. Some of this increase will be, of course, the result of repossessions and increasing unemployment as well as lower construction activity. However, much is also due to the shortage of social housing, whose availability decreased over time.

The economic gear shift
Probably nothing constitutes a more dramatic admission of change than the criticism of the now opposition conservative shadow housing minister saying, “The [Labor] government’s record on social housing is embarrassing — the average annual number of social rent properties delivered has halved since 1997.” The other main opposition party in the UK, the Liberal Democrats, is no more polite. “The government allowed the bubble in the housing market to get out of hand for many years. We are now seeing the results of that bubble bursting,” they said. Now the government’s target is to build 240,000 new homes each year until 2016, while Gordon Brown admitted that “the economic downturn marks the end of the era of laissez-faire government.”
One cannot but welcome a more balanced approach to managing the economy. The days of the glorification of financial markets as a magic creator of wealth have come to an end. Financial markets are not an end in themselves, but a means that enables the real economy to be more productive. Along with the individual efforts of the US, the UK and other high-income and developing economies, the UN set up a commission of experts chaired by Joseph Stiglitz to put forward “credible and feasible proposals for reforming the international monetary and financial system in the best interest of the international community.” There is also increasing recognition of the importance of multilateralism. Both the IMF and the World Bank are currently looking into governance structures that would increase their effectiveness.
Luckily, the attempt to create a one-sided global ideology failed. Hopefully, the attempt to find shared global solutions will succeed.

PROFESSOR ZAFIRIS TZANNATOS is a Beirut-based economist and was previously advisor to the World Bank and chair of the economics
department at the American University of Beirut

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Executive Insights

The bankers’ duel for deposits

by Julien Faye & Sameer Chishty
written by Julien Faye & Sameer Chishty

The global financial crisis has hit Gulf banks hard. The catalysts that boosted their growth — high oil prices, a booming real estate market and strong credit ratings — have run out of steam. The challenges now are many. As the region’s equity markets tumbled, so did the banks’ lucrative wealth management services. The likelihood of additional asset write-downs has triggered concerns about banks’ balance sheets. Moreover, Gulf bankers have seen cheap wholesale funding dry up and are reluctant to lend to each other, leading to higher cost of funds and liquidity shortfalls.

The region’s banks are now locked in a battle for the lifeblood of banking — retail deposits. Winning this battle may be a matter of survival. The deposit opportunity is big as Gulf investors keep over 40 percent of their financial wealth in deposits. Deposits are also a low-cost source of funds. They can cost banks as little as one percent of capital versus seven percent for bonds.
To make the most of the deposit opportunity, banks need to focus on four areas: pricing, products, promotions and people.

Pricing — be nimble. 

Banks must urgently deal with how best to price offerings to lure and retain depositors. The big risk is that banks will be dragged into a price war, encouraged by government deposit guarantees. Simply to offer higher rates for deposits will only encourage customers to churn their accounts. Gulf bankers need to ensure the rates they pay on deposit products are aligned with their average cost of funds. They can also be more analytical about gauging how responsive different customer segments are to different rates. Lenders can offer rate-sensitive depositors higher- yielding products. In the UAE, a foreign bank offers a six percent rate of return on a one-year $13,500 deposit. Smart banks will compensate less rate-sensitive customers by emphasizing convenience and benefits. Banks must closely monitor competitors’ moves and act preemptively to retain customers — without triggering a price war. Some banks are converting short-term demand deposits into longer-term holdings. Several local banks are looking at offshore depositors.

Products — innovate.

The most innovative banks develop a deep understanding of customer buying behavior and target product offerings accordingly. By bundling products, for example, banks can offer savings accounts that entitle the holder to a home loan at a preferential rate once the customer accumulates enough assets in his or her deposit account. Watch for Gulf lenders to boost product offerings by highlighting non- price benefits such as a tie-in with an airline where a depositor gets air miles for opening an account. Some banks, like HSBC, have already started innovating. Its new ‘e-saver account’ permits UAE customers to open the account instantly online with no management fees, no minimum balance and a 5.3 percent rate.

Promotion — The right timing.

Smart banks will promote attractive offers when customers are most likely to respond, such as when a customer’s deposits mature. To build awareness of deposit products, they will launch promotional campaigns visible to customers wherever they come in contact with the bank — from branch windows to ATM receipts.

Bankers can also increase deposits by providing incentives to customers with salary accounts to directly deposit a percentage of their earnings each month.

People — Recruit, reward.

With the spotlight on deposits, banks will recruit top talent to staff product management and marketing support for their deposits operation, as well as build high-powered analytical capabilities. They will deploy their new talent to improve the end-to-end customer experience, such as setting up effective application processes. Successful banks will also set up dedicated deposit teams and reward employees who bring in new deposits and cross-sell products to existing customers.

For Gulf banks coping with falling profits, the stakes couldn’t be higher in the battle for deposits. Those banks that are analytical and innovative enough will become the places where much of the Gulf’s money is kept. Or, at least, they will secure their positions in a region that still has strong long-term growth prospects.

Julien Faye leads the financial services practice for Bain & Company in the Middle East and is based in Dubai. Sameer Chishty is a partner in the firm’s financial services practice, based in Hong Kong.

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Finance

IPO Watch – Spring investments

by Executive Staff
written by Executive Staff

Economists far and near differ widely in their forecasts on when leading financial markets will enter into a new virtuous cycle, but one thing experts do agree on is that the global investment landscape has changed drastically in the past year due to the US-born financial crisis. As companies had to delay or cancel their plans for initial public offerings (IPOs), stock exchanges have been scrambling to drum up IPO business as investors continue to remain cautious and in standby mode.

There have only been three IPOs in the past two months in MENA region, with a total value of $99.15 million. This is not entirely bad when compared to the United States’ one IPO so far this year. Yet the lonesome offering of pediatric nutrition maker Mead Johnson Nutrition Co., a spin-off by drug company Bristol Myers Squibb Co., raked in more than $780 million, which was admittedly leagues larger than the three MENA IPOs combined.
March was void of any IPO subscription offerings — a stark contrast to nine companies that had invited subscribers in the same month a year ago — but there was a bit of consolation as the first quarter in 2009 saw the trading debuts of three companies. Quite remarkably in these shaky times, two of the three newcomers ended their first day up by healthy percentages: Etihad Atheeb, which started trading on March 21, climbed 55 percent and Green Crescent Insurance Co ended its first day on March 26 with a sunny gain of 32 percent, both from the issue price.
Both companies had listing obligations under legislated rules for their specific industries but the mandatory nature of their debuts apparently did not impede investor interest. On the other hand, construction group Drake and Skull International, which had delayed its debut by quite a while, traded 27.5 percent lower on its first day of March 16. The listing environment for the company, whose IPO last July was hugely over-subscribed, was subdued by the real estate and construction sector performance even as the firm had a surprise in store for listing day in the form of announcing a $162 million contract.
It is too early to speculate if March marked a singular low month in primary market activity around the Middle East, but the gains of Etihad Atheeb and Green Crescent in their first sessions at least give room for new hope that things may look up in the second quarter. A positive view can be further supported by the IPO calendar for April, which entails five IPOs. According to the latest data from information provider Zawya, the five IPOs are tempting subscribers with a combined subscription value of over $1 billion. The largest of the five is Vodafone Qatar, part of the Vodafone Group. The telecom provider will offer 40 percent of its shares to the public in an attempt to raise $951.88 million. Subscription will open on April 12 and close on April 26. Afterwards, the company will list on the Doha Securities Market. The IPO will consist of 338,160,000 ordinary shares at $2.75.
Meanwhile in Saudi Arabia, the region’s largest economy, the Saudi Capital Market Authority gave its approval for four insurance firms to float portions of their shares in an IPO from April 18 to April 27. This is the next batch of newly licensed insurance firms in the kingdom and one can expect their public offerings to be calmer than those of the 16 insurers that undertook their IPOs in the 2007 to 2008 period. The shares of these newcomers will hopefully be less prone to wild fluctuations in the first months of trading.
The new Saudi insurance companies include AXA Cooperative Insurance Co. and Wiqaya Takaful Insurance and Reinsurance Co.; each has a capital of $53.3 million and each will offer 40 percent of their shares to the public. Al Rajhi Company for Cooperative Insurance, with a capital of $53 million, will float 30 percent of its shares to raise $16 million. ACE Arabia Cooperative Insurance Co., which has a capital of $26 million, will offer 40 percent of its shares to raise $10 million. All the companies will offer the share at $2.67.
Also in the insurance industry, Bahrain-based Solidarity Group said it has received regulatory approval to establish a $146 million firm called Solidarity Saudi Takaful Co. in Saudi Arabia, with an authorized and paid- up capital of $147.9 million. The new company, which will provide takaful and family takaful services, will float around 40 percent of its shares in an IPO between August and September of 2009. A total of 60 percent of Saudi Takaful’s capital will be raised from contributions by Solidarity and other Saudi founders, with Solidarity holding a major stake.
While enduring the first quarter dry spell in primary action, executives of regional securities markets have busied themselves with discussing potentials and expected easing of listing requirements. Jeff Singer, NASDAQ Dubai chief executive told the press that NASDAQ Dubai “expects companies to resume launching IPOs by the second half of this year.” Singer also spoke of plans to ease listing thresholds to draw more IPOs from local family-owned firms.
“NASDAQ Dubai is in talks with several UAE companies, including some that are government-owned, about IPO listings at the exchange,” Singer said. “We expect to see some activities by the third or fourth quarter of this year, provided the market window opens,” he added. New listing policies would allow companies to list, but offer less than the current mandatory minimum of 25 percent of their shares and reduce the minimum capitalization requirement for companies hoping to list on the exchange.

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Executive Insights

Digital advertises our tomorrow

by Nohad Mouawad & Ramsay G. Najjar
written by Nohad Mouawad & Ramsay G. Najjar

The future of communication is here in the form of digital signage on buildings, blogs criticizing companies or lauding products, live television shows watched on mobile handsets and online avatar characters used to enter virtual web environments and interact with colleagues, friends and strangers.

This stranger-than-fiction future may not have enveloped the Middle East yet, but in Europe and the US, digital media has been taking over the communication scene with digital ads in doctors’ offices and supermarkets, and people spending the majority of their time acquiring and sending content on the Internet or mobile phones. Ad spend has been burgeoning in this area as companies have discovered this medium’s flexibility and ability to reach their target audiences through channels they are using the most.
The majority of corporations in the Middle East, however, have yet to exploit the potential of this phenomenon, having only dipped their toes into online advertising in the form of banner ads and keyword searches, without a strategy specific to digital communication. These banner ads are an application of traditional advertising campaigns translating the same visuals and messages into another medium.

There are numerous strategic reasons for regional companies to go with the digital media wave, as it can help a company drive home its messages and build stronger relationships with stakeholders, complementing and reinforcing traditional communication campaigns. As Internet penetration and advanced mobile phone technology use grows in the Arab world, organizations must be fast movers, capitalize on opportunity and stay ahead of the trend.
As part of a comprehensive communication strategy, the use of digital media should help companies further reach out to audiences who are bombarded with messages on a regular basis, by grabbing their attention throughout the day and night, as they browse the Internet, use their mobiles or walk down a street. Unlike TV messages requiring focused audience attention, or billboards ads that distract people cruising the highway, much of digital communication is intended to be part of people’s daily activities, including email, Facebook or other social networking accounts, and browsing news and information online.
Making digital media an essential communication strategy component allows organizations to more effectively target audiences. On the web, messages can be placed on websites with related content or that have audiences with a similar demographic to that of the company or brand. The value of demographic data and information about Internet users’ interests and habits can be seen anytime you visit a celebrity gossip site and see ads for clothing targeting females, or type the word ‘coffee’ into a search engine and uncover numerous sponsored links to coffeehouses. This targeting ensures companies get their message across to someone that might be interested in what they have to say.

What’s more, the impact of this media is measurable, as the targeted person can rollover the visuals, click on a link or even purchase the advertised product, allowing organizations to measure the ad’s impact and effectiveness.
Digital media also provides the ideal platform for interactivity between companies and their audiences, bringing their brand or product to life. Many companies today, including Johnson & Johnson, promote their corporations through blogs about their values, the people that work at their organization and even the socially responsible causes they support, showing the more human side of what they do, while giving their stakeholders the chance to provide feedback. Companies have even set up their own YouTube pages offering visitors a glimpse of their latest advertising or public service videos, highlighting the importance of particular issues they support.

Others, like Pepsi, include images and branding of their products throughout popular online games, while Vodafone created its own game that it posted on its website. BMW and Adidas caused a huge buzz amongst young audiences when they created original short films featuring celebrities and their products, which then became ‘viral sensations.’ In the region, Emirates is one example of a company that embeds videos on popular websites, such as an expandable ad featuring footage of its new terminal three.

In the current financial crisis, there is another important benefit of digital media that cannot be ignored: cost efficiency. The lower production and media buying costs of digital communication means that companies will be getting more bang for their dollar when they leverage the interactivity and measurability of digital formats to target their audiences and involve them with their brand. In fact, online ad spend is the only area of advertising spending predicted to grow in Europe and the US in the coming years.

The credit crunch provides regional organizations with a unique opportunity to shake up their communication strategies by adding a much-needed digital component and reaching out to their audiences through the media they are growing to know and love best: websites, email, mobile phones, social networking sites and online video clips among others. Using these tools will give companies the chance to not only target certain groups more effectively but also to measure the impact of their message and elicit direct responses. All of this leads to higher recognition of their brands, better understanding of their messages and even increased sales of their products and services.
When it comes to digital media, the future has already arrived and it is up to companies to start living this present before they become part of the past.

Nohad Mouawad & Ramsay G. Najjar, S2C

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Finance

Islamic banking – Sharia by the books

by Executive Staff
written by Executive Staff

Islamic banking is regarded as the fastest growing segment in the banking sector with a growth rate of 20 to 30 percent per year recorded over the past decade. With more than 390 Islamic banks in over 75 counties, this segment offers products and services compliant with the sharia that is the backbone of Islamic religious law. As a large percentage of the world’s Muslim population are located in the Middle East and North Africa region (MENA), it is logical that this region accounts for nearly 56 percent of total Islamic banking assets. The top three Islamic banks, Al Rajhi bank (KSA), Kuwait Finance House (Kuwait) and Dubai Islamic Bank (UAE) are all located in the MENA region. Since this sector is still in its early stages of development, with market opportunities yet to be exploited, estimates about the size of the industry still differ.
The International Monetary Fund (IMF) estimates total assets of Islamic banks in the world to be $250 billion and they are expected to reach $1 trillion by 2016. Conversely, McKinsey, a consulting firm, and Euromoney magazine are more optimistic as they expect total assets of Islamic banks to reach $1 trillion and $2 trillion, respectively, as early as 2010. In addition to geographic expansion, Islamic banking is also witnessing expansion in the financial services it offers, including retail banking, insurance and capital market investments.
Contrary to popular belief, Islamic banking does not target Islamic populations only. Non-Muslim customers are also demanding Islamic products and services that offer competitive products. As a result, non-Muslim countries are adopting this new trend and offering Islamic banking services. According to HSBC, more than half the customers for Islamic services in the UK were non-Muslims. It is worth noting that Islamic products and services can be offered either through Islamic windows at conventional banks or through newly established Islamic entities.

Sharia and the global financial crisis
The Islamic banking industry does face some challenges as no Islamic interbank market is present. Moreover, similar to conventional banks, Islamic entities were affected by the drop in equity valuation and Gulf property to which they are exposed. Even though the financial crisis did not affect the Islamic banking industry in particular, the drop in Gulf real estate and oil prices had repercussions on the industry since its sources of funds and liquidity were distressed.
Nonetheless, the impact of the crisis was lower on Islamic banks due to the asset-backed nature of their operations. As a result, the Islamic banking sector will continue to grow. However, it will grow at a pace expected to reach 10-15 percent in 2009, which is slower than its previous rate.

Islamic Banking in the MENA Region
The MENA region holds the largest share of the Islamic banking industry. In the four years leading up to 2007, the industry recorded a compounded annual growth rate (CAGR) of more than 31 percent. Islamic bank assets in the MENA outperformed their conventional counterparts that witnessed a lower CAGR of 24 percent.
Within the region, countries can be divided into two groups: Gulf Cooperation Council (GCC) countries and non-GCC countries that account for 51.4 percent and 48.6 percent of total Islamic assets in the MENA region, respectively. On one hand, the Kingdom of Saudi Arabia (KSA), with strong religious traditions, accounts for 35 percent of total GCC Islamic banking assets, representing 18 percent of the total MENA region. On the other hand, Iran represents 95 percent of total non-GCC Islamic banking assets, equivalent to 46 percent of the total MENA region.
Although the development of Islamic banking is dependent on the establishment of Islamic banking laws in Western countries, consumer demand is the main driver in the Arab world. Nonetheless, government support is still an important aspect as it controls barriers to entry in the industry. Oman for example, does not allow Islamic banking — the sultanate encourages conventional banking products and services. Contrarily, Islamic banking in Saudi Arabia and Bahrain is highly supported by the government, making the latter a regional hub.

Products and services
Despite its recent entry to the market, Islamic banking offers a variety of products and services that correspond to conventional banking sector services and are compliant with the Sharia. Murabaha, mudaraba, takaful, sukuk, ijara and qard hassan are only a few of the Islamic products offered.
The murabaha facility occurs when a lender buys an asset and sells it back to the customer at a higher price. The latter allows the lender (i.e. the bank) to make profit through an agreed mark up in price, without violating Islam’s interdiction on lending with interest. This fixed income loan is only used for the purchase of tangible assets such as real estate or a vehicle.
Mudarabah is another service offered by Islamic entities that allows the bank to finance a business without receiving interest payments. Instead, both parties (the lender and the borrower) share profits made by the business, according to a predetermined ratio. In case of loss, the bank loses its capital, while the borrower forgoes the labor and management provisions.
Takaful is the Islamic substitute for insurance, in the form of a murabaha, mudaraba or as a combination of both. In principle, takaful allows policyholders to pay an amount of money and place it in a single pool. The latter will then be used to aid those in need of assistance.
Sukuk is the Islamic equivalent of a bond. It is a financial certificate that is sold to a lender who rents it back to the original issuer at a higher price. It is worth noting that the issuer is obliged to buy back the certificate at a future date at par value. At that point, the issuer would have borrowed money and the lender would have made a profit margin without the use of interest payments.
Unlike the previously mentioned products, qard hassan does not have a counterpart in Western banking. It is a loan granted on a good will basis. The borrower is only required to repay the original amount of the loan. No profit margin is passed on to the receiver of the loan. However, an extra amount may be paid by the debtor as a token of appreciation.

Growth drivers
The key aspects behind the success of Islamic banking vary widely. The most important of these is the world’s rapidly growing Muslim population, which recorded a higher growth rate (1.9 percent) than that recorded by the total world population (1.2 percent) during the period 2002 to 2006. This represents around 24 percent of the total world population and it is expected to reach 30 percent by the end of 2025. Additionally, the world’s Muslim population is very young. Another major reason behind the rise of Islamic banking is the increasing wealth of Muslim nations. This is due to the discovery of vast oil deposits in the Gulf region accompanied by higher oil prices in previous years. The planet’s oil dependence has helped the region to benefit from abundant liquidity, which in turn has created enormous development opportunities. Projects worth more than $2.91 trillion are either underway or in the pipeline in oil-rich countries.
The acceptance of Islamic banking activities and its demand by non-Muslims has helped the industry overcome geographic and religious barriers. Western countries and non-Muslim populations are attracted to Islamic banking due to its perceived stability. The attractiveness of the profit-loss sharing schemes has also contributed to the wide acceptance of Islamic banking products. Furthermore, the spiritual appeal of the industry, its focus on the Islamic identity, the support granted by governments and its regulatory systems have also contributed to Islamic banking’s growth.

Opportunities and challenges
Like other industries, Islamic banking is faced with many opportunities and challenges. One of the most important challenges for the sector today is the interpretation of the sharia, which differs among countries and the various religious schools due to the lack of a unified Islamic regulatory body. As a result, an Islamic product may be accepted in some parts of the world while it is rejected in others.
However, the most important challenge faced by the Islamic banking sector is the unavailability of experts schooled in both banking and Islamic issues. An Islamic banker must possess a profound knowledge of Islam, in addition to finance. The shortage in experienced and qualified scholars is forcing them to field positions on multiple sharia boards, which in turn increases the risk of a conflict of interest. What is also important is that for an Islamic product to enter the market it ought to be approved by two sharia boards, one at the bank level and the other at the state level.
The financing of the many development projects in the Gulf region represents a growing opportunity for Islamic banking. As most Arab governments encourage Islamic banking practices, an increasing number of sharia-compliant financial institutions have benefited from the financing contracts of these projects. The latter has been made possible through the issuance of sukuk. Some economists believe that the sharia-compliant finance deals will account for more than 25 percent of the total project finance market in the coming years.
In brief, the Islamic banking industry is a fast growing sector that offers an array of opportunities yet to be exploited. Although the MENA region still represents the biggest share of the total Islamic banking sector, Western countries are gearing towards this new trend that presents a unique opportunity to diversify. With a growing market share and a considerable growth rate recorded over the past decade, it is essential for a unified Islamic banking authority to be established. The latter will be charged with standardizing Islamic banking operations and facilitating communication between the different entities, leading to the full exploitation of the sector’s potential.

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Executive Insights

Securing your ship in an economic storm

by Wassim Karkabi
written by Wassim Karkabi

What was ‘expected to happen’ is really happening. There is no doubt anymore as to whether the world is in recession, crisis, downturn or whatever else you want to call it. There is also no doubt that the Middle East is affected in its own way by this global downturn. Of all the constituents of the Middle East, Dubai is perhaps the most affected. This is a fact of life, despite how well the news covers it up and the most important issue is that it has not yet hit rock bottom.

Some employers will not be affected. If you are one of the lucky ones, then you are an employer who is cash rich, in a high margin business, with leverage so low that it is minimal or a combination of any or all of the above. If not, then you have some tough decisions to make and you need to build a strategy to manage this financial tsunami, and strategy doesn’t mean mission, vision or a three to five-year plan for growth, but a real problem-solving strategy that will get you through this downturn.

We would like to suggest the 3Ms that are key to managing through turbulence: margin, margin and margin. The bottom line is it’s all about your bottom line; the numbers, how well you can crunch them, how well you can sustain them, tighten them, grow them or just maintain them. Research and history show us that companies who purely pursue a defensive strategy will perform a lot worse than those who adopt a more proactive one.

Leadership

Leaders require a new set of competencies in this turbulent time. The key set of skills that existing CEOs possess to drive through this storm is not the same as the one they used in the booming economy. Unfortunately, some CEOs don’t possess the skills, hard or soft, for this adventure sport.

According to Lowell Bryan and Diana Farrell in their article on ‘Leading through uncertainty’, executives need greater flexibility to create strategic and tactical options they can use offensively and defensively as market conditions change; they need a sharper awareness of their own and their competitor’s positions and they need to make their organizations more resilient.

Strategy

This crisis is an opportunity in disguise for companies equipped with leadership that has the know-how to implement an action-program that works during a downturn. In a panic situation, companies, run by human beings, will react in the same way humans do. It’s the ‘fight or flight’ dilemma. The ‘flight’ companies, which have closed down their operations completely or downsized to an ineffective size are well documented.

Then you have the ‘fighter leaders’, and those come in two types. There are those that will flap around grabbing at straws to make ends meet without any particular strategy and others that will build a real and interconnected response to a challenge, an overall approach based on an analysis of a demanding situation, with an articulate viewpoint of the forces at work.

The usual ways of doing business no longer apply and a new action plan is needed to ride this wave. What follows are some areas that need to be immediately addressed to compose an overall strategy for survival and even triumph.

Maintaining the customer experience

The most important pillar of the strategy should be, no matter what, to maintain the customer experience. Companies that manage to do so will become leaders in the market that will emerge after the downturn. Just because you are in a crisis does not mean that your customers will tolerate a lower quality of service or product.

The light still has to turn on when you flip the switch in your home. The food you order still has to taste as good as it did during a booming economy. Similarly the oil that your customer puts in his car has to maintain the car’s engine just as well as it used to, if not better.

Actually, if anything should be done regarding customer experience, it should be to upgrade it. Service towards the customer has to become more flexible, provide more options and alternatives, and most importantly it should take into consideration the fact that your customer is going through the crisis too, hence innovation and added value become key for loyalty in the downturn. Take advantage of this downturn to strengthen your competitive edge. Take business away from competitors at a profit and rethink costs of doing business to deliver a healthier margin that will support you through the crisis.
This crisis will present some opportunities and companies have to examine them closely. If you are cash rich, take advantage of distressed competitors’ assets and buy them at basement prices. Many suppliers are willing to negotiate better terms. Real estate developers around the Middle East who have made enormous sales records during the boom and did not start building, or even those who already started building, can re-issue tenders to suppliers to negotiate lower prices.

Examine carefully what your customer breakpoints are and re-adjust the service level to one that maintains customer experience with negligible attrition, while at the same time offers tremendous savings that can be re-invested in improvements as part of the ongoing problem solving process.

Upgrade the talent pool

While reducing staff and consolidating responsibilities is already a widespread practice, companies should make sure to address the implications this has on the employer brand, it’s internal culture and external reputation towards the larger community. Still, a crisis can offer a tremendous opportunity and — sadly — an excuse for companies to reduce the levels of redundancies, or rather, the duplications that were the initial result of over-hiring which took place across the GCC in anticipation of market demand, opportunities, expected growth and upcoming projects. This will allow companies to rethink their organizational structures and their effectiveness and to rebuild a tougher, more robust organization that is capable of surviving, and even triumphing, in this tough economy while containing a springboard and a model for more balanced growth once the economy begins its turnaround.

Marketing and sales

Marketing and sales executives are now asked to do more with less. What will work in today’s economy is by and large different from the sales and marketing strategies that used to work. For example, cut down on traditional media spending and explore what used to be considered complementary media, such as Internet and social networking, which have in the past few years gained major momentum. Additionally, consumer activation programs and being close to your customers by interacting with them on the ground may offer better results and lower costs than traditional mass media vehicles. Replace your “more-feet-on-the-street” strategy with a more customer-centric frontline, product specialists and industry specific sales managers that can provide more customized and better service, and identify and target new revenue opportunities in specific market sectors. It is also important to focus efforts on serving specific sectors with industry specialists that are capable of identifying and targeting new revenue streams from a specific category of clients across a number of its products. It is crucial to create a map of the market that will identify a new ‘who’ and ‘where’ regarding the remaining profitable customers, the sectors and the geographic locations, mobilizing the most effective sales and marketing vehicles to reach them.

Rethink your learning and development approach

Learning and development is always one of the first budgets to be affected by downturns. Yet it seems that these situations may be the best opportunity to upgrade your already existing talent pool by continuing to invest in training solutions. Companies cutting jobs should carefully maintain and rigorously protect training and development programs, as they are necessary to provide your talent pool with the skills needed to perform redesigned jobs that have bigger responsibilities and a greater span of authority and control. One solution is to replace external trainers with internal ones by offering the opportunity to internal specialists and the company’s senior leaders to participate in your learning programs, while also enhancing their facilitating and coaching skills. This approach can both reduce the cost of training and development tremendously, while at the same time redirecting the content of leadership programs by tying them to decisions and skills affecting the company’s current performance issues.

In short, there is definitely a need for a different set of skills and without those skills some companies may not survive. Here is the upside: this is a classic case of survival of the fittest. Companies that stay afloat during this period will find themselves in a more robust market with less competition and more demand to meet their supply; the ship will be stronger, manned by a tough crew and led by a clear minded strategist at the helm, with a strong vision for growth in the years to come.

Wassim Karkabi is partner and regional practice leader EMEA, Stanton Chase International

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