Putting comparisons of its fellow GCC members’ banking magnitude aside, the bite-sized banking sector of Oman is performing exceptionally well. Oman acts as a front-runner in attracting foreign direct investment (FDI), as the financial sector is determined to renovate the Omani economy from a mainly oil-producing and exporting economy to one of a diversified, non-oil based nature. Diversification of its economic base is one of Oman’s great successes, as its Seventh Five-Year Development Plan aims at sustaining long-term development, enhancing contribution to GDP of the non-oil sectors, and improving employment opportunities for Oman’s fast growing population.

Although oil production has been declining, recent economic growth is still accredited to high oil prices. The sultanate’s Ministry of Information (MOI) believes “apart from phenomenal growth in oil income, a strong local demand and improvement in non-oil exports contributed to the better performance of the economy.” The ministry predicts a 5.5% growth in the oil sector, “despite a 3.7% fall in crude oil production in 2007.”

Presently, Oman’s economy is witnessing intense growth, which, despite high inflation levels, the banking sector is embracing with open arms. Unlike every other GCC member, Oman completely prohibits Islamic banking operations throughout the sultanate. In an interview with Middle East Economic Digest (MEED), Executive President of the Central Bank of Oman (CBO) Hamood Sangour al-Zadjali boldly stated, “We shall not allow [Islamic banking]. We believe that banks should be universal. We won’t allow specific banks.” Regardless of the many Islamic banks operating throughout the GCC, Omani banking seems to be doing fine without sharia-compliant services for the moment.

In its latest report, Moody’s Investors Service underlined the contributing factors in the generation of strong earnings as amelioration in domestic operating conditions: the government’s diversification strategy, sustained high oil prices and amplified levels of liquidity. The openness of Oman’s banking sector allows it to flourish, enhancing its outlook in terms of risk management and corporate governance practices. Moody’s also emphasized the assets of the sector are gradually improving, underlined by a decline in non-performance loans and improved provisioning coverage.

Oman’s banking sector has witnessed several mergers in recent years, enabling commercial banks to better handle large operations. MOI boasts that the Omani banking sector “is stable, highly efficient and able to respond to regional and international developments, including the growing trend towards freeing up financial services within the framework of the [WTO].” The ministry further vaunts that “the banking sector is a model of successful Omanization[, with the] College of Banking and Financial Studies playing a vital role in preparing nationals for banking careers.” Most Omani banks are investing funds to train and recruit nationals, and thus improve the scope of the banking sector.

Moody’s says “Omani banks continue to operate in a challenging and highly concentrated economy that constraints the upside potential to their ratings. Oman still relies heavily on hydrocarbon exports, which results in considerable cyclicality in the operating environment, which in turn affects the performance of the banks.” On a rather optimistic note, Moody’s concludes that, “given the current strength in oil prices, hydrocarbon exports are contributing positively to Oman’s economic up cycle.”

The sultanate’s young and expanding population, along with rising per capita income and major investments, present immense opportunities. Despite all the good news for Omani banking, Oxford Business Group (OBG) believes that “the question on everyone’s minds is if Omani banks, small by regional standards, can meet demand on an unprecedented scale.”

Total assets of Omani banks ($ billions)

Bank performance

In 2007 Omani banks recorded a strong year, possessing a 35.3% rise in total assets to $25.5 billion, with foreign assets comprising $5.1 billion (20%) of this total. According to OBG, deposits also surged by 32.5% totaling $16.12 billion. Private sector deposits represented 81.4% of total deposits, and foreign deposits accounted for 18%. The IMF believes that Oman’s “economy withstood well the impact of the June cyclone and real GDP grew by 6.4 percent.” Also, OBG reports that in 2007 combined profits of all banks were sound, experiencing a 26.4% year-on-year increase, totaling $460 million. OBG holds that during 2003-06 period bank profits grew at a CAGR of 39%, and believes profits “are expected to remain strong in 2008.”

The Omani banking sector is comprised of six national banks, 10 foreign banks, and three specialized banks. Four domestic banks — namely BankMuscat (BM), Oman International Bank (OIB), National Bank of Oman (NBO), and Bank Dhofar — rule the industry. Combined, these top banks account for 78% of total commercial banking assets and 75% of total branches. In 2007 Bank Sohar became the latest domestic addition since 1990 to Oman’s banking sector. Foreign investment is highly encouraged in the banking sector, as the Omani government diligently persists to implement liberalization policies. Blatant proof of such liberalization is the increasing presence of new foreign banks entering the playing field; the latest foreign newcomer to the sector is Qatar National Bank, which opened its first branch in Muscat in December 2007.

While liberalization trends continue, national banks yearn to improve their services and draw more customers in order to maintain a larger market share. OBG finds that “banks are working aggressively to gain clients through various means including building [more] branches, creating new products and services, and even expanding operations abroad.” BM, for example, already has branches in Kenya and India, and premiered its first branch in Riyadh last year. BM allegedly has plans to expand further into neighboring GCC countries as well.

As the leading bank of Oman, BankMuscat’s total assets at last year’s end stood at $11 billion. In the first quarter of 2008, BM announced that its profit climbed 39.4% due to increased earnings from lending, as reported by Bloomberg. Oman’s largest bank also witnessed a robust net income increase from $49.3 million to $68.8 million just from earlier this year. In addition, net interest income also increased 31.2% to a considerable $96.1 million. Operating revenue rose by 45% from earlier in the year, totaling $142.9 million. Chairman of BM AbdulMalik bin Abdullah al-Khalili noted that “the most significant development that took place in the first quarter of the year 2008 was the bank’s acquiring a major stake (35%) in Saudi Pak Commercial Bank in Pakistan.” BM boasts its strong presence with over 100 branches, a representative office in Dubai, and a branch in Saudi Arabia. The bank owns a 43% stake in the Mangal Keshav Group, noted as one of the most respected security houses in India’s fast growing equity market. The Banker has voted BM the “Best Bank in Oman” fives times in a row, Euromoney has voted it the best bank six times consecutively and Global

Finance Inc seven times. The list of awards is lengthy and clearly indicating BM’s domination of the Omani banking sector.

Coming in second place, the National Bank of Oman (NBO)’s total assets for Q4 2007 rang in at $3.8 billion. The first quarter of 2008 recorded net profits of $28.3 million, while operating profits grew by 49% from the same period of 2007, to $33 million. Such profit accelerations proves NBO’s continuous success via its growth strategy. “The results for the first three months of 2008 continue to reflect a growth trend across all our businesses. Net advances and deposits crossed the RO 1 billion [$2.6 billion] mark with the increase of RO 109 million [$283.1 million] and RO 123 million [$319.5 million] respectively during the quarter. Net interest income grew by over 8% to RO 10.1 million [$26.2 million] and non-interest income climbed by 81% to RO 9.6 million [$24.9 million],” explained NBO Chairman Sheikh Suhail Salim Bahwan. The bank insists that it will go on to “invest in people, process, and brands which will support the bank’s progress towards achieving sustainable value for its stakeholders.” NBO affirms it is “focused on new and improved ways to serve its customers,” as its “non-performing loans have now [been] reduced to 5.6% of total loans and nearly 95% of these covered by provisions.” In 2005, CBO purchased a 35% share in NBO. Regarding Basel II, NBO states: “The capital adequacy ratio based on the regulatory capital was at a healthy 14.57% well above the mandated requirement of 10% under Basel II norms.” The bank’s CEO Murray Sims said that “the growth in operating profit over the last year has been very encouraging. The outlook for the bank’s principal markets is positive.” Sims went on to say that the inspiring outlook “combined with committed and engaged employees, loyal customers and continued enhancement of the strategic alliance with Commercial Bank of Qatar will augur well for continuation of the trend.” The CEO also said NBO has determined plans for growth, that distinguish the numerous opportunities present “in terms of the pace and depth of economic expansion in Oman today.” NBO insists customers are their priority, and will continue to be as the bank “seeks opportunities to grow their business further” to insure the improved quality of their service offerings.

Oman’s third leading bank is Oman International Bank (OIB). Last year, the bank’s total assets accumulated to $2.8 billion. In 1984, OIB became the first fully Omani-owned commercial bank in the sultanate. OIB now has 82 branches throughout the state, as well as 4 branches abroad (Mumbai, Kochi, Karachi, and Lahore respectively). OIB prides itself as “an innovative bank with a long list of firsts to its name, the first bank in the Gulf region to offer mobile banking service, the first Omani bank to issue a Visa Card, and the only bank in Oman currently offering unique Phone Banking service. Also being the only bank at present in Oman which enjoys the advantages of having a fully automated branch network.” Acting CEO Nani B. Janveri explained that OIB’s strategy is “to focus on quality and not quantity, in both assets and liabilities… Rather than looking to increase profitability through higher net interest income, we are looking to generate more fees from new banking and expanded services in the areas of treasury, investment banking, private banking, credit cards etc.”

At present, the IMF trusts that the “banking sector remains sound… as the banks are profitable and well-capitalized, and nonperforming loans are being reduced.” Javeri noted that the “policies of the CBO are fundamentally sound and designed to maintain the financial strength of the banking system.” Moody’s Investors Service also expects that Omani banks will continue to prosper and bask in heaps of abundant capital ratios and strong earnings.

Active banks 2007

Fighting Inflation

By March 2008 inflation had hit an 18-year high at a staggering 11.5%. The country’s inflation is likely caused by government spending, increasing rent prices, and the soaring cost of food. The government of Oman is implementing prudent monetary and fiscal policies to curb such swelling inflation in its $40.3 billion economy. In his own attempt to ease inflation pain this year Sultan Qaboos bin Said ordered a 43% increase in state worker’s wages, as well as a 5%-35% increase for state pensioners.

Like many other GCC states, Oman pegs its currency to the waning US dollar. This forces the CBO to track US monetary policies set up by the Federal Reserve. Despite this peg the banking sector has been unfazed by the US subprime mortgage crisis. Yet, OBG notes that, “Oman’s continued pegging of its currency with the US dollar has been a force behind rising inflation, pushing up the costs of imports, in particular foodstuffs.” The central bank is prepared to once again tighten lending curbs so to control credit growth.

In December 2007, the sultanate raised the reserve requirement for banks from 3% to 5% of total deposits, in order to prevent lower borrowing costs from driving inflation. According to a Reuters December 2007 poll, Oman’s inflation could fall to 3.9% by the end of this year. With high rents, accelerated food costs, and increased government spending, whether or not this figure actually materializes is rather questionable.

Basel II

Since January 2007, Basel II regulations have been implemented and followed by Omani banks. “In fact,” states OBG, “the minimum capital adequacy is above the coverage mandated by Basel II, even after the CBO reduced the requirement from 12% to 10%.” In a bid to improve Basel II implementation, BankMuscat teamed up with Edutech Middle East to create an e-learning solution to help train BM employees meet the accord’s compliance. AbdulRazak Ali Issa, CEO of BM believes that, “Basel II is a significant development in the global banking industry, which is continuously evolving with the emergence and improvement of new and existing standards to protect clients’ finances.” Issa emphasized that BM’s partnership with Edutech will allow the staff “to keep at pace with rapid developments being undertaken by international financial organizations.” Overall, the application of Basel II will help Omani banks govern risk and capital management issues.

Forecast

Based on the bank financial strength ratings, Moody’s predicts a poised outlook for the Omani banking sector. Similarly, Gulf Investment House reported that they “expect the banking industry to capitalize on [credit growth] through actively participating in the financing of many of [infrastructure] projects.”

Elena Panayiotou, a Moody’s analyst expects “the government’s ongoing strategy to diversify and expand the non-oil segment of the economy to continue to boost economic activity in the country and create growth opportunities for the Omani banking sector.” Panayiotou went on to warn that banks are in need of beefing up their non-interest related income so to ease pressure on margins, and thus sustain profitability at current levels.

Popular consensus finds that the sector has become more competitive in recent years, and will continue to do so. Even with problems of inflation and a limited local market, the banking sector of Oman is undoubtedly on the rise. Taqi Ali Sultan, General Manager of NBO, explained, “We’re seeing new entrants from the Gulf, and local banks are expanding as well. But I think there are real growth prospects, so there is sufficient room for every player.” OBG adds that, “Omani bankers are confident the country’s strong economic forecast will translate into increased lending improvements and better asset quality.”

In brief it is fair to say that despite its relatively small size, the Omani banking sector is performing remarkably well. Although inflation rates are uncomfortably high, banks in Oman are coping well and functioning soundly. With FDI emphatically encouraged, liberalization is greatly aiding the growth of the sultanate’s banking sector. With Basel II and other monetary regulations in place and inflows of foreign investment, the Omani banking sector is set to perform at stellar levels in the coming year. GCC banks should keep an eye out for the expansion of Omani banks, as banking prospects can only go up from here on out.

Country forecast

The banking sector in Kuwait did exceptionally well in 2007 thanks to a buoyant economy prodded forth by the rapidly growing oil wealth that is sweeping the region. In fact, it was not just last year, but the last few years that have been good for the small Gulf country. Between 2003 and 2006, the economy more than doubled and strong growth continues. Success begets success and the vast new wealth has spurred construction, resulting in a greater need for financing. This in turn has lead to a greater return in equity markets and corporate sector investments. It is thus no wonder bank profits have hit record levels across the board.

Although foreign banks like Bank of Bahrain and Kuwait, Doha Bank and Qatar National Bank have opened their doors recently in the country (the latter two just this year), there has been no real struggle for market share as the vibrant economy has been able to support all comers. Another minor concern about climbing credit levels has largely been swept under the rug by various analyses, including one from the IMF that called Kuwait’s banks “financially sound and effectively supervised.” Furthermore, it has called on the Central Bank of Kuwait (CBK) to reverse its efforts to quash credit growth. This may not be a bad idea as some reports suggest that Kuwaiti banks are so desperate to get around the regulations that they have taken to routing loans through foreign and non-bank financial institutions.

Nine Kuwaiti banks make up the local banking sector, with five more under partial or total foreign ownership rounding out the field. The local banks have done especially well during the last year. According to the Oxford Business Group, “growth is being driven by the continued strong expansion of banks’ credit books, underpinned by confidence in the corporate environment, new investment opportunities, strong consumer incomes and banks’ robust liquidity positions.”

The CBK seems to agree with the diagnosis in their fiscal year 2006/2007 report. Local banks (commercial, specialized and Islamic banks) had an aggregate balance sheet of $109 billion, compared to $88 billion the previous year, which represents a growth rate of 24%. The regulatory authority suggested that both assets and liabilities related developments played a role in the healthy bottom line.

On the assets side of the balance sheet local Kuwaiti banks saw a 25% (roughly $13 billion) rise in profits from private sector investments. Facilities, which account for more than half of all bank assets, grew by 18%. Growth in private sector loans resulted in 26% increase in profit for the sector.

Banks also did spectacularly well with funds invested with the CBK. Profits from accounts, deposits, bonds and others reached $13.8 billion, a whopping 210% increase on the previous year. This was largely due to the cashing in of a higher number of time deposits than the previous fiscal year. It is also worth noting that Kuwaiti banks’ holdings of treasury bonds fell by 11%. Foreign assets held by local banks were also down by .5%.

In terms of liabilities, only a couple of concerns exist. The local banking industry saw private sector deposits move up to $62 billion. The decline in foreign currency reserves has also been cited as a liability by the CBK. It is noteworthy that this growth in liabilities has not seriously affected asset quality.

A report by Global Investment House has suggested that the ratio of non-performing loans (NPLs) to gross loans fell from 4.4% to 2.6% from 2003 to 2006. In a further step to stave off sector deterioration, banks’ provisioning levels have climbed to 151% of NPLs. This move should help stem doubts about bad debt.

Other key moves by the country include the implementation of Basel II on December 31, 2005. The move came a year earlier than expected for Kuwait and two years before implementation for most of the other regional banking systems. Due to high liquidity and strong capitalization, the minimum cash requisites were easy for the majority of banks to meet.

Net profit of Kuwaiti banks ($ million)

Total assets held in Kuwaiti banks ($ billion)

Kuwait’s big seven

The top seven Kuwaiti banks by net profit are assessed here in terms of profit growth and total assets. While many of these banks have different profiles, whether they are conventional or Islamic, traditional or progressive, one generalization that can be made is that all of the banks listed here have seen sustained and substantial growth in profit over the last three years.

First on the list with total assets of $42 billion is the National Bank of Kuwait (NBK). It came in second in terms of profits, with a take of $998 million. This bank has seen profit grow by over $100 million per year for the past three years. Licensed in 1952, it was the first commercial bank, not only in Kuwait, but the entire Gulf region. NBK is a full service bank with a focus on retail banking resulting in the establishment of 63 branches. It has also recently acquired banks in Turkey and Egypt.

Second is the fully Islamic, Kuwait Finance House with assets worth $32 billion. This bank had the best showing in the country in terms of profits, which climbed over $1 billion. That is a $444 million gain on 2006 profits.

Gulf Bank comes in third in terms of total assets, with $18.5 billion, and claiming profits of $476 million for 2007. This represents just over 25% profit growth since 2006. Gulf Bank was incorporated in 1960 and the aesthetic of its branches reflect the bank’s “seafaring heritage.” Commercial Bank of Kuwait follows with $15.6 billion in assets and profits of $439 million. This bank is a great advocate of technology and has innovated a “loan over the phone” program and banking by SMS.

Fifth on the list, Al Ahli Bank of Kuwait counts its value as $10.8 billion and it took down a respectable $277 million net profit in 2007. It has 18 branches in Kuwait and one in Dubai. Further expansion in the near future is possible.

Burgan Bank has assets of $10.3 billion and $273 million in profits for 2007. The bank was wholly government-owned at founding, but in 1997 it become publicly traded with the government retaining 10% ownership.

Bank of Kuwait and the Middle East has $8.1 billion in assets and $273 in net profits. It is dedicated to mid and long-range financing for industry and agriculture.

Finally, Boubyan Bank checks in at $8.1 billion in assets. The bank is an exclusively Islamic institution and the youngest bank in the country as it was founded in 2004.

Forecast

Real GDP growth is expected to rise to 5.9% in 2008, which is slightly better than 2007. It does not approach, however, the 12.6% registered in 2006. Furthermore, inflation is expected to drop by over half a percent. Sustained high oil prices in the foreseeable future will encourage the economy and in turn the banking sector. According to the Oxford Business Group, one of the main risks to watch for is “the potential for a deterioration in asset prices, which would undermine loan quality, increase the risks of local real estate investments and further drive down non-interest income.”

The America-based subprime crisis and the resulting credit crunch pose little threat, as high levels of liquidity should stave off credit hunger. With threats largely under control and abundant opportunities, Kuwait’s banking sector looks set to see continued, sustained profit growth for the rest of the year.

Country forecast

The Qatari banking sector is entering a new phase of high growth in 2008. In its latest report, Global Investment House (GIH) believes that banking penetration in Qatar has been accelerating over the last few years. GIH states the ratio of credit deployment to GDP has increased to 49.6% at the end of 2006, and is estimated to have hit 69.1% in 2007 due to deceleration in the country’s overall GDP growth rate. Diversity and expansion top the Qatari financial sector’s list of strategic economic priorities.

Economic growth has been augmented with proactive macroeconomic initiatives. Qatar continues to adopt and implement new regulations, with the aim to “make the investment environment more investor friendly,” according to GIH. In addition, Qatar has made several positive moves to attract foreign investors, as exemplified by the creation of the Qatar Financial Center (QFC). It acts as a national institution seeking to draw “international financial institutions and multi-national corporations to set up their offices and to forge closer partnerships with international business houses.” QFC offers quite an appealing package to foreign entities, giving them a three-year tax holiday, full repatriation of profits, as well as 100% foreign ownership.

In its extensive efforts to widen its economic base, Qatar launched a remarkable domestic investment program. This recent development is aimed at diversifying the country’s economic base from the hydrocarbon sector. GIH reports that Qatar is most likely to spend around $140 billion on various projects over the next five to six years. The banking sector would be one of the chief beneficiaries of this project scale and regional diversity agenda.

Qatari banks are also focusing on expanding their capital base, since many banks have voiced their intentions to come out with rights issues in 2008 and 2009. This step will not only aid banks in shoring up their CAR and swaying their balance sheets, but it will also help the banks tap into Qatar’s incoming profitable lending opportunities.

In light of all these reforms and strong finance performances, Standard & Poor’s has upgraded Qatar’s sovereign rating to ‘AA-‘ from ‘A+’. GIH highlights that Qatar is planning to bring its financial sector under one integrated financial regulatory body. “With this initiative,” GIH explains, “Qatar follows an international trend towards an integrated approach to the regulation of different financial services products and activities.” The Qatari government is also ardently focusing on developing other economic sectors, to further boost the country’s economic growth.

Generally, the structure of banking sector has been altered further as commercial banks have dived into Islamic banking. Now, in order for the domestic market to face the changing facets of the industry, several local banks are concentrating on regional expansion via acquisitions and opening new branches across the Gulf. The country’s leading bank, Qatar National Bank (QNB), and Doha Bank (DB, the third top bank) are focusing on regional branch expansion. In contrast, the Commercial Bank of Qatar (CBQ) — the second-largest bank in the country — and newly established Al Khaliji Commercial Bank are both directing their expansion strategies to acquisitions in order to amplify their foothold in the region. GIH considers this strategy as headed “in the right direction as it will bring diversification in the asset class of Qatari banks.”

Total assets of Qatari banks ($ billions)

Bank Performance

With a total of 17 banks, nine banks are Qatari owned, while seven are foreign banks, and the last is a specialized government-owned bank. Of the nine national banks, six are commercial banks — namely Al Khaliji Bank, Al Ahli Bank, Commercial Bank, DB, International Bank of Qatar and QNB — while the remaining three are Islamic institutions. Locally owned banks account for approximately 80% of the banking sector’s assets.

Last year was exceptionally prosperous for all banks listed in Qatar, as each bank’s balance sheet witnessed significant increases. CPI Financial reports that, “the aggregate balance sheets of all the listed banks grew by 61 percent in 2007 to $69.2 billion from $43.1 billion in 2006.” Aggregate assets of all banks in Q1 of 2008 saw profits grow by 15.1% to $76.7 billion, up from $69.3 billion at the end of 2007.

From $1.4 billion in 2006, the combined net profit of all banks operating in Qatar grew by 56% year-on-year in 2007, coming to a total of $2.2 billion.

In efforts to hold back accelerating consumer lending, Qatar Central Bank (QCB) published a directive explaining that personal loans will be limited to a maximum of QR 2.5 million ($687,000), and that the payback period must not surpass seven years. The directive also mentioned that the total cost of the loan repayment is limited to 70% of an individual’s salary. All leading banks in the country are following directives issued from the central bank, with the country’s top three banks paving the way for expansion

QNB is currently Qatar’s largest operating bank. Partly government-owned, the bank holds over 55% of total deposits and handles most of the government’s business. By the end of 2007, QNB’s total assets stood at $31.41 billion. With already two branches in Paris and London, last year the bank further achieved significant regional expansion, opening new branches in Yemen, Oman, and Kuwait, increasing the number of the bank’s overseas branches to five. QNB also has representative offices in Iran, Libya, and Singapore. The bank has acquired a 30.5% share in the Jordanian Housing Bank for Trade and Finance (HBTF). The bank is highly esteemed for its successful participation and completion of the region’s largest and most competitive syndicated loan, amounting to $1.85 billion. GIH comments that QNB is viewed as “one of the best banks in Qatar considering its sound assets portfolio, which we believe will continue to remain its main focus area despite significant growth in its loan portfolio over the last few years.” With such vast operations and rapidly growing assets, QNB makes it difficult for other banks to compete.

As the second leading bank, CBQ’s assets stood at $12.47 billion at last year’s end. Like its competitors, the bank is actively expanding its operations, exemplified by its 35% purchase of the National Bank of Oman in 2005 and most recently acquiring a 40% stake UAE-based United Arab Bank. CEO Andrew Stevens believes strong performance of Q1 2008 is “a reflection of the continued favorable economic conditions being experienced in Qatar. In the first three months of this year, CBQ’s total assets rang in at $13.4 billion, compared to $8.7 billion at the end of Q1 in 2007. The performance of National Bank of Oman and United Arab Bank, in which we own interests of 34.85% and 40% respectively, continues to be extremely encouraging.” Steven went on to highlight that CBQ aims to ensure that it has “a capital base sufficient to cope with future growth, both organically and through acquisitions, to meet the requirements of Qatar Central Bank and the ratings agencies, and the returns expected from [its] shareholders.” Following the trend, CBQ is focused on developing healthy customer franchises and expand its scope of operations.

In third place is Doha Bank, with total assets measured at $8.3 billion. The bank is highly profitable, what The Peninsula reports as being partly attributable to its leading position in the comparatively high margin retail segment. Alongside its peers, DB has witnessed swift growth under Qatar’s enjoyable and buoyant economic conditions. The Peninsula notes that, “this is, however, asserting negative pressure on liquidity and capital indicators, which are both at acceptable levels.” Like its fellow banks in expansion efforts, the bank is planning to open a branch in Kuwait sometime this year. In general, DB is successfully expanding internationally and its performance remains sound.

Market share of total assets 2007

Growth in balance sheet

Market share of total deposits 2007              

Growth in loans & advances

Inflation

Like most of its fellow GCC members, Qatar still pegs its currency to the falling American greenback. The dollar peg, along with soaring oil and rent prices, has caused Qatari inflation to hit a record high of 14.81% in 2007. According to the General Secretariat for Development Planning rent and utility costs increased by 27.7% in Q4 of 2007. As the country diversifies its economic base, inflation rates are expected to drop slightly to around 13% in 2008.

Currently, Qatar is looking into policy options to battle inflation, including the possibility of dropping its peg to the dollar. Youssef Hussein Kamal, Qatar’s Minister of Finance, told Reuters in January 2008 that the government has plans to sell bonds in order to mop up some liquidity, build more affordable homes, and control building material prices so to tackle swelling prices.

Basel II

Supervising the financial sector, Qatar Central Bank has introduced numerous regulations in tune with international standards. The most influential of such regulations is the Basel II accord. Most banks in Qatar and in the region as well, are putting in efforts to implement Basel II in order to raise the bar for the financial sector. QCB is responsible of ensuring that banks remain in line with the accord. This regulatory framework is sure to guide banks in enhancing their performance.

Forecast

Regional investment bank EFG-Hermes believes that Qatar’s banking sector is sure to benefit from its mushrooming gas market and rapidly growing knowledge industry. “With the economy booming from government-directed investment and the initiation of over $120 billion of gas, infrastructure and other major development projects, Qatar, and indeed the local banking sector, has a very solid outlook,” explained Raj Madha, Director of Equity Research at EFG-Hermes.

Madha predicted that real GDP growth will reach double-digits, whilst inflation is anticipated to fuel nominal growth into the high teens. “The impact on the local banking sector is clear — lending growth has averaged 42% per annum for the last three years to October 2007 and, although this is slowing, we anticipate this trend to continue for some time”, Madha said. With exceptional performance on their record, banks in Qatar are expected to further flourish.

In short, the outlook for Qatari banks is stellar. CPI Financial trusts that Qatar “has huge investment potential.” Madha added that, “for the foreseeable future, we believe Qatar’s prospects are bright — strong loan growth, driven by a strong economy, driven by massive liquidity and investment.” Without question, there is a tremendously bright future ahead for the Qatari banking sector.

Country forecast

Despite losses in profit growth for some banks, overall the Bahraini banking sector did well in 2007. According to a recent report by the Central Bank of Bahrain (CBB), “Against the background of recently completed structural changes, domestic banking institutions (conventional and Islamic) show sound financial health, as rapidly expanding balance sheets are underpinned by high capital adequacy, low non-performing assets, plenty of liquidity, continued growth of earnings and stable ratings from accredited rating agencies.”

Despite this praise, prudent observers will keep their eyes on some of Bahrain’s bank portfolios that contain high concentrations of certain sectors. Further unchecked growth in the construction and real-estate sectors will leave some banks uncomfortably exposed.

Current difficulties in the industry include the recent structural changes implemented by the central bank, related to the CBB’s single license policy. Furthermore, it is worth noting that three wholesale banks have become retail banks, which has expanded the aggregate balance sheets of the retail banking sector considerably.

Total retail bank deposits were $49 billion at the end of September 2007, according to the CBB. The growth appears astounding when compared to the $18.4 billion recorded for the financial period ending in March the same year. Yet the growth was largely due to the previously mentioned restructuring process. Without the restructuring, deposits would have only reached $24.9 billion for the September report.

Retail deposits are readily available thanks to high liquidity and the nation’s banks enjoyed year-on-year growth in net profits of 78%. In terms of loan concentration, over 40% of banks’ loan books are in either the personal or the financial sector. Uniquely, the growing regional demand for credit has benefited Bahraini loan books as well. In fact, things are so good on this level that if loan growth becomes even more rapid, it could threaten the sector.

While things are rosy for most banks, not all is well in the kingdom. Most of the region’s banks avoided significant exposure to the subprime crisis, but a couple of Bahraini banks did see fall-out. Fitch Ratings reported “two major Bahraini wholesale banks, Arab Banking Corporation and Gulf International Bank, suffered extremely large cumulative impairment charges, mainly for investments in structured investment vehicles and collateralized debt obligations with exposure to US sub-prime residential mortgage-backed securities.” Those cumulative impairment charges lead to operating losses of $758 million for Gulf International Bank and a 59% decline in operating profits for Arab Banking Corporation in 2007.

The big three

There are three major banks on the Bahraini banking scene in terms of total assets. The largest is the previously mentioned Arab Banking Corporation, with assets of $32.7 billion. While this bank’s exposure to the America-based subprime crisis cut deeply into its bottom line, the banks was still able to record net profits of $125 million. The bank was able to keep its cash reserves high during the crisis thanks to injections from shareholders and it is anticipated that the write-downs are largely finished.

Second in terms of assets is Ahli United Bank with $23 billion on the balance sheet. This bank was the big winner in earnings for 2007 with $296 million in profit thanks to significant international activity in Kuwait, Oman, Qatar, Egypt and the UK.

The third largest bank in Bahrain by assets is Albaraka Banking Group with $10.1 billion in assets. Albaraka took down $144 million in profits for the year, as compared to $80 million the previous year.

Net profit of Bahraini banks ($ millions)

Total assets of Bahraini banks ($ billions)

Forecast

Real GDP growth is expected fall incrementally for both 2007 and 2008, while consumer inflation should remain relatively steady despite the country’s currency peg to the dollar. Bahraini banks should profit from continued high asset quality and liquidity in the country. Although the real-estate market is moving quickly and presents a minor threat to the sector, it is in much better shape than other, more overheated markets of the GCC. As long as a watchful eye is kept towards the unique local challenges and oil prices stay high, Bahraini banking should be in for another good year in 2008.

Country forecast

Cautious optimism is the word of the day in the Saudi banking sector as the gains of mid-decade failed to recur in the wake of a bearish first quarter 2006 at the Riyadh-based Tadawul (stock exchange). The remarkable fall in brokerage and asset management fees, which had seen record profitability over the previous three years, proved a serious concern for the industry. A Fitch Ratings report based on an analysis of ten major commercial banks in Saudi Arabia suggests that on average the banks recorded a year on year decline in profit, the first in recent years. New regulatory curbs on lending, and the global credit crunch resulting from the US subprime crisis fallout, also had negative impacts on the sector.

Competition from new entrants to the industry proved another challenge for Saudi banks. According to Zawya Dow Jones, there are now six foreign banking institutions in the kingdom and this number is expected to rise. Saudi banks have duly raised capital to help fend off the burgeoning threat as the region prepares for a wave of mergers and acquisitions. Global Investment House has suggested that the “banking sector in the country is on the threshold of a new era, where foreign banks are likely to give a tough time to local banks.” Capital has been raised by a handful of banks to date, including Samba Financial Group, which has upped its capital 50% from $1.6 billion to $2.4 billion. Al Rajhi Bank will increase its capital from $3.6 billion to $4 billion, Arab National bank has gone up 43% to $1.7 billion, and Saudi Investment Bank has added $200 million to its $1 billion cash base. Riyadh Bank and others are expected to follow suit as well.

The capital boosts also help facilitate Basel II, which was implemented in January. The new rules should help stakeholders better understand risks taken by banks, said one expert. Basel II compliance is expected to have a moderately negative affect on year-end capital ratios for Saudi banks.

Effects of oil and inflation

Despite the poor performance in asset management fees and the challenges of raising capital, banks in Saudi Arabia did show consistent improvement in their core revenues. Loan volumes grew quickly due to record high oil prices and effervescent economic conditions. Bank assets grew by 25% in 2007, however, inflationary pressures on wages and rising loan provisions cut operating profitability.

Slow growth in consumer lending, due to new regulatory constraints, was also an issue. It is suggested that the new constraints were aimed at slowing the practice of borrowing money to invest in the overheated Saudi stock market. The slowdown was, however, offset by accelerated growth in private sector corporate credit. High regional liquidity pushed up consumer deposits and funding asset growth. In a further boon to the industry, 43% of these deposits are non-interest bearing, which has proven to be an excellent source of low cost funding for Saudi banks. Fitch Ratings believes that “the asset quality is sound.” But write-offs and retail loan provisions are climbing in an early indication of segment deterioration.

On the upside, US subprime woes and structured credit risk pose little risk to the industry. Saudi banks have modest exposure to CDOs and SIVs, according to regional bankers. Write-downs from the incident are mostly taken care off and have had little impact on profitability. However, residual fall-out has prompted some delay in new debt issues as spreads widen due the global credit crunch. Furthermore, large maturity gaps and concentrations in funding remain.

Net profit of top 10 Saudi banks ($ million)

Top ten banks by total assets

The Saudi banking sector had total assets estimated at $290 billion in 2007 after a 16% year-on-year drop in total net income. The majority of this vast sum is shared between the top ten local, commercial banks by total assets. Largest among them is the National Commercial Bank (Al-Ahli) with $55.6 billion in total assets. The bank saw its profits drop from $1.67 billion in 2006 to $1.60 billion in 2007, although this was still stronger than its 2005 profits recorded at $1.32 billion. Established in 1953, National Commercial Bank is the oldest bank in Saudi Arabia.

Second on the list of total asset value is Samba Financial Group with $41 billion. The group saw its 2007 profits down to $1.28 billion after earning $1.38 billion in 2006. Samba, formerly known as Saudi American Bank, has a strong presence in Pakistan as well. It was established in 1980 when Citibank’s branches in Riyadh and Jeddah were taken over by Saudi investors in a partial nationalization scheme that required banks in the country to be 60% owned by Saudi nationals.

Al Rajhi Bank, despite its third place rank with $33 billion in assets, was the most profitable bank in the line-up for 2007. Although it lost ground from 2006, the bank was still able to turn a whopping $1.72 billion in profit for the year. This is ostensibly due to its prominent position in Islamic banking, which has recently experienced massive growth.

The only bank on our list of top ten to actually record a year-on-year rise in profit is Riyad Bank, which saw profits climb from $776 million in 2006 to $803 million in 2007. The bank sports total assets of $32 billion and is entirely Islamic, another nod to the success of the sharia-compliant finance industry in an otherwise sluggish year. The non-interest bearing nature of Islamic finance provides an excellent source of cheap funding for banks.

Middle of the list at number five is Banque Saudi Fransi with total assets of $22 billion. Net profits fell from $802 million in 2006 to $723 million in 2007. The bank was established in 1977 and is affiliated with Calyon of France. Next up is SABB (formerly known as the Saudi British Bank), which counts $26 billion among its total assets. This affiliate of HSBC was established in 1978 and saw profits drop from $811 million in 2006 to $695 million in 2007.

Number seven on the list with $25 billion in assets is the Arab National Bank, founded in 1979, with profits declining from $668 million in 2006 to $656 million in 2007. It should be noted, however, that both of these figures are significantly better than the bank’s 2005 net profit of $487 million.

Next is Saudi Hollandi Bank with $13 billion in total assets. This bank came in last on our list in terms of profits with its 2007 earnings of $117 million, well behind its 2006 take of $254 million. According to Fitch Ratings, the drop in profits was “due to higher impairment charges taken on its corporate book.”

Saudi Investment Bank has $12 billion in assets. The bank’s net profits fell by more than half, from $535 million in 2006 to $219 million in 2007. The first quarter of 2008 has shown no respite from this trend with a further 16% year-on-year drop in profits.

The final bank on our top ten is Bank Al-Jazira, holding some $5.7 billion in assets. This bank had a poor showing this year as well with profits falling from $526 million in 2006 to $215 million in 2007. Apparently, it was highly dependent on brokerage during the recent boom and this factor lead to the bank’s large drop in profit for 2007.

Total assets held by top 10 Saudi banks ($ billion)

Country Forecast

Forecast According to Zawya Dow Jones, “growth opportunities abound in the region for players who are willing and ready to meet the challenges.” This comes as no surprise considering Saudi Arabia’s real GDP growth is expected to climb from 4% in 2007 to 5% in 2008. Record high global oil prices and private sector investment should encourage private sector corporate lending. This will likely make up for slow consumer lending growth. Furthermore, strong asset growth should drive-up profitability, despite the continuing global credit crunch. Looming risks include growth in credit card holders, real estate lending and consumer NPLs. Increased competition from foreign banks in Saudi is also on the horizon. High liquidity will continue to fuel large customer deposit bases, which means there will be no shortage of funding for the banking industry. In conclusion, the Saudi banking sector suffered a bullish year in 2007 as a result of the 2006 stock market tumble. And although the sector faces noteworthy issues in 2008, high liquidity and the

E What are the top three most challenging issues the banking sector faces today? And what is your bank doing to address them?

Human capital. That’s the most important challenge in banking today. Not only on the management side of the activities, but at all levels below that. You just cannot find enough qualified people to hire. This is going to have an impact in the future on the newly formed giant bank. For example, there is a new, very large bank coming to Saudi Arabia, and the challenge for them is not to collect money and capital to run the bank, it’s finding the right people to run the bank. To hire people with a long history of banking experience is very expensive, and with a specialized bank there is an even greater need for the right people; it’s a major challenge, especially within Islamic banking, to find somebody who is “well-trained”, highly qualified, someone with the knowledge to handle Islamic banking — both simple transactions and more sophisticated transactions. It’s very difficult to find people of the right caliber. Islamic banking requires a lot of sophisticated people in all departments — legal, sharia, management… all of that needs qualified people.

We have confronted the problem on two fronts: training and retaining. To train, we have established a management associate model where we go to top-notch schools all over the world, and recruit only A students. When I talk about A students I mean 3.6-4.0 GPAs, nothing lower. We put them on an intensive program for 2 years until they’re trained, and then we polish and further educate them according to whatever market we feel they best fit into.

The second front is retaining. We have been watching the market very carefully, and we’ve even engaged an international company to study the market for us so that we can see where we stand compared to the rest of the market. Basically, we want to always be in the 50th-to-75th percentile of the market, and we try to maintain and move within that. We do this with action, every Khaliji knows that. For example, if I feel that there is a 20% push upward in the housing element, I will act on that. I will act on that because we have to remain flexible and be prepared to make moves; in the UAE market there is a lot of competition taking place so retaining is a very important issue. Because we are in 102 countries we tend to tap from different markets in the region. We are approaching a fantastic period all over the world. If you look around the bank we have at least 20 to 25 different nationalities, not necessarily just Arabs from the UAE, but Latin Americans, Indians, Pakistanis, Malaysians, and others. Even within the Gulf we have Bahrainis, Kuwaitis, Saudis… We have managed to achieve quite a good mix. That’s one way that we’ve been able to overcome this challenge.

E In your opinion, especially with Emiratization, is the development of human resources the responsibility of the private sector, of banks like you, or of the public sector?

Actually, both. What you see today is a private sector that does the hiring and training, and a public sector that re-hires. That’s always the case, except for a few, very rare cases where people start in the public sector and then move to the private sector. The majority, though, start in the private sector and move to the public especially with the Emiratization trend. There is an issue with Emiratization for each institution. I think we are meeting the issue. We have very strong human resources programs in the UAE. We train Emirati candidates for four months academically and on the job, and then there’s a series of tests that they have to pass. On successful completion of the program, they land full-time positions at the bank. This has been a very successful program here, evident in the hundreds of full-time hires we’ve achieved through the program.

E When Emirates Bank and NBD merged everyone said that this is a new era in banking. Do you think that the synergies are there in the market to say that “yes, there will me more Mergers and Acquisitions (M&A)”?

I think there definitely will be. The Basel II capital adequacy stipulations will really force people into mergers, but what I would like to see here is a more active role for central banks to orient and educate banks about the merits of merging and creating larger entities, versus forcing them to merge because that’s not their job. It should become clearer for local banks that joining hands makes sense in order to survive in the future and to be able to create the activity and growth that they truly aspire to achieve. Having said that, we’ve found that when there is a huge project, the majority of local participants are able to participate thanks to strong capital adequacy monitoring by the UAE central bank and other central banks in the region. In some markets we are even competing head-to-head with larger, stronger banks that have more capital.

Competition is good for our bank; it brings better quality, better customer services, and better customer satisfaction. We welcome competition. We are unique in the sense that we consistently bring value-added products into the region and more often that not we do complement local banks activities rather than compete with them. If we cannot continue to add significant value as a global bank, then we should not really be here. We have to bring expertise, new and innovative products that benefit institutional clients as well as individual customers. That’s what differentiates us from other banks.

E What are the pros and cons of financial sector liberalization? How will banks be affected by liberalization? How do you plan to utilize this liberalization?

We are entering into a new era of economic liberalization at all levels including in the financial sector, and I think the biggest challenge that would persist is the lack of transparency. Today you don’t have immediate access to figures that come directly from the banks. A lot of activities take place and these activities cannot necessarily be translated into a number or disclosed properly. On a macro level, you have chronic issues with accounting for inflation levels and fairly assessing the currency system… these all cause problems in terms of putting raw numbers into strategy models, hence creating an information gap and major distortions. We work very hard and pay a lot of money to find estimations of these numbers. It’s very difficult to find information that can actually help you.

On the other hand, the opening up of the financial sector and other sectors will create huge financing opportunities especially in infrastructure and real estate projects. There is a phenomenal need for financing, and banks have to really work together to handle significant transactions.

For us, there is much opportunity for M&A services and advisory activities here in Dubai and out of Dubai. On the consumer side, liberalization means that we will be able to compete on equal footage with any local bank, so we expect more products and services to be rolled out through an expanded footage.

E What role does corporate governance play in this environment?

Again, this needs an education process. The regulators have to find a way to educate financial institutions on the crucial role of corporate governance and its ensuing benefit. For example the UAE Central Bank and the DIFC are putting a lot of emphasis on corporate governance and they are finding ways through meetings and round tables and discussions to enrich this subject. More of that, I think, will have banks buy into the need to put in place strong corporate governance mechanisms while they go about making money.

Issues such as corporate governance and capital adequacy should not be addressed at the senior executive level only, but should go to the board of directors of the institution who should fully understand the grave implications of a lax attitude. This can be done informally through roundtable discussions or even over casual meetings, not to say more formal gatherings. Bottom line, the subject should be brought to the table as a top priority and a matter of survival. Every bank should start thinking: “I cannot survive in this funny sea, unless I join efforts with another or more banks, or unless I cease my operations. Unless I am very big like a crude carrier, I will certainly sink.” Preparing for the next stage has to be mapped, really mapped, and I think this is exactly what the UAE Central Bank is doing.

E Do you have plans to expand in the region? If so, to which countries, and why?

The Middle East market as a whole is among our top five globally significant markets when it comes to growth potential. We certainly see opportunities across all banking sectors, especially in investment banking and consumer markets.

We now have presence across 10 Arab countries including all of North Africa, Egypt, Jordan and Lebanon. In the Gulf region, we’ve had a presence for the past five decades. In the last two years, we established full-fledged branches in Kuwait and Qatar, while the DIFC is now housing our regional businesses, including Investment Banking, Equities Distribution, and Equity Research covering the MENA region. In fact, we have recently shifted our global Co-Head of Investment Banking, Alberto Verme, to the DIFC, in recognition of this fact. Saudi Arabia is on our expansion list; meanwhile we continue to provide our full suite of global services to top institutional clients in the region include Saudi clients.

E Do you feel that banking regulations in the UAE are growing as fast as the banking industry?

Regulators here tend to be selective and prudent when it comes to issuing new licenses. We certainly do not see a wave of, say, 20 or 30 banks coming to the market every year. Rather, in the past two years we’ve seen only two or three banks joining the banking community and they are mainly Islamic banks. Another new bank is now operating out of the DIFC and regulated by the DIFC’s regulatory body.

E What is your perspective on GCC countries de-pegging their currencies from the US dollar? What is your take on inflation in the region, especially in the UAE, and what are the best policy measures to deal with inflation whether on a macro level or on a micro level, because at the end of the day it will be affecting your customers. What are the policy measures at hand to deal with the inflation problem?

I think they have tried one, and I don’t think it fully worked. They went for a salary increase of 70% to every single government employee. It helped but not enough to match inflation. To the contrary, such an action would eventually contribute to even higher levels of inflation by itself. The only solution is to do something about the currency. That’s a costly solution for the UAE and for other Gulf countries, nevertheless a solution. De-peg and revalue. This could cost money, most likely in the GCC countries whose currencies and a big chunk of their imports and major export, oil, are denominated in dollars. With a sliding dollar and an ever increasing oil price, this is going to be very, very costly.

Another complicating factor is that the ultimate buyer of dollars in this region are central banks who have seen a huge demand for local currencies in anticipation of revaluation. If they contribute indirectly to a weak dollar, they would reduce the value of their own holdings. It’s definitely a dilemma, so central banks, at least here in the UAE, are staying on the message that they will not revalue, full stop.

Meanwhile, an active subsidy system has to be put in place to combat inflationary pressures and to see this phase away. This is of course a sub-optimal solution, but can be part of the ongoing social welfare system, especially with ever increasing oil revenues. If we take the position that the dollar is at bottom levels, then revaluing at this time may not be in the best of the UAE’s interests.

E Let’s talk corporate social responsibility. In what way is Citi Bank giving back to the community? What is the CSR role that is played?

I think this is a good question. We are extremely committed to the community and we do give back in different forms. Ours is a universal CSR model, which aims at empowering all the communities which host us across the world, including those in the region. The best way to do that is to engage in activities where we can contribute more than just checks, but rather expertise and volunteer time.

Financial Education is an extension of what we do every day in more than 100 countries. We provide scholarship funds to deserving university students whose only barrier to achieving good education is financial. This we do across top universities in the region, including AUB and LAU, whereby we take it upon ourselves to provide full or partial scholarships to business and finance students. Meanwhile, a strong system of transparency is put in place to ensure that there is no conflict of interest or any touch of favoritism — as a bank, we do not recommend that so and so student receives one of our scholarships… this violates our compliance rules which are very, very stringent. However, Citi scholars are welcome to train with us in summer time, and once they graduate, we seriously consider them for full time positions with us.

Another CSR avenue is micro-finance. Here, again, we not only provide grants to micro-finance institutions — which in turn disperse them to deserving micro-entrepreneurs — but we do provide banking expertise to help orient micro-finance clients in rural and urban areas in the region about the best ways to access banking resources for improving their businesses. An excellent program that we execute here in Dubai is a women entrepreneurship workshop with the University of Dubai, which educates young women entrepreneurs about building robust feasibility studies for their upcoming businesses. We take an active role in evaluating and improving these studies to stand out when evaluated by banks’ credit officers.

The UAE’s banking sector has recently been crowned the largest market in the GCC by total assets, valued at $336 billion. The IMF believes the “financial system remains sound,” even though external borrowing by financial institutions and big corporations has tripled from 2004 through the end of 2006, reaching $80 billion. The IMF holds back from sounding any alarms, as the UAE’s large net creditor position suggests  there is no reason to worry.

The bursting economy of the UAE is mainly due to population influx, considerable infrastructure projects, and increased oil prices. Mihir Marfatia, author of a Global Investment House (GIH) report published in March 2008 believes, “High oil price revenues are a major benefactor to [the banking sector which is] benefiting from a booming economy.” The increased demand for sharia-compliant banking services is also positively influencing the banking sector.

The US subprime mortgage calamity is a hot topic throughout the global financial sector — yet the majority of banks in the UAE have been unaffected, as according to Fitch Ratings, the “UAE banking system seems to be less exposed to the turmoil than the Bahraini sector, where a number of banks have reported significant losses.” Fortunately, the UAE economy has vanquished most external negativity, allowing its economy to rocket further. Marfatia added that: “These boom times are creating strong investment-led growth, a rapidly expanding population and a recovery in fee income.”

In May 2008 Fitch Ratings released a report United Arab Emirates Banks: Annual Review and Outlook, analyzing the overall performance of the UAE banking sector. Fitch Ratings states that as the banking sector is “benefiting from a benign operating environment and a strong demand for credit, operating profits for most banks grew in double digits.”

Further, GIH brings to light the factors aiding efflorescence of the banking sector: “The considerable project pipeline in the UAE is also providing ample finance opportunities for the Emirates’ leading institutions. In addition, a favorable demographic profile is accelerating urbanization and infrastructure investment, providing impetus for corporate and consumer lending portfolio growth.”

While the banking sector flourishes, there are some factors to be wary of. Fitch Ratings rightfully highlighted that UAE macro-economic indicators suggest “the banking system is highly exposed to risks associated with rapid credit growth, excessive property price increases (and to a lesser extent stock market exposure), and high inflation.” Overall the banking sector is exceptionally robust, but the IMF notes that it faces challenges ahead.

Total UAE bank assets ($ billions)

Key performance measures

Bank performance

At present, Fitch Ratings states that the UAE banking sector “continues to benefit from the buoyant economic environment it mainly operates within.” The banking sector’s net income greatly increased by a healthy 26% year-on-year growth, reaching record highs of $6.53 billion in 2007. Overall, the performance of banks in the UAE “have been very encouraging, with all banks (with the exception of ADCB) experiencing double-digit annual growth in operating income during the year.” The Index of Economic Freedom 2008 reckons that six major banks in UAE account for 70% of total assets. According to Fitch, the net interest of banks operating in the UAE swelled by an average of 26%, and “[for] almost all banks, it remained the main source of income.”

The UAE tops its fellow GCC members, possessing the highest penetration level in the banking sector in terms of assets, loans, and deposits. Abu Dhabi-based investment bank The National Investor (TNI) trusts that such soaring levels of banking penetration “is reflective of the relatively developed nature of banking infrastructure in the UAE.” Between 2003 and 2007, assets to GDP of banks witnessed a sturdy increase from 118% to 180.2% respectively. Banks’ deposits to GDP also saw a substantial increase, from 76.4% in 2004 to a whopping 105.6% in 2007, “and credit penetration, i.e. loans to GDP ratio increased from 75.2% in 2004 to 105.3% in 2007,” reports TNI. Currently, UAE deposit penetration ranks highest among all other GCC nations.

Fitch firmly believes that “banks with domestic retail franchises continue to benefit from increasing demand for consumer credit, where wider margins can be charged.” For example, the National Bank of Ras Al-Khaimah (RAK) bears considerably higher net interest margins than other banks in the UAE.

The banking sector is dominated by the recent birth of Emirates NBD (ENBD), a merged entity of the UAE’s two leading banks — Emirates Bank International (EBI) and the National Bank of Dubai (NBD) — in 2007. In terms of asset size, the merger recently surpassed Saudi-based National Commercial Bank, becoming the largest banking entity in MENA region. (It is imperative to note that the merger is still in its final phases, as EBI is still independently operating in some aspects. Regarding total assets, with $39.5 billion EBI ranks second in the UAE. The last phase of the merger includes de-listing EBI and NBD from the Dubai Financial Market.)

As a necessary trend to follow, bank mergers assist the government’s diversification plan involving colossal infrastructure projects. TNI firmly states that, “size is the key with respect to project execution and scalability.” TNI views the merger as highly beneficial “by way of cost and revenue synergies as well as help the merged entity to fund such large ticket projects at competitive pricing.” Due to an increase in demand growth and corporate and retail loans, Q1 profits in 2008 weighed in at $324.5 million, up 37% from the same period last year. ENBD rules in the UAE with total assets measured at $69.2 billion, and according to TNI are “expected to grow at a CAGR of 21.8% during [2007-2011].” The enormous ENBD amalgam makes competition slightly difficult for other UAE banks.

Coming in third place, the National Bank of Abu Dhabi (NBAD)’s total assets for 2007 rang in at $37.9 billion. Better known as the ‘bank of the Abu Dhabi Government’, TNI notes that NBAD capitalizes from both government and public sector companies. First quarter profits for 2008 rose 45% from the Q1 of 2007, reaching $238.3 million. TNI reports that NBAD should expect a CAGR growth of 20.5% in fee income for 2007-2011. “The thrust towards consumer lending has benefited the bank during the last three years… the consumer loan has increased by 19% to AED14.3 billion [$3.9 billion] in 2007” asserts TNI. At present, NBAD is making efforts to diversify its non-interest income by increasing fee related business. TNI ensures that the bank “is well positioned to benefit from the current economic boom in Abu Dhabi.”

National vs. foreign banks (asset size)

National domination

With a population of 4.5 million and 49 banks, the UAE is rather ‘overbanked’. Currently, of these banks, 22 alone are national banks while the remaining 27 are foreign banks. And let’s not forget the 65 representative offices of other foreign banks throughout the UAE, as well as two specialized banks. Emirates Bank Group highlights that the UAE has “one of the highest ratios of bank branches / presence population.” Although there are more foreign banks than local ones, the latter largely surpasses the former in overall performance. The market share of domestic banks increased from 78.7% in 2003, and by September 2007 had reached 82%.

While national banks are outperforming foreign banks, especially in terms of credit growth, “one might feel that the [domestic banks] must be having a tough time in sustaining the current position in the UAE market,” according to the March 2008 Global Investment House report. More bad news for foreign banks is they are restricted from operating more than eight branches, whilst national banks are not subject to any such regulations.

Though outnumbered, domestic banks have an unbeatable edge over foreign banks. Seeing as there is no homogeneous taxation policy for banks throughout the UAE, national banks are exempt from any tax operations within the UAE. Foreign banks are not as lucky and are subject to a 20% tax on all profits.  The IMF suggests extending liberalization policies to non-GCC foreign banks, thus permitting them to benefit from the thriving economy, as currently GCC banks have the advantage, especially regarding credit growth.

An April 2008 report Exciting Times Ahead by TNI states that internal banks are able to dominate the sector “as they have access to the UAE government surplus funds”.

Although the UAE has been under pressure from the WTO to liberate the banking sector to allow foreign competition, TNI doubts any such action will occur in the near future. But, TNI observes, “local banks are scaling up their operations and are expanding their footprint locally and regionally to combat the increased competition.”

Even more good news for national banks: TNI identified that UAE national banks account for approximately 75% of the banking sector’s total assets. With the perks of government on their side, domestic banks will continue to reign over the banking kingdom.

United Arab Emirates bank ratings at May 2008

Current United Arab Emirates bank government ownership

Inflation on the rise

The banking sector’s most noted challenge to growth is undoubtedly the continuous rise of inflation. The UAE economy was smacked with a 19-year peak of 9.3% inflation rate in 2006, and soared further in 2007 to 10.9%. According to Zawya Dow Jones, inflation velocity is expected to surge to possibly reach a dangerous height of 12% in 2008. Investment bank Merrill Lynch cautioned that such a staggering increase is unavoidable “unless the dirham is re-valued or de-pegged from the US dollar.” The UAE government is bravely attempting a target of 5% inflation for 2008, but in reality this goal is acutely unattainable.

The UAE’s endeavors to fight inflation involve tightening monetary policies and cutting interest rates. Given that all GCC currencies have been pegged to the US dollar since 2003, shielding options are rather restricted as central banks of the region are required to emulate the US Federal Reserve’s policy.

In line with Federal Reserve reductions, Central Bank of the UAE (CBUAE) cut its discount rate in 2007 and “is expected to continue to move in step with US dollar rates, given that the UAE dirham/dollar currency peg still holds,” according to Fitch Ratings. What’s worse is that “high inflation has put the peg under pressure, and Fitch expects that any potential revaluation of the currency would be coordinated with other GCC states, as preparation for a GCC currency is still ongoing,” albeit, Fitch subtly notes, “the official target date of 2010 looks unlikely.”

At a time when, according to OBG, the “US economy’s fundamentals are precisely the opposite of the Gulf’s,” the dwindling muscle of the dollar has jeopardized the ambition of a GCC monetary union by 2010. OBG notes that “the varying effects of the weak dollar and the high price of oil have strained solidarity among the [GCC] members.”

Mohsen Khan, IMF Director of the Middle East and Central Asia believes, “At the moment, since inflation is not driven by dollar depreciation, focusing on de-pegging or revaluation is not the solution.” Contrarily, other financial experts consider that by making imports more expensive, the dollar peg plays a key role in driving inflation rates in the UAE as well as throughout the GCC as a whole. The paramount downside to revaluation, explained Khan, is that Gulf states risk suffering approximately a $400 billion loss in their holdings value, “if they were to revalue by [only] 20%.” Without a doubt, CBUAE needs to create an anti-inflation strategy in order to tackle the banking sector’s primary dilemma. 

Transparency concerning the veridical level of inflation in the Emirates is rather limited. In February of this year, the government of the UAE revealed it intended to kneel to long-term pressure imposed by the IMF and agreeing hereafter to publish a monthly consumer price index (CPI) rating. “However,” the Oxford Business Group (OBG) notes, “there is some debate as to whether the CPI basket currently used will give an accurate reflection of the true picture for UAE residents. Economists say up to 50% of local inflation is directly attributable to increases in rents, whereas the basket allocates only 36%.”

Country forecast

Basel II

As of January 2008, banks operating throughout the UAE were required to implement Basel II, a standardized regulatory accord to credit risk. The CBUAE has worked alongside UAE and other GCC banks in order to efficiently utilize the principles “giving due consideration to points of national discretion under Basel II.”  Fitch Ratings believes that the 2008 implementation of Basel II “has had a moderately negative impact on most banks’ capital ratios given the charge for operational and market risk.” Under the auspices of Basel II, the large UAE banks “are aiming to maintain capital ratios… at 12%-15%,” considered sufficient by Fitch. In the big picture, Basel II should aid transparency regulations as well as management of credit risk.

Forecast

Mainly thanks to mammoth infrastructure projects, real estate investments, expanded bank investments, high oil prices, monetary liquidity, and consumer spending, the UAE banking sector has seen vigorous growth. TNI trusts that the “contribution of UAE’s banking assets to the aggregate GCC banking assets as at end 2007 stood at 40.5%.” Fitch reports that UAE banks will continue to enlarge their branch networks in order to “remain competitive and attract retail customers.” With Emiratization efforts being made, talented UAE nationals are being urged to join the banking sector. Many banks are providing programs aimed at informing new graduates of the new developments, issues, and services of the banking sector. With such opportunities, the banking sector is only sure to flourish from here on out.

TNI expects collective assets of UAE banks (specifically ENBD, NBAD, Abu Dhabi Commercial Bank, Mashreq Bank, RAK, First Gulf Bank, and Union National Bank) to increase at a compound annual growth rate of 20.1% in the coming four years. Profitability is predicted to persist “in 2008 at broadly the same levels as in 2007,” given the UAE’s propitious operating environment.

Although tackling inflation is a challenge for UAE banks, their performance is rather stellar. Sallie Krawcheck, CEO and Chairman for Citi Global Wealth Management believes that the “best is yet to come in the Middle East… and the UAE is making quite a significant impact on the global economy.” The future of the UAE banking sector looks exceptionally positive, and trends of profitability are expected to remain sound.

E What are the top three most challenging issues CBD faces today? How can they be solved?

Without hesitation, I think that the number one issue is hiring and retaining quality employees. The business has been growing at such a fast pace; CBD as an example has been doubling its business in the last 18 months. New banks have been established, and UAE nationals in particular are in high demand. There is a responsibility for all banks to recruit, train and retain them, but it’s not easy as there are so many good opportunities for young people entering the field.

Another important challenge is inflation. I believe that inflation, more and more is becoming a critical issue, and it’s become more difficult to control imported inflation. The UAE does not have an independent monetary policy as it is following the US in relation to the dollar-peg. Fighting the double-digit inflation in the UAE with a 2% interest rate is very difficult. Inflation affects peoples’ daily budgets and it means that debt-service ratios are no longer representing the appropriate level at which people can actually bear debt and repayment of debt.

When people came here a few years ago, there were good opportunities to save, in particular for foreigners; today it’s getting more and more difficult for people to actually make ends meet. For companies, the cost of doing business has increased significantly, and imported inflation is partly responsible.

E Human Resources are a continuing issue for regional banks. How does CBD ensure to acquire and retain highly qualified staff and management? What internal training programs does CBD have? Do you have programs supporting Emiratization?

Let’s start on the level of management and leadership. About 18 months ago we deliberately started a very innovative leadership development program where we complete 360-degree reviews of our managers. We supply direct reports to give input to the managers — how they felt about the climate, how they felt they were supported in their career development, in their jobs, in their personal growth. Based on this, we’ve organized workshops where the top 75 managers of the bank are trained in applying different styles of leadership depending on the environments and the situations they are faced with. We emphasize that there are different leadership styles which can be applied in different situations and, as a good leader you need to be able to use those styles when they are required. The changing leadership culture has a major impact on the people working in the different departments.

Second, training and development of people is a very important element of our Emiratization drive. We have extensive training programs set out for both internal training as well as external training. We have an entire floor of our building completely dedicated to training, not only training of our own people, but also external young Emiratis. We train them just to make sure that they are prepared for professional life in society. It is partly a social responsibility, and partly our own teams that are being trained.

Emiratization is an important issue for us. We have one of the highest Emiratization rates of all banks. We gave special attention to ensure that when young UAE nationals come to our bank we prepare them though induction programs for each level, ranging from those with a high school diploma to university graduates.

Another element is the right incentives. We are one of the few banks that have introduced long-term incentive plans for the top layer of our bank. We have KPIs — Key Performance Indicators — objectives that actually cascade down to the lowest level in the organization. It’s relatively easy to do that at the top level, but at the lower levels it’s complex to measure; it’s complex for people to understand what the KPIs are and how they are measured objectively. We went through the process and I think it made people feel more engaged with what the organization is all about. This serves to provide very clear alignment and much more transparency in terms of why some people receive a higher bonus, or a higher salary increase than others.

When Emirates Bank & National Bank of Dubai merged everybody said it was the start of the mergers and acquisitions (M&A) phase in UAE, and that it was in preparation for the liberalization of the market and the penetration of the big banks like HSBC or City Bank, which were expected to become much more aggressive once the market liberalized, but then nothing happened…

I tend to disagree with what everybody said. Typically, in the West, mergers are driven by a desire for higher returns or more efficiency.  Here, if you look at the efficiency ratio or cost to income ratio of banks, we’re talking typically between 30-35%. If you look at Europe, banks are typically between 60-65%, so banks here are already quite efficient.  Then, if you look at the returns, a return equity of 20-25%, which is higher than the returns in the West, is not unusual here. So, it’s not yet the time for shareholders to look at mergers from that perspective.

However, I do believe that Emirates and NBD have set a very important example in the region, as we now need larger banks. One of the reasons is that our projects are becoming larger and larger, and the region should be able to depend on its own banks to a large extent.

If I look at the years to come, I do believe that in the next two to three years we will see a fair amount of consolidation. The Basel II requirements, the corporate government requirements, will require higher degrees of professionalism and for smaller banks it’s difficult and costly to achieve that on their own.

E Lebanon is a small country where banks have much smaller assets, and obviously less profitability. They are able to expand and to penetrate new markets whether it’s in North Africa, or Sudan, or other parts of the region. But we haven’t seen this yet with huge banks in Emirates for example. How can one explain this?

We must look at this from both sides. Let’s start with the GCC side: the returns here are still so high, and the market is growing at such a rapid speed, there is a lot of business for everybody. So the incentives to look outward are not as strong as they are in Lebanon. The Lebanese market is a very peculiar market. It’s a relatively small market and you have a lot of very good banks with well-trained people. Realizing that their market is relatively restricted, Lebanese banks have been innovative in going out into markets that show higher-risk profiles, but because of the depth of the management that many Lebanese banks have, they are able to mitigate those and do profitable business.

Eventually, I believe we will see cross-border mergers and acquisitions in the region, but typically the case is that first we’ll see consolidation within the country, and after a strong entity is established we’ll see cross-border mergers.

E In an increasingly competitive environment, M&A strategically benefit most banks. Is CBD planning to merge with any banks in the UAE?

I think every CEO of a relatively large bank, as part of his agenda, must look at inorganic growth, in other words, acquiring. CBD, because of its shareholder structure, is very keen about keeping destiny in its own hands. We would like to be on the acquiring side.

For us, it’s important to see that what we acquire will fit our strategy. If we execute an M&A transaction, we should then be able to export the specific knowledge and the specific strength that we have into any entity that we acquire. It’s not about just expanding, we have a very distinct strategy that is about family-owned business — both middle-sized and large-sized — it’s about wealth management. We service, through wealth management, the owners of these family businesses and the management of these family businesses.

E What are the pros and cons of financial sector liberalization? How will CBD be affected by liberalization? How does CBD plan to utilize this liberalization?

Liberalization is a good thing. It will bring all of us to a higher level, and it forces us to provide better quality service to our clients. When we have international banks coming in it just means we have to work a little bit harder to ensure that we provide service that is comparable or better in terms of quality. I think liberalization will bring better personnel, more professionalism, better client service, and more competition. I do believe, however, that there are distinct client sectors that national banks will focus on, and distinct client sectors that local banks will focus on.

E What does CBD believe are the best policy options to fight the increasing inflation rates at present?

Apart from the monetary policy mentioned before, I would say that the short supply, high demand, and liquidity have increased inflation. Now, what do we do as a bank? In terms of judging credit risk and looking at the capabilities of people to repay, we are very clear about not wanting to bring people into financial difficulties. Our consumer lending is relatively conservative and that’s not only to protect the bank, but also to protect our clientele.

Regarding our corporate clients, it’s about making them aware of what’s happening around them; making them aware of what’s happening to their suppliers, their buyers, and the market as a whole. It’s really about understanding the business, being a good business partner, and advising the business owner. We feel that this is an added value to the relationship, which is why we often become the main bank for many of our clients.

E How is CBD giving back to the community? What are the CSR initiatives you are supporting & why?

We are a bank that has been here for nearly four decades. We are really an integral part of society. We have a strong desire to achieve and maintain a high Emiratization ratio, not just to meet the numbers, but to make sure that we prepare UAE nationals for careers within our bank as well as outside. Even if people leave us, hopefully they will have had a good experience and they will come back to us as clients at the end of the day.

It’s about making sure that we give back to society through that. We don’t advertise this, but we have been a very significant contributor to the Dubai Cares Program; we’ve contributed 20 million dirham [$5.45 million]. Moreover, we have for many, many years contributed to a large number of organizations which help disabled, orphans and underprivileged. It’s not just about giving money, it’s about really participating. I am very proud to say that our staff actively participates in blood donation programs in a stand against poverty. It creates engagement — it makes people feel more connected to their bank. 

E What are the keys to strengthening the institutional framework of the banking sector in the UAE? To what extent are Basel II and WTO implemented throughout the regulatory framework of CBD?

More than ever, the need for a fast implementation of Basel II has been proven by what has happened in the US subprime crisis. Basel II is not only about compliance with the rules, it’s about improving risk-management capabilities, improving risk-management awareness within the banking sector, which is very important. Many of the central banks in the region are quite proactive and I think that banks have been given the proper timeline to adjust to it.

E What role does corporate governance play in CBD?

We are very keen to follow corporate governance guidelines. We have very clear internal controls in place, which ultimately ensure that the financials that we publish as a company are indeed transparent and are projecting reality. I think the transparency aspect is particularly important in the corporate governance guidelines because we have many shareholders and we don’t want to privilege the larger shareholders over the smaller shareholders. CBD has always been one of the first to come out with the quota results; we’ve actually won awards for that. We have a committee within the bank that has been implementing corporate governance according to the standards and regulations that have been issued.

E Does CBD have plans to expand regionally and/or internationally? If so, to which countries, and why?

Every CEO, particularly of the most significant banks, has been looking at expansion inorganically as well as organically. I think the priority for us would lay first within UAE because a lot of opportunity remains in UAE, and the returns are still significantly higher here than other parts of the region. We also scan the market internationally, but at this moment there is nothing specific that we are looking at. Whenever you have an expansion strategy you must be ready in terms of depth of management, and if you buy a stake in a bank you must make sure that it fits into your strategic framework.

E What is CBD’s perspective on GCC countries de-pegging their currencies from the US dollar? How will valuation against a basket of currencies affect CBD?

In all fairness, de-pegging is not really the discussion, the way I see it. The discussion is much more about monetary policy. I can understand that if you have a lot of your assets invested in dollars you don’t want them to devalue from one day to another, so I appreciate why certain governments have expressed their reluctance. However, to have an independent monetary policy in a country that’s going through a strong growth phase is important. You cannot follow the same monetary policy of a country that is sliding into recession or already is in recession, that being the US. For me, de-pegging is a little less important on the agenda than monetary policy.