Speaking at the MENA Economic Forum in Kuwait in November 2007, Ibrahim Dabdoub, CEO of the National Bank of Kuwait, declared that the “Arab banking landscape is being transformed” by the four horsemen of globalization, liberalization, technology and staggering regional growth. He noted that from now on, banks would have to prime themselves for competition and should seriously consider consolidation. “Success,” he said, would mean creating an ideal “economic, financial and institutional environment.” His words are as good a blueprint as any for the GCC banking sector in 2007.
Historically slow growth
Historically, conditions have stifled growth for Arab banks, but this is no longer the case. At the turn of 2007, the Arab banking sector finds itself, at last, in an environment conducive to sustained investment and strong economic activity that should persist until 2010. What has prompted this about-face? Among other factors are strong growth fundamentals, high liquidity and genuine moves to diversify and reform. And while oil prices remain high, there will be demand for lending as new and ambitious real estate developments are announced—and built—at a staggering rate. Both assets and revenues are set to increase, propelled by IPOs, bullish stock and property markets.
As profits boom, the new areas are emerging with strong growth potential. These break down into two categories: those that are already gaining momentum and those that show promise. In the former, there are new opportunities for corporate banking in an “energized” private sector and the financing of real estate projects, given the thriving commercial, office and residential markets. There’s also Islamic banking and brokerage and investment services as sectors to watch. In the “promising” category are on-shore private banking and wealth management services, as well as investment banking, which should accelerate as more family-owned businesses go public, new industries expand and private equity moves across borders. Finally, look for substantial prospects for financing oil, gas and infrastructure projects.
Nonetheless there are always challenges—maintaining bullish performance—and threats—bubbles and geopolitical risks in a region known for its turbulence. As local competition intensifies, weaker banks tend to move towards speculative lending without putting the necessary risk-reward structures in place. Capital markets are increasingly being used as alternative sources of financing; likewise, investment funds have begun to overtake low-cost deposits. Meanwhile, fiscal reforms and labor policies may actually have a negative impact on a low-cost sector that is already feeling the bite. Just as worrying is the threat that the technology sector, the WTO and market liberalization will open up profitable business segments to foreign banks that can, in turn, pick off local customers already looking for higher-quality service and better performance.
Attention should be paid to the underdeveloped regional operating environment, where the combined assets of all Arab banks are less than the total assets of Barclays Bank PLC. The environment is further limited by numerous structural weaknesses. A low spending capacity for development has held back innovation. Compared to their international counterparts, GCC banks invest relatively little in tech, and the regional human resources pool lacks real and sustainable talent. There is also an excessive dependence on interest income, while risk management and corporate governance remain weak.
Banks are employing a variety of strategies as they forge ahead, however. Some have sought out mergers with larger partners, while others have exploited niches such as Islamic and private banking to diversify revenue streams; as competitors seek to differentiate themselves, some banks have integrated strong IT platforms and process control. Furthermore, the culture and concept of corporate governance is slowly beginning to work its way into the banking consciousness.
New problems arise
However, these developments have spawned a new set of structural problems. They include speculative lending by smaller banks and an excessive number of new banks emerging that are liquidity-driven, rather than predicated on a real business plan or strategy. Meanwhile, effective asset and liability matching and large dividends in an era of rising capital requirements are also a concern. Also, in banking, at least, size does matter: smaller banks quite simply cannot compete with their larger, often foreign, counterparts. These competitors are financially stronger, better-equipped to absorb and diversify risk and technologically sophisticated, with a greater ability to innovate. They can also hire better bankers, often importing professionals from abroad—and raiding the best employees from local banks. In addition, several niches may prove vulnerable, such as private banking and wealth management, areas that offer new options to businesses that previously kept their wealth onshore.
With an ever-broader array of choices and products, customer loyalties in the Arab banking sector are set to be tested. Technological advances now offer customers greater options—and flexibility—in where they bank, and foreign banks tend to provide better access to capital markets, as well as strong experience in wealth management. These factors, especially in conjunction with generational transfers of wealth, could lead many customers to abandon longstanding family ties with local banks and move their business to more competitive foreign branches.
So what must Arab banks do to compete? First of all, they must recruit and train better-quality staff—from abroad if necessary—and improve their tech infrastructure. They also must be able to offer objective, comprehensive assessment of risks and rewards while coming in line with internationally accepted standards of corporate governance.
Banks must improve in order to compete
Success will also hinge upon improving core banking business, offering broader product lines, better advising services for clients, and strengthening their brands, in addition to improvements in the three most basic determinants for customer satisfaction: lower prices, better service and a higher level of convenience (both through wider branch networks and online banking services). Local banks should also play to their strengths, and highlight the value-added they can bring to the table, such as local market and customer knowledge and offering tailored services and products.
Much like the consolidation trend among Western banks in the 1990s, which saw the formation of “mega-banks,” Arab banks must also expand geographically, buying or merging with other banks in the region. To do this, governments and regulators should play an active role in ensuring the vitality of Arab banks by supporting the consolidation process across the region. However, they must be equally vigilant in preventing mergers that would create banks with too a large market share, threatening the stability of the sector, as well as those that could give foreign banks control over domestic sectors. They should introduce supervisory methods that suit new, larger banks, update local legislation on mergers and reform labor policies regarding layoffs as merged banks seek to maximize efficiency and productivity. Banks should also change their attitudes: acquisition targets have become limited due to the undervaluing of shareholders, paired with the tendency of controlling shareholders to overvalue their independence. Misplaced national pride and even tribalism present further challenges to expansion.
In addition, more basic issues also need to be addressed as banks eye the regional market. The Arab banking sector needs a degree of homogenity, especially in terms of labor, management, corporate governance, accounting standards and tax laws.
Yes, as Dabdoub said, the future competitiveness of Arab banks ultimately depends on the achieving the optimum economic, financial and institutional environment. This must be coupled with macroeconomic stability, bringing fiscal reform, privatization and market liberalization drives. In addition, more vigorous financial regulation and supervision must be implemented, to foster the kind of enabling institutional atmosphere banks need to operate effectively: a legal framework, a culture of corporate governance, genuine transparency and disclosure as well as greater emphasis on education and labor market reform.
Time will tell … but the clock is ticking.
