THE dominant theme of Arab banking in 1998 is likely to be consolidation, in the form of mergers or takeovers between banks. Smaller Arab banks in particular are coming under pressure to merge, because of increasingly strict central bank rules on capital levels and because of the cost of updating technology and hiring expertise to keep up with competitors. The pace of consolidation, which has always been slow, speeded up sharply in the second half of 1997 with a series of mergers. More are likely in 1998.

Consolidation can take different forms. Banks of roughly equal size can combine, as with the United Saudi Commercial Bank/Saudi Cairo Bank merger of September 1997. Big banks can take over small ones, as with the various purchases of small Lebanese banks by larger competitors like Banque Audi or Byblos Bank during the year. Or a well-capitalised bank or group of investors in one country can take control of a bank in another, as when a group of investors led by Khalid bin Mahfouz of Saudi Arabia bought Credit Libanais for $163 million during the summer of 1997.

Consolidation is likely to be powered by the capital of Gulf Arab investors. The countries where further mergers or takeovers seem most likely during 1998 are those with numerous small banks and/or relatively liberal banking regimes, such as Lebanon, Egypt, Jordan and possibly the UAE. Mergers have also been talked about in Kuwait.

Privatisation is also likely to speed up in some places. During 1998, Egypt is expected to sell a minority shareholding in one of the four state- owned banks which dominate the local market. Most people expect it to be Bank of Alexandria, the smallest of the four. Further away on the horizon, there could be a greater role for the private sector in some of the regional banks based in the Gulf, like Arab Banking Corporation, Arab Petroleum Investments Corporation or The Arab Investment Company.

Most Arab banks are commercial banks. As yet, there are few Arab investment banks and almost none with the ability to operate in more than one country. This will change in 1998: more investment banks will be set up to cater for niche markets like mergers and acquisitions or Islamic finance, while big commercial banks build up their own investment banking capacity. Some Gulf Arab banks, notably National Bank of Kuwait, National Commercial Bank (Saudi Arabia) and Emirates Bank International (UAE), have already dipped their toes into pan-Gulf capital market activity, and more are likely to follow.

At the same time, the growing demand for infrastructure and industrial financing will require banks to find stable sources of medium-term funds. This means that more banks are likely to issue bonds with maturities of up to five years or even longer. Some will be tempted to bolster their capital with international share issues, adding to the six Arab banks which had European stock market listings at the end of 1997.