Banks in the Middle East have reported a mixed performance for 1994. Of the Gulf institutions which have announced results, more than half show higher profits than 1993, and two-thirds have increased the size of their balance sheet. But the picture for profitability is less rosy. Only 16 of the 30 banks represented in the table compiled by MEED showed an improved return on assets (see pages 21 & 23).

By the standards of 1993, when only a few institutions failed to increase earnings, last year was a demanding time for Middle East bankers. Tumbling bond markets, volatile equities and, closer to home, low oil prices, created a challenging environment. And 1995 is unlikely to offer any immediate respite. Capital markets are recovering slowly and governments are keeping all spending on a tight rein.

Yet, the changing climate in which banks are having to operate is also creating new opportunities. As the state beats a retreat, the private sector is going on the offensive, and fuelling demand for capital. Privatisation, which is being considered with ever more seriousness, will open the way for arrangers and financiers. And, as the flush years of the oil boom era fade from memory, Gulf savers will be looking for higher returns from their funds than the simple interest earned by leaving money on deposit.

From the start, 1994 promised to test the skills of the best financial institutions. As the recovery in the US and European economies gathered pace, interest rates started rising once again. In response to the rise, bond prices went into a tailspin. In the frenzy of trading that ensued, stock markets around the world came under pressure. This hit those institutions with active trading departments and exposure in the securities markets.

Offshore investment banks were among the worst affected. Gulf Investment Corporation, and its wholly owned subsidiary Gulf Investment Bank, reported a sharp drop in profits and profitability. Investcorp, the Bahrain-based institution, reported a 24 per cent drop in profits, due to losses by its proprietary trading unit. In response, Investcorp concluded that the risks were unacceptably high for the size of the institution and dismantled its derivatives trading department.

Arab Banking Corporation, which continues to dominate Gulf-based institutions in balance sheet terms, also reported lower profits because of adverse conditions on international markets. However, the bank has also had to contend with other challenges. In February 1994, the bank’s founder, Abdullah Saudi, announced his resignation with effect from the following May. The former head of Riyad Bank, Ahmed Abdellatif, has since been appointed president and is expected to take up his post in April or May this year.

It was not only the offshore investment banks that found themselves exposed to global market turmoil. Several commercial banks, particularly in Saudi Arabia, reported a sharp drop in earnings from trading in securities on international markets, where the banks had placed substantial sums. The banks found their spreads decreasing and their ability to fund fixed interest deposits was reduced as the value of floating rate investments fell.

‘The differing performance relates to the differing investment profiles of the banks,’ says the head of one leading Saudi bank. ‘Some were less prudent than others. Those banks that invested in the Saudi Arabian and US markets, probably did better than those that invested in European markets.’

New lending opportunities in the kingdom have narrowed as government spending, the major engine of economic growth, has been trimmed. Many banks have only managed to increase their loan portfolio by lending more to existing clients to help them bridge gaps in their cash flow. Cash shortages have developed because of protracted delays in government contract payments.

‘Lending in 1995 will probably be very slow. Bank deposits are not growing so there will be some reluctance to increase the loan to deposit ratio,’ says one Riyadh-based banker. He says banks will have to rely on the interbank market for asset growth, but most banks are cautious about expanding their exposure in this manner. Yet, Saudi bankers also note a number of new lending opportunities that should develop this year, particularly in the petrochemical sector.

Saudi American Bank turned in the strongest performance for 1994 of all the Saudi banks, becoming the first bank in the kingdom to announce profits of more than SR 1,000 million ($267 million). The bank attributed much of the increase to higher earnings from fee income. Private banking and corporate finance services should generate further increases in fee income in 1995.

It is a similar story elsewhere with rises in fee income accounting for the higher earnings at many banks around the region in 1994. The UAE, where banks fared better than most last year, was no exception. The seven emirates have a diversified economy and activity remained buoyant despite the uncertain outlook for oil prices. But federal government spending has been frozen for the past three years and the UAE’s highly liquid banks have had to work hard to find new business.

‘There is a limit to the amount of fee income that can be generated in the Gulf at present,’ says Brian Fredericks, senior manager in the UAE for The British Bank of the Middle East. ‘There is more liquidity than quality business.’

One feature of the changing environment in the region is the growing sophistication of investors who are demanding better returns and a greater variety of investment vehicles to choose from. Both the retail and the offshore investment banks are having to work harder to cater to this demand.

‘Banks have got to get back to the basics of identifying who their clients are and producing the products that they want,’ says Robin McIlvenny, general manager of Bahrain International Bank. Few Middle East banks can compete with the comprehensive range of investment products offered by the major international institutions. However, BIB has concentrated on products specifically directed at Gulf investors, and more banks are turning to similar strategies.

Many of the banks’ traditional clients are also changing. As the restrictions on government spending become more apparent the private sector has every opportunity to expand. And, over the next decade the privatisation process should create new entities with new financial needs. Privatisation is still some way down the agenda in most Gulf states, but the sell off of state assets is already having a distinct impact on the banking sector elsewhere in the region.

‘Banks in Egypt have become much more competitive than five to ten years ago,’ says Mona Yassine, a vice-president at Citibank in Cairo. The state banks still dominate, but competition among them has intensified. State banks and private and joint-venture institutions are now becoming a force for innovation. The banks are in the vanguard of the economic changes underway in Egypt, responding to the new demands of investors and creating new consumer products ranging from mortgages to investment funds. They are also preparing to provide more project finance as fewer major schemes can rely on the state to see them through.

Capital market development should also become a force for change in the banking sector. Companies that were once able to borrow money, often at rates fixed below inflation, are now looking towards the equity market to fund capital increases. ‘Corporates have changed the structure of their balance sheets to reduce the need for borrowing,’ says Yassine. ‘We are starting to see banks shifting from traditional lending towards the securities market as evidenced by the two recent bond offerings.’


Egypt also highlights a perennial problem for the banking community in many Middle East countries – overbanking. The Central Bank of Egypt has raised the capital requirement for local banks to £E 50 million ($14.7 million) in an attempt to strengthen the sector.

‘While it was expected that smaller banks would merge or be acquired by larger banks, most of them chose to increase their capital instead,’ says Yassine. ‘I think mergers or acquisitions in the banking industry make more sense because of the evident synergies.’

Similar observations can be made about the status quo in the Gulf. In Kuwait, the central bank has made clear that it wants to see the emergence of fewer, larger banks. But here too there has been a muted response. ‘As long as the central bank supports small banks, it takes off the pressure to merge,’ says the head of one of Kuwait’s largest institutions. ‘I don’t see voluntary mergers, quite frankly.’

Margins for Middle East banks are being squeezed and traditional markets are being transformed. No longer can Gulf banks rely on an inexhaustible flow of undemanding depositors, nor can they expect the easy returns that were generated when the region’s economies were posting double digit growth rates. But as the competition to provide capital heats up, those closest to their clients and catering for their growing demands can still expect a healthy return.