THE trend for mergers and acquisitions among banks is more of a trickle than a wave, but it is likely to swell from now onwards. Arab governments are starting to realise that if they want to benefit from free-trade agreements like the World Trade Organisation, they will have to reciprocate by lifting restrictions on foreign banks in their domestic markets. Many Arab bankers also believe that open markets are on the way, which is why big banks - with the encouragement of regulators - have begun to bolster their capital and market share by buying up smaller ones.

Even where there is no direct threat from foreign banks, the growing integration of the world's financial markets in recent years has led regulators in the Arab world, as elsewhere, to insist that banks strengthen their capital. This puts pressure on smaller banks, which find it harder to raise the extra money. They are also facing the rising costs of new technology and hiring specialists for new business lines like investment banking and fund management. 'On the one hand, you have the drive for synergy, and on the other, the market pressure and incentive for banks to sell,' says Bassam Yamine of Lebanon Invest, an investment bank which advised on the merger of Byblos Bank and Banque Beirut pour le Commerce (BBC), agreed in December.

Few things happen fast in Arab banking. Many banks are controlled by governments, which are usually committed, in theory, to privatisation and free markets, but tend to move very cautiously in practice. Many other banks are owned by business families who are reluctant to give up any of their influence unless they have to. This all tends to mean that changes in the structure of the industry are sporadic and slow.

Nonetheless, a sprinkling of mergers and takeovers in the last year suggests that a trend may be taking shape. Apart from Byblos Bank, Lebanon's Banque Audi has also been acquiring smaller banks or their assets, while several banks in Jordan are believed to be planning to merge. Two of Saudi Arabia's banks merged last summer to create a new institution, the United Saudi Bank (see page 16).

There have also been a series of cross-border acquisitions, usually funded from the deep pockets of Gulf Arab investors. The biggest of these was the purchase of Credit Libanais last summer for $163 million by a group of investors led by Khaled Bin Mahfouz, the chairman of Saudi Arabia's National Commercial Bank. Other Gulf investors content themselves with a minority shareholding: Dubai's Emirates Bank group has just bought 10 per cent of Bank of Beirut for just under $20 million.

Acquisition is a strategy used by some big banks as a way of widening their regional network. Credit Agricole-Indosuez, the giant French banking group, has been competing against Arab Banking Corporation and Kuwait's International Investment Group, a small Islamic finance house, to buy an Egyptian bank. Despite the fact that Egypt has dozens of small banks, there has been little consolidation so far. 'Banks are trying to consolidate their balance sheets by raising capital and issuing bonds. The merger concept hasn't really caught on in Egypt, especially among the banks,' says Yasser al-Mallawani, managing director of the Cairo-based Commercial International Investment Company (CIIC), a subsidiary of Commercial International Bank (CIB).

When two Arab banks come together, the transaction is usually described as a merger. However, a close look reveals that most of them are in fact takeovers of small banks by bigger ones. Arab banking analysts tend to explain this as a first stage of consolidation, when small and weak players retire from the field. If competitive pressures get more intense, bigger banks could join forces in future, either by merging or by forming strategic alliances. A complementary explanation is that takeovers are simpler to manage than mergers, because one bank has a free hand to impose its way of doing things on the other. 'Takeovers are easier because you don't have to change the culture of both banks, only of the one that is taken over,' says Mallawani.

Although the merger trend may be growing, consolidation among Arab banks has a quieter, more sedate character than the thunderous mega-mergers that have convulsed the ranks of global banks in the West. Most of the Arab banks themselves are small and their shareholders usually have a distaste for publicity. Difficult issues are negotiated in private, as the two sides try to work out a deal that keeps everyone happy. Speaking of the merger between United Saudi Commercial Bank and Saudi Cairo Bank that created United Saudi Bank, Riyadh-based accountant Shadi Sanbar says: 'I think Saudi businessmen know the sensitivity of these things and go out of their way to make sure it happens in an orderly and friendly way.' Sanbar is a managing partner at Arthur Andersen, one of the new bank's two auditors.

In small economies, where business relationships are often very personalised, banks do not want to stir up needless hostility by shouldering their way into takeovers. Even if they wanted to, local stock markets are often too small or illiquid to make it easy for a predator to buy up the shares of its quarry. This means that a merger or acquisition has to be carefully and tactfully negotiated. It also means that it is harder for foreign investment banks or consultants to act as intermediaries on deals in countries like Lebanon.

'The deals are too small for them,' says Lebanon Invest's Yamine, who argues that foreign players also lack the detailed local knowledge needed to negotiate an M&A transaction, and may find it harder to win the trust of owners who are wary about revealing sensitive information about their banks. 'The relationships we had with both Byblos Bank and Banque Beirut pour le Commerce really gave a lot of comfort to them. You have to remember that psychologically this is a major, major issue. There is a lot of ego and a lot of history involved.'

Arab governments seem to be becoming more supportive of mergers between banks, though the strength of this support varies from country to country. Some, like Lebanon and Oman, offer such incentives as tax holidays or low-cost deposits to newly-merged banks. Some central banks have increased capital adequacy requirements for banks, as in Lebanon, Jordan and the UAE, though in the last case this has not led to any small banks being taken over. 'Given the upward trend in the UAE economy where all the banks have been showing improvement in their performance, mergers will not be in the offing in the near future,' says Khalifa Hassan, managing director of Abu Dhabi Commercial Bank. ADCB, a state-controlled institution, is itself the product of a merger between three troubled banks in 1985.

One issue which tends to make governments touchy is jobs. In the Gulf, banks mostly employ expatriates, but are supposed to steadily increase the proportion of nationals among their staff. Banks that want to merge have to make sure that they win permission from the authorities before making local staff redundant. 'It's to do with functionality, but more foreigners than locals will go,' says Karl Swoboda, general manager of United Saudi Bank. 'It would be foolish to make sure that more Saudis [lose their jobs] than foreigners.' The merger will make about 200 people redundant out of 1,200-1,300.

On the plus side, there is a shortage of trained bank staff in the Gulf, which should make it easier for redundant employees to find new work. The jobs problem may become more of an issue in other countries where governments are wary of upsetting public opinion by allowing widespread redundancies. The prime example of this is Egypt, where the four big state- owned banks are widely seen as heavily overstaffed, though labour laws, which currently favour workers' rights, are being revised to give more power to employers.

It is not clear which parts of the Arab world are going to be the most affected by consolidation. The three countries with the largest numbers of small banks are Lebanon, the UAE and Egypt. The process has already begun in Lebanon, but has yet to touch the other two countries. There has been one merger in Jordan, and a new investment bank has been set up by London-based financier Faisal Kudsi and former central bank governor Said Nabulsi, among others, to act as a catalyst for future deals. There has been talk for years about mergers in Kuwait, but previous attempts have all come to grief for reasons that remain obscure. The consensus seems to be that there will be at least a couple of mergers in most other Arab states in the next few years.