The balance of power in the GCC banking sector is shifting. For years, Saudi Arabia was by far the biggest market, with the largest assets and the highest profits. But this is about to change. Rapid growth in the UAE means it is set to eclipse Saudi Arabia as the region’s biggest banking sector by assets some time in 2008. Including the assets of foreign banks held in the UAE, it already is the region’s biggest.
Saudi Arabia’s role as the regional banking champion is being challenged on two fronts. Not only are the country’s rivals gaining ground, but Saudi banks are also still struggling with the effects of the collapse of its stock market in 2006. Profits at the majority of Saudi banks have been down through the first nine months of 2007, and several banks are expected to report continuing declines in the final quarter of the year.
The UAE in particular is capitalising on the sluggish performance in Saudi Arabia. Strong economic growth and a less restrictive regulatory environment have led to Emirati banks outperforming the region in terms of growth in the size of their loan books and assets.
They have lent more money than any other GCC country, while deposits have more than doubled to about $155 trillion - nearly the same level as in Saudi Arabia, despite the kingdom having 20 million more people.
In terms of individual institutions, Saudi banks account for seven of the top 20 banks in the region by assets. Jeddah-based National Commercial Bank (NCB) has been the undisputed giant of the region, even though it has little presence outside the kingdom. It is followed by Samba Financial Group and Al-Rajhi Bank.
However, they are about to face a strong challenge from Emirates NBD, the bank being formed by the merger of Emirates Banking Group and National Bank of Dubai. The new Dubai-based bank will be second only to NCB in terms of assets.
The question now is how Saudi banks, particularly the two largest, NCB and Samba, will react to the challenge. “We have not seen any Saudi banks making announcements about plans to merge, or any indication that they plan to move outside their domestic market,” says Hateem Alaa, banking analyst at HC Brokerage.
Conversely, the likes of National Bank of Kuwait (NBK), Commercial Bank of Qatar and Mashreqbank are all getting involved in new markets. At present, Saudi banks can afford to concentrate on their domestic market. With less than one institution for every 2 million people, there is plenty of room for growth.
Saudi banks also still outperform the region in terms of the amount of deposits they hold, with seven of the region’s top 10 banks coming from the country by this measure. This gives Saudi banks more leeway to expand their lending portfolios before having to look for alternative sources of funding. At the moment, loans represent just 38 per cent of gross domestic product, making the kingdom one of the least penetrated banking markets. In the UAE, the figure is 84 per cent.
These figures are also what makes the Saudi market so attractive for other banks in the region, if only they could gain access to it. But the Saudi Arabian Monetary Agency’s (Sama) stance towards granting new licences ensures the current 11 institutions will remain in a sheltered market for some time to come.
“The Saudi market is large and under-banked, while markets like Kuwait are small and overbanked,” says Randa Azar Khoury, chief economist at NBK. “Banks in Saudi Arabia can still achieve good growth concentrating on their domestic markets.”
This is not the case in the rest of the GCC, where small, highly competitive markets mean future growth in the banking sector is constrained by the rate of overall economic growth. Expanding internationally offers banks in the five other GCC countries one of the few opportunities to outperform their local rivals.
But despite their healthy local market position, Saudi banks have been finding the going tough. The stock market collapse hit them hard, and in the final quarter of 2006 the size of their assets fell as the value of investments dropped with the stock market.
The creation of the second-biggest bank in the GCC, Emirates NBD, was expected to spark a wave of regional consolidation and the emergence of the first cross-GCC banking brand. That has not happened yet, but other deals have been widely talked about.
One such deal, which is still speculation, is the merger of National Bank of Abu Dhabi and Commercial Bank of Abu Dhabi. If it does occur, it will create the region’s biggest bank by assets, and another key player across the region.
However, consolidation has only been piecemeal so far, with even the most ambitious banks only managing to take minority stakes in rival institutions across borders. The most aggressive among these is NBK, which has taken stakes in banks in Egypt, Jordan, Iraq, Qatar and Turkey.
“Our strategy at NBK is to create a pan-GCC banking brand,” says Khoury.
Diversification outside the GCC is also particularly attractive for banks seeking to tap into stable revenue streams from non-oil-based economies. Markets such as Egypt, Jordan, Syria and Turkey have all been targeted by GCC banks.
Amr Abol Enein, a banking analyst at ING bank in Dubai, says there are several factors that will prevent widespread consolidation of the GCC banking sector, including a regulatory cap on foreign ownership in several GCC states and a strong economic backdrop that supports the growth of small banks.
The issue of foreign ownership is of particular concern. “Most banks have controlling shareholders who may have other priorities than maximising value,” says Khoury.
“There is still a mindset that banks are national assets. How do you change a mindset?”
The governments of Saudi Arabia, the UAE and Qatar all hold majority stakes in their country’s biggest banks. Riyadh owns 79 per cent of NCB, the Abu Dhabi government has a 73 per cent stake in National Bank of Abu Dhabi, while Qatar’s rulers have a 50 per cent share in Qatar National Bank.
Nevertheless, a limited amount of consolidation is expected. Enein identifies the key banks to watch as National Bank of Abu Dhabi, which made 19 per cent of its operating profit in 2006 from its international operations, and NBK, which is targeting 25 per cent of total operating profit to come from overseas.
The size constraints of their domestic markets, coupled with strong economic growth, means that banks in Qatar, the UAE and Kuwait show the best prospects for emerging as regional champions to compete with increasingly prominent inter-national banks.
They need to grow quickly. Traditional sources of income for local banks such as Islamic finance are also no longer immune to competition. HSBC, Standard Chartered Bank, Citigroup and Deutsche Bank have all launched Islamic banking divisions targeting the region.
Global giants such as these are becoming more established across the region, with operations in Dubai, Qatar and Bahrain. However, restrictions on branch openings mean they are unable to compete effectively for retail banking.
As the deepening of the GCC financial market occurs, there will be pressure for the barriers to cross-border takeovers to be removed. The results of this should be good for consumers and businesses, as larger institutions will get better access to sources of international capital, be able to achieve economies of scale and offer cheaper products.
Membership of the World Trade Organisation and other free trade agreements should also play a part in removing barriers to merger activity, and prompt local institutions to move outside their relatively small domestic markets more aggressively.
The one exception is likely to be Saudi Arabia. With banks from the UAE and elsewhere taking a more ambitious stance, unless Saudi banks manage to exploit more of the potential in their home market, they could struggle to win back their crown from Dubai and Abu Dhabi.
The UAE could remain the largest market by asset for some time to come.