So old are the calls for restructuring, they seem like echoes. But the point of crisis has arrived and it seems the authorities, at long last, are serious.

The banking sector is to be meaningfully reformed, the dead wood stripped out, and the full benefits, and dangers, of open market forces are to be unleashed. The aim is a restoration of confidence in the sector, and the laying down of firm foundations for future economic growth.

The Arab bankers can now wake up from their favourite dream – or worst nightmare.

But in Turkey, this is the reality. In the 18 months since it came to power, the coalition government of Bulent Ecevit has surprised many with its ability to maintain its reformist momentum. One of the first moves it made, in June last year, was to pass legislation targeting reform of the banking sector, and the issue has remained firmly on the agenda ever since.

However, fresh legislation passed in November has provoked the crisis that could ultimately prove healthy for the financial community and the country at large.

The government has shown itself determined to purge the public sector banks – in preparation for privatisation – and sell most of the institutions that have been taken into receivership in recent months and placed under the control of the Savings Insurance Fund managed by the Regulatory & Supervisory Board for Banking. The chances of such a programme being conducted painlessly are slim, but the direction taken is sound.

Undoubtedly, the path ahead will be littered with liquidity crises, bank failures, corruption scandals and criminal investigations. But these are all developments with which the banking community is already familiar.

Consolidation, either through agreed mergers or hostile acquisitions, is unavoidable. A number of the larger private sector banks, such as Akbank, Turkiye Is Bankasi and Yapi Kredi Bankasi, have been assiduous in their preparations and are likely to be aggressive movers in the shakedown to come. Many of the smaller institutions need to realise that there is more to banking than living off government treasury bills or recycling the debt of sister companies.

Therein lies a lesson for parts of the Arab banking community. It is significant that some of the ailments of the Turkish sector are mirrored elsewhere in the region, not least in Lebanon. Both markets have a superfluity of banks: in Lebanon a population of less that 4 million is served by 70-odd institutions.

And in both markets a host of banks live only to gorge themselves on government debt. The inflationary and interest rate gyrations in Turkey – compounded by the recent liquidity crunch – might have grabbed more headlines over the last few months, but, to a lesser extent, the situation in Lebanon is not dissimilar.

The massive cost of post-war reconstruction has forced the government to borrow extensively in local capital markets and a number of banks simply feed on the steady supply of treasury bills, which consistently offer returns of around 16 per cent. Highinterest deposit accounts are successful in attracting deposits to fund the buying of government debt. It is estimated that about a third of the entire banking sector ‘s funds are invested in government securities.

Unimaginative banks, often privately owned, have found it relatively easy to survive. But their days are numbered.

Riad Salameh, the central bank governor, has long made his desire for mergers clear, and has introduced a number of measures designed to accelerate the process. Capital adequacy ratios have been raised, soft loans introduced and restrictions have been placed on the number of new branches that can be opened each year. And some moves have been made. Of the big players, Byblos Bank, Fransabank, Banque Audi and Bank of Beirut have all made acquisitions in the last three years, but the tail of small banks continues to be far too long. With the economy still in the doldrums, a number of bank boards will undoubtedly be worrying about the need to merge at a premium before it gets too late. Across-the-board net earnings in the banking sector fell by about 15 per cent in 1999 and there is little reason to think the trend will be reversed this year.

For the moment, international and regional banks are still interested in buying into the sector. Standard Chartered picked up a controlling stake in Metropolitan Bank late last year and Arab Banking Corporation (ABC) is understood to be in advanced talks for the acquisition of a local player. But the longer deals are left, the less interest there will be from foreign buyers.

The Turkish lesson could also be well learned by the Egyptian banking community. The sector has been hit by a persistent liquidity squeeze: interest rates have been driven up, and foreign currency reserves drawn down. Though not to the dramatic extent witnessed in Turkey, where the central bank’s foreign currency reserves fell by $5,491 million in the two weeks to 1 December, and overnight interest rates went as high as 180 per cent in early December. However, for a number of Egyptian institutions, the game has moved out of the comfort zone.

The turmoil has not dented Cairo’s ambition to establish itself as a regional financial centre, though slow progress on the sale of a number of banks has acted as a bottleneck on the rate of arrival of new institutions.

On the plus side, ABC acquired Egyptian Arab African Bank in a $100 million deal last year, and HSBC smoothly seized a controlling stake in Egyptian British Bank in October.

But other sales have been more troubled. The attempt by National Bank of Kuwait (NBK) to acquire Misr America International Bank has collapsed in the face of irreconcilable differences over the sales and purchase agreement. And the much-trumpeted offerings of controlling stakes in Misr Iran Development Bank and Arab African International Bank have gone quiet, with no clear progress made.

Equally, good intentions, aired in the past, over the desire to privatise the stateowned banks have come to little, though the concerns over asset quality and the strength of their internal processes have not gone away. A Turkish-style crisis might not be on the horizon, but the need for structural reform remains.

In the Gulf, the situation is very different.

The clarion call for consolidation is just as loud, but the drivers for it are different.

Unlike Turkey and, to a certain extent, Egypt and Lebanon, GCC banks have not been confronted with serious liquidity problems. In fact, the opposite is the case.

As retail and commercial banking has gradually become more sophisticated, the ability of institutions to attract deposits has, in a number of cases, outgrown their ability to find strong lending opportunities. The aggregate first-half results of 39 GCC financial institutions covered in a recent MEED survey, saw customer deposits up 8 per cent while loans and advances expanded by only 4 per cent. Most GCC banks are well capitalised and, unlike Turkey and Lebanon, domestic government debt does not stand as the highest-yielding block of assets on their books.

Equally, there is no proliferation of private sector banks without any apparent function, and there are none in immediate danger of collapse. The region might be overbanked, but all but one of the GCC institutions reported a profit last year, and most saw their profits rise: interim results suggest this year will see the trend continue.

However, the underlying issue of size cannot be escaped: it does matter. For all the existing strength of the GCC banks, many are simply too small to be confident of their long-term future. The potential impact of World Trade Organisation (WTO) regulations provokes heated debate, with some arguing that the erosion of protective barriers will allow the international banking community to ride roughshod over local markets, stealing market share and strangling a number of the local players.

The alternative view is that globalisation has, so far, been about building massive financial institutions that straddle the world. Some think the giants will be disinterested in the comparatively small percentage of the global market that the GCC will occupy and that the rewards to be gained from entering and dominating the region will not be worth the expense and effort. Instead, they will aim to cream off the big-ticket transactions, and show little interest in the medium-to-small deals or building retail or commercial banking franchises. To put the debate in context, the aggregate gross domestic product (GDP) of the six GCC states in 1999 was well under half the total assets of HSBC alone.

Either way, one trend can be forecast with comparative certainty. The dominant regional institutions will get bigger, and will look to be more active on a cross-border basis. And the quickest route to this will be through mergers or acquisitions.

The process has already started. The merger of Bahrain-based Gulf International Bank (GIB) and London-based Saudi International Bank was a landmark deal followed up by GIB moving directly into the Saudi Arabian market. The merger of London-based United Bank of Kuwait and Bahrain-based Al-Ahli Commercial Bank stands as a different form of cross-border thinking, but the aim is clear: a truly regional institution is under construction (see page 30). Few other pan-Gulf banks exist, though regional heavyweights such as ABC, National Commercial Bank, Saudi American Bank (Samba) and NBK are clearly aiming to establish themselves in other markets.

Size will also be of importance as the regional banking community confronts the global trend of disintermediation. The financial services industry is in flux and the distinction between institutions dealing in asset management, brokerage, insurance and old-fashioned banking is becoming increasingly blurred. It is likely that the cross-selling of products will increase as institutions focus on their areas of core competence but seek to expand the range of products and services they offer. At the very least, strategic alliances will be formed between banks in the region and those based outside it, as well as between regional competitors.

As these trends continue, the smaller banks operating only within one market are expected to find themselves increasingly squeezed. The GCC markets are notable for the fact that each, with the partial exception of Saudi Arabia, has either one or two dominant forces. National Bank of Abu Dhabi, NBK, Qatar National Bank and their counterparts elsewhere will find it relatively easy to defend their prominent positions and market share.

The main reason is size. The greater the resources, the easier it will be for new products such as pension schemes, investment funds, and insurance programmes to be developed and brought to market. The larger the institution, the greater will be the potential economies of scale derived from improved IT systems, back office integration or new delivery platforms such as internet or WAP banking. For both retail and commercial banking, the success of a number of institutions will be determined by their ability to market a wider range of better products over increasingly sophisticated platforms. The days when banks measured the expansion of their services by their number of branches have passed.

On the wholesale side, the need for scale and innovation is just as important. At present, few regional institutions have the balance sheet strength to underwrite large corporate or project financings. The big deals – particularly those with a long tenor – are lead arranged by international banks and syndicated into international markets. However, there are signs that the dynamic is changing, with some of the larger national institutions increasingly looking for cross-border exposures. It was noteworthy that in October, two Saudi banks participated in the underwriting of the debt financing of Abu Dhabi’s Taweelah A-1 independent water and power project.

Cross-border thinking

Equally important are the attempts by some to develop meaningful advisory and arranging capabilities. While the $1,000 million-plus transactions will continue to be underwritten and placed by the international players, a middle market could open up for those large regional banks prepared to use their balance sheets strategically and offer high-quality services. Those who move decisively into this market might find a rich diet of work. And those that do so with regional platforms and local knowledge of more than one market are likely to be the most successful.

Of course, the impediments to widespread consolidation are all too real. The vested interests of shareholders have been difficult to break down. For example, more than half of the 20 local banks of the UAE have the governments of the different emirates as their major shareholders: consolidation is difficult to imagine. Equally, in Saudi Arabia half of the banks have sizeable portions of their equity held by foreign financial institutions. In addition, potential cross-border deals raise political issues. It is significant that attempts to merge Kuwaitbased Burgan Bank with Bahrain-based United Gulf Bank foundered on the disapproval of the two regulatory authorities.

These issues will, eventually, have to be addressed. When they are, the boards of a number of Gulf banks will have to start thinking about whether they want to do deals from a position of strength or from weakness. Just as in Turkey, the players that predict the future, and prepare for it, will end up calling the shots.