By Mark Wallace
The 2003 Iraq war threw markets into turmoil across the Middle East. On the heels of the global economic slowdown that had preceded it, banks were hit especially hard. But in readjusting to an uncertain economic climate, Middle East banks are making some interesting changes.
With more liquidity in the region, banks are bringing on their retail operations and at the same time growing more sophisticated in their dealings with commercial clients. Though weaknesses remain and consolidation is on the horizon, regional banks find themselves at a crucial moment that could determine the shape of the banking industry across the Middle East.
According to Maria Khoury, head of research at Atlas Investment Group in Jordan, the biggest opportunities for banks in the Middle East are in the retail sector. ?People in the Middle East are becoming real ?consumers', and so the old habit of saving every extra penny has become antiquated,? she says.
East meets west
With a majority of the region's population now between the ages of 15 and 40, Western-style consumer habits are becoming more prevalent, and banks around the region have started to adapt to this by offering all sorts of new consumer products, from credit and debit cards to housing and car loans, online banking, discount brokerage accounts and more. Low interest rates are also allowing banks to take advantage of the hungry credit market, Khoury says, and central banks are doing their part by pushing banks to extend more retail credit facilities.
As retail business has come on, corporate loans as a percentage of total outstanding lending have fallen. Across the six Gulf Cooperation Council States (Kuwait, Bahrain, Saudi Arabia, Qatar, the United Arab Emirates and Oman), corporate loans accounted for only 55.2% of total outstanding credit in 2003, down from 63.2% in 1999, according to Standard & Poor's.
At the same time, corporate banking in the Gulf is growing more complex and sophisticated. Where at one time it was
relatively straightforward, with big loans made only to strong borrowers, banks are now moving towards a more comprehensive relationship management approach. Trade finance, cash management and financial advisory services, structured finance and institutional investment on behalf of corporate management are now playing a bigger part in banks' corporate services profile.
Segmentation
Middle East banks are also becoming more aware of the market segmentation that has grown more distinct with the economic diversification of recent years. Instead of seeing corporate clients as small enterprises, mid-market firms or large companies, lending officers are increasingly looking at industries as a criterion in credit decisions. Trade finance captures the majority of the lending market in Saudi Arabia and Bahrain, while construction and real estate lending takes almost half the market in Kuwait. In Oman, loans are made to companies in a range of industries, according to S&P.
With markets still relatively protected, the proliferation of small local banks has led to strong competition and a small number of big players. One strong presence in the GCC states is National Bank of Kuwait, says Emmanuel Volland, director of financial services ratings for Standard & Poor's in London.
With a return on equity of about 25%, NBK has been the most profitable Gulf bank over the last decade, Volland says. And though Kuwait is small, NBK is also one of the most geographically diversified banks in the Gulf. ?With its superior management philosophy and risk management, it's a model in the region,? Volland says.
Saudi banks remain among the strongest in the region, he adds. Operating in a country of more than 20 million people, they enjoy the biggest market. One of the leaders is Riyad Bank. With no foreign shareholders and a strong market share, the bank has managed to attain healthy operating profits and superior capitalization, even while continuing to pay high dividends.
A more difficult situation is faced by some of the smaller investment banks in the region, according to Volland, which have had a more difficult time benefiting from the increased retail activity that has taken place as investors, wary of putting their money abroad, keep more liquidity at home. For wholesale banks with investments abroad, the dire straits of European and US markets have meant big losses. As a result, Bahrain International Bank is in the process of being liquidated, and Bahrain's BMB Investment Bank is also struggling to recover from a recent default on international loans. Though BMB remains in default on a $75 million credit facility with a consortium of international banks, chief executive Albert Kittaneh is confident the bank will pull through.
Best strategy?
In all markets in the Middle East, one of the chief challenges banks will face is increasing competition as World Trade Organization accession opens markets to foreign players. Consolidation could well become the strategy for facing this challenge, Volland says.
?This is a trend that we would welcome,? he says. That trend is already beginning. Volland points to the recent acquisition by National Bank of Kuwait of a 40% stake in a small bank in Qatar. ?We expect to see more of these kinds of transactions,? he adds.
Strong players have emerged throughout the region, according to Khoury, and include Saudi Arabia's Al-Ahli National Commercial Bank, National Bank of Kuwait, Jordan's Arab Bank and Lebanon's Blom Bank.
Saudi banks will be well placed for future buying sprees, Volland says. One factor that could slow consolidation is the large degree of family ownership among Middle East banks. Owners are wary of giving up
control of assets that may have been in the family for decades, and creative solutions to this point will have to be found before real consolidation can take place.
Jordanian banks are also due for a round of consolidation, according to Khoury. The Jordanian central bank has pushed this trend by raising bank capital requirements recently in order to drive larger banks to purchase smaller ones.
Another development is the diversification of funding profiles. While Middle Eastern banks have traditionally relied heavily on customer deposits for their funding, banks are moving to make bank loans, syndication and bonds an increasing part of their funding. Regulatory climates have determined where this is taking place more strongly, with Kuwait a leader in bond financing because of its relatively liberal regulatory climate. Regional banks should begin to tap international debt markets in a more consistent way in coming years, according to S&P, leading to a better balance of maturities and insurance against bank runs in a region plagued by political instability.