Fault lines in GCC banking sector

While a new era of development has begun for banks in the GCC, the macroeconomic environment remains precarious and industry-specific risks need to be addressed to ensure that recent growth and increasing profitability are sustained.

A study released today by AlixPartners, the global business advisory firm, highlights the return of profits and notable performance at both the individual bank and GCC-country level, while identifying some fundamental fault lines in the GCC banking sector that will hinder any progress unless restructuring efforts are made.

The report suggests that significant risks in the economic environment remain, requiring immediate counter-measures by bank managers.

First, the recovery in banks’ net interest margin (the difference between the interest income generated by banks and the amount of interest paid out to their lenders, relative to the amount of their interest-earning assets), which the report says has been driven mostly by government infrastructure projects, underscores that the link between banking performance and oil prices is too close.  Heavy government involvement in such projects, which guarantees free capital to the system, coupled with protection at home, has resulted in safe and stable returns, notes the study. In order to be successful globally, however, GCC banks must learn to survive without these securities and compete internationally.

Second, the-still cheap funding that has sustained GCC banks’ lending is constrained by the withdrawal of Western banks’ lending, and by an underdeveloped interbank financing market. Other significant risks highlighted in the report include the stark contrast between the sector’s relatively strong capital base and improved credit ratings, and GCC banks’ underlying non-performing loans in some countries and contradictory lending practices that often intertwine personal and business dimensions – coupled with government intervention, generates inefficient asset allocation at best, and fosters moral hazard at worst. Finally, the concentration of GCC banks in a few geographies and those countries’ limited populations may seriously constrain future wealth generation, said the study.

Claudio Scardovi, managing director at AlixPartners and author of the report, said: “Certain banks remain crippled by a real-estate overhang, asset quality concerns and a post-credit bubble legacy. For those banks, restructuring is essential sooner rather than later. Similarly, nearly all GCC banks suffer from various ‘concentration issues’ underpinned by a false dependency on high oil prices. Significant benefits could be achieved if restructuring and diversification were pursued independently; however, even greater benefits would ensue if these issues were addressed simultaneously. On the restructuring side, opportunities lie in the ability to implement a hard and fast strategy, while on the diversification side, opportunities lie in exploiting any potential competitive advantages beyond the Gulf region.”

The study identifies the ‘Three Ages of GCC Banking’, the third of which began in 2010 and is seen as being the pre-amble to a new ‘Diamond Age’. Although crude-oil futures will continue sustaining the current levels of free capital, GCC banks need to reach out more aggressively to new sources of sustainable and profitable growth, says the study. These sources include not only lending assets and net interest margin, but also services and fees income. Further bubbles and bursts could result from renewed, uncontrolled asset growth, and loss of status could follow poorly pronounced strategies and implementation.

In order to successfully enter this Diamond Age of banking, policy makers as well as bank managements must be prepared to address issues of the past and to build a new stage for GCC banks, says the study.  It maps out four key strategic objectives. First, consolidation can be achieved through mergers and acquisitions (M&A) or by organically merging similar entities to exploit economies of scale and scope. Second, greater development is needed, which would result in greater commercial effectiveness allowing the sale of more goods and services to an increasing number of clients and markets. Third, an escalation in productivity, through an increase in the quality and quantity of desired output, while maintaining the same level of input, is needed. Fourth, innovation that aims to exploit current pools of profit while simultaneously creating new ones through new business concepts, is also called for. 

The study further emphasizes that international diversification and proactive internal restructuring, when necessary, could circumvent current constraints and shifts in the region that are creating new structures for markets and societies.

Scardovi added, “The power shifts that have taken place in the MENA region are redistributing wealth across countries, companies and individuals, which will eventually lead to banks needing to adopt new wealth and investment management services. Shifts have also taken place on the economic powers scene and are creating more opportunities for GCC banks to adopt the right timing and strategy for their oil-driven excess free capital.”

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