A changing economic scenario is expected to drive a wave of mergers and acquisitions in the Gulf's banking industry, a management consultancy has predicted. New dynamics in the global and regional financial markets present unique opportunities, AT Kearney said in a research report.
A significant fall in market capitalisations would further drive consolidations in the sector, it said. The prediction assumes significance as it comes at a point when banks in the UAE have to meet a Central Bank deadline to increase their Tier 1 capital adequacy ratios to 11 per cent by June and to 12 per cent next year.
Kearney expects the build-up of national champions first, driven by major shareholders, as in the case of the merger of Emirates Bank International with National Bank of Dubai to create Emirates NBD. The merged entity is the largest bank by assets in the UAE and the region.
At the same time, regional investment banks may seek to diversify and merge with retail banks. "In the long run, true regional players will emerge," said Dr Alexander von Pock, Senior Manager, Financial Institutions Group, AT Kearney Middle East.
A decline of almost 60 per cent in UAE banks' market capitalisation could be one of the major driving factors for consolidation. At the same time, market shares are relatively low.
The market shares of the top three banks in the region is only around 16 per cent, Kearney said, which reflects the fact that no single bank stands out in the region as a whole and thereby creating room for consolidation.
In spite of unprecedented growth in recent years and a significant increase in assets, the banking market in the Gulf remains largely fragmented, said the report, while highlighting the basic factors that could result in banks opting for mergers.
"Consolidation is gathering momentum driven by structural, market and regulatory factors," said Dr Dirk Buchta, Managing Director, AT Kearney Middle East. "The declining market capitalisation of regional banks in the wake of the financial crisis has created favourable conditions for acquisitions and the large proportion of public ownership in some of the banks may also facilitate takeovers. Local banks should start now to prepare for the challenges ahead."
Asset growth
Banks in the Middle East have seen unprecedented growth over recent years and many still reported profits in 2008. From 2002 to 2007, UAE banks saw a 39 per cent increase in net profits and a 34 per cent increase in total banking assets. Moreover, banking assets in relation to GDP today are still comparatively low in most GCC countries, leaving room for growth for the banking industry and its players.
At the same time, the Gulf banking market remains largely fragmented. Even though several domestic markets already have a consolidated banking sector, the picture changes on a regional level: no single bank stands out in the region as a whole. While the regional banking market has so far largely shunned major mergers and acquisitions, changing conditions in the global and regional financial industry have created unique opportunities for a long-predicted wave of mergers and acquisitions.
Market structure
The current market structure indicates that there is room for further consolidation. Bank density, which is the number of banks per 100,000 of population, is 0.6 per cent in the GCC region, and 1.1 per cent in the UAE. The market share of the top three players has been 32 per cent in the UAE and 16 per cent in the GCC, the report said.
"We see great potential for regional banks to consolidate and grow regionally," said Dr von Pock. "While the region has witnessed very few banking mergers and acquisitions over the past years, there will be more activity in the future. GCC banks are still small compared to the big international banks and eventually will need to grow externally to compete. Banks need to proceed carefully, though, as most mergers fail to meet their objectives due to poor planning or execution."
Several "regulatory obstacles" to cross-border mergers and acquisitions have long been in existence and affected mostly foreign banks, Kearney said. "There are various restrictions on foreign ownership and these restrictions also curtail business development of foreign players, especially in retail banking," it said.
Key drivers
Highlighting the consolidation drivers, Kearney said revenue growth stagnated in 2008 while expenditure control did not keep pace, resulting in declining margins.
A liquidity shortage could act as another driver with Islamic banks, especially the Islamic investment banking sector facing greater difficulties in accessing funding.
With World Trade Organisation requirements increasing financial market openness and countries taking the initiative to issue laws supporting new products, consolidation is expected to get a fillip.
The declining market capitalisation of Islamic banks, the report said, has also created favourable conditions for acquisitions. From June 2007 until February this year, while the UAE has seen almost a 60 per cent decline in market capitalisation, this fall was 49 per cent in Bahrain, 36 per cent in Kuwait, 33 per cent in Qatar, 32 per cent in Saudi Arabia and 26 per cent in Oman.
The large proportion of public ownership in Islamic banks may also facilitate takeovers, Kearney said.
With investment banks seeking mergers with retail banks amid reduced trade barriers, further consolidations are conceivable, the report said. The region saw a couple of substantial merger and acquisition activities in the GCC Islamic banking sector in the past few years.
Driven by structural, market and regulatory factors, consolidation is gathering momentum, the report said.
Crisis and the banking sector
The economic crisis is likely to see the emergence of clear trends in regulatory controls, government intervention, rating agencies and customers, Kearney said in an earlier global report.
The crisis is "not the end of the world and banks will emerge stronger once more", it said. The issue before top management was to find ways to accelerate the recovery and build stronger institutions along with detecting the correct time to do so.
The consulting firm emphasised on measures like rethinking risk management, redefining business scope, re-inventing products and rebuilding brand and trust. The banking industry's risk management function was, perhaps, able to see the disaster coming, but was unable to avoid it, Kearney said.
The consultancy firm stressed the need to make risk management a part of each area of management instead of considering it a specialised department. It also said adopting alternative models to assess risk, an improved risk awareness, and seeking reinsurance against capital base could facilitate better handling of this aspect.
A focus on core competence to boost long-term shareholder value could also help, the firm said.
Disposing of unattractive business lines – activities that no longer belonged to core of the institution – could be considered, it said, adding that businesses could look for acquisitions.
"Once the institution is on the new path, it can consider whether to acquire other lines of business or even institutions in order to grow."
Kearney recommended that acquisitions should be in line with the focus area, as replicating them would merely relieve them from the burden of the implementation.
With a falling consumer spending and credit crisis sweeping the world in Q1 and Q2 of 2009, and market valuations at historically low levels, corporate consolidation promises to be a critical business trend in 2009, Kearney said in another recent study of some 660,000 public and private companies worldwide.
"We are not particularly happy about the global consolidation trend, but having studied the empirical data for the past 25 years, we can only advise our business clients to accept it as a matter of fact," it said.
With profits getting a severe blow, the financial system has been under pressure in recent months. The Kearney report pointed out that the quest for liquidity put a premium on attracting or maintaining balances. Banks have also been facing issues such as high credit risks. While traditionally banks were rewarded for providing liquidity by earning money on a rising yield curve, revenues from this activity are currently very low. In most cases, true yields are hard to calculate as volatile assessments of embedded credit or liquidity risk are hard to measure, the report titled "Reinventing Banking" said.
In addition, fee from classic payment transaction processing are under intense pressure, it stated.
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