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01 December 2023

Strong fundamentals help GCC banks recover quickly

Total bank assets in the UAE exceeded Dh1,500bn at the end of January. (EB FILE)

By Shveta Pathak

The asset base of Gulf banks has grown twice as fast than the region's GDP and banks here have been more profitable than their Western counterparts, AT Kearney said in a study.

In the UAE alone, the Central Bank statistics showed that total bank assets exceeded Dh1,500 billion at the end of January this year.

Even as timely intervention by the governments, central banks and the banks themselves have helped in a quick recovery, it is the intrinsic strong fundamentals of the GCC banking sector that has helped it recover in a "surprisingly short" time period, the study said.

Favourable demographics, low banking penetration, lower costs and easier access to cheap funds have contributed to a continual growth in profitability, but as the economic crisis brings fresh challenges, GCC banks will have to look into product and asset portfolio, distribution and customer service, risk management, operations, governance and performance management and re-strategise with a view to effectively deal with fresh challenges posed by the economic environment, it said.

"The crisis has provided GCC banks with the impetus to take a big step on the road to maturity and consider operational excellence given the current scenario of non-performing loans (NPLs) and deteriorating asset quality," said the study.

Cyril Garbois, Principal, Financial Institutions Group, AT Kearney Middle East, said some of the factors that contributed to growth in the banking sector are still relevant but, "slower growth in the future, deteriorating asset quality, changing competitive landscape and rising regulatory constraints, all pose new challenges for the GCC banks".

Analysing the financial results of the banking sector, AT Kearney said the latest results of the leading GCC banks reveal an overall positive trend.

"In fact, quite a few banks enjoyed organic top-line growth in 2009 and have continued to invest in future growth," it added.

With 30 to 40 per cent of the population in the GCC under the age of 35 years, and a high per capital income, demand for banking products in the region continues to rise.

Further rising oil revenues and government investments in diversification have helped the region grow at a "comparable pace to Bric economies", the study said. Investment in large-scale projects, in particular, has increased the demand for financial products.

In spite of this "credit hungry" environment, penetration levels of the banking system in this region is lower compared to its Western counterparts, said the study.

Comparing the assets to nominal GDP ratio, AT Kearney said till 2008, only the UAE has achieved penetration comparable to countries such as Germany, France and the United Kingdom.

Evaluating loans against nominal GDP ratios, all GCC countries show an even lower penetration, it said. Relatively low levels of competition and operating costs, combined with easy access to funds, have resulted in highly profitable banks, said the study.


Market share

Taking a look at market share, the study said the top five banks in the GCC, except Bahrain, own more than 50 per cent market share. This significant market concentration has ensured high margins for the sector as a whole, it noted.

Further, labour-intense operations and limited geographic spread have helped GCC banks keep down operating expenses and capital expenditure. GCC countries have traditionally been able to attract skilled and unskilled workers from Asia and Africa, by offering them higher wages.

Moreover, the limited geographic spread and number of branches has also helped GCC banks limit capital investments by using labour-intense processes instead of expensive infrastructure. Thus, the GCC banking sector is able to maintain lower staff costs and has lower information technology and infrastructure costs compared to their Western counterparts. A typical cost-to-income ratio for leading European banks ranges from 60 to 75 per cent, while the same ratio for major GCC banks is less than 40 per cent.

According to the study, as governments have substantial ownership in most GCC banks, it helps some banks gain access to stable deposits at lower costs than would otherwise be possible.

Additionally, banks have been able to use the buoyant capital markets to raise funds – both debt and equity – at a reasonable price, further reducing their cost of funds. This has allowed the banks to maintain high interest margins.

These basic fundamentals will stay relevant and continue to benefit GCC banks even in the post-crisis period, said AT Kearney.

However, it added, a slower growth environment, deteriorating asset quality, a changing competitive landscape and rising regulatory constraints all pose new challenges for GCC banks.

Foreign investments declined and GDP growth was nearly flat in 2009. This slow growth environment is expected to persist and banks will have to adapt their approach to doing business.

Banks are forced to expand their collection capacities as credit card and personal loan defaults rise. This holds true for corporate banking as well, said AT Kearney. The immediate consequence is greater provisioning and from early 2008 till now, the top 10 GCC banks have had to significantly increase their provisions. The full impact would be visible in 2010, said the study.



Another challenge that the sector now faces is a changed competitive landscape.

Even as overall competition is relatively low, it is likely to grow in specific operation areas, the study said.

As banks struggle with credit losses and to make their credit policies more stringent, they are competing with each other for the same pool of "good customers". The competition for these high-profit customers will be fierce, in particular large corporate accounts, well-performing small and medium-sized enterprises and high net worth individuals.

Customers are expected to be more selective in their choice of banking partners, which would necessitate that banks differentiate their products beyond pricing, said AT Kearney.

Rising regulatory influence would further pose challenges in some areas.

To adjust to the new market conditions, banks need to reassess their strategic direction and realign their operating models. For bold, forward-looking banks, the current market provides a unique opportunity to differentiate themselves from their competitors – now and in the future. The study said there are five main areas that GCC banks need to address across the value chain, including more focused product and asset portfolios, better customer service and risk management.

Banks will have to make their product and asset portfolios less complex, and tap into new product segments.

GCC banks typically have lower product-per-customer ratios than their Western counterparts. On average, the ratio is two or three products per customer in GCC retail banks compared to eight or nine products per customer in best-practice Western retail banks. The lower ratio is largely because most GCC banks take a product-centric approach to selling rather than a customer- centric approach and this will have to change, it said.

The study said many local banks have approached the SME segment with a "one size fits all" approach. However, there is a need to differentiate between various SME segments and decide which one to target, it said.

Another segment that can be tapped into more aggressively is wealth management, said the study.

Besides, the current market sensitivity to risk and rising NPLs requires better management of credit risks. GCC banks' current credit-underwriting processes are typically insufficient and not aligned to market demands.



Banks also need to develop outsourcing and offshoring strategies and rationalise processes and invest in technology, the AT Kearney report recommended.

Although outsourcing is a relatively new concept in the GCC, it is commonplace among banks in more mature markets and a good way to increase productivity through centralisation, improve service levels and increase controls. This can be attained through limited technology investment and crunched lead times. Banks can start with outsourcing of low-complexity functions where supply market is well established.

Offshoring, said AT Kearney, can result in a 30 to 40 per cent benefit in labour cost trade offs. It identified India and Egypt as the most favoured offshore destinations due to language and cultural similarities.

The current market situation also requires better management of risk and product and risk managers can work together to identify target customer segments. They can also focus their marketing and commercial efforts to help minimise risk while leading to a prudent growth, it added.


Governance structures and financial transparency key


GCC banks need governance structures, financial transparency and performance management to ensure the entire organisation is aligned with its strategic goals, said AT Kearney.

Emphasising on the need to re-inforce the role of board members, it said they have a clear oversight of the strategic decisions taken by senior management to ensure that they are in line with board guidelines.

Regulators and central banks will play a larger role in strengthening governance structures. Stronger provisioning norms, capital adequacy requirements and setting-up credit bureaus will significantly improve the efficiency of the overall banking sector and reduce the risk of future bank failures.

While the impact will only be seen over a period of time, capital costs will fall and become more accessible, thus fuelling future growth. Banks that take a preemptive approach, making these changes ahead of their competitors, will benefit significantly, especially in the eyes of their investors and customers. Not only in financial and statutory reporting, banks will also have to increase transparency in how lending decisions are taken, said AT Kearney.

Internal audit functions must be strengthened and results reported directly to the board, it said. All these changes, it said, will require a thorough monitoring process and banks will have to review their performance enhancement systems.

"The challenges that lie for the GCC banks span across the full spectrum of banking services, be it Islamic or conventional banking. These banks are indeed playing in the same competitive arena. Not surprisingly, their strengths and their development needs are very similar," said Dr Alexander von Pock, Principal, Financial Institutions Group, AT Kearney Middle East.

The economic crisis can actually result in a boom for the GCC banking sector and this opportunity should not be missed. It should act as an opportunity for all key players to review their operations. The future definitely remains challenging in the sector, and managing this transition will be far from easy.

But the banks that are able to adapt to the changes will emerge winners, it said.

"More than ever, GCC banks need governance structure, financial transparency and performance management tools to ensure the entire organisation is aligned with its strategic goals", said Cyril Garbois, Principal, Financial Institutions Group, AT Kearney Middle East.


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