The merger between National Bank of Abu Dhabi and FGB could well trigger a series of consolidatory moves across the Gulf's banking sector. But will this lead to the emergence of a handful of regional powerhouses? Kit Gillet assesses the situation.
In early July it was announced that the boards at National Bank of Abu Dhabi (NBAD) and FGB, two United Arab Emirates-based lenders, had approved a merger that will create a combined bank with total assets of more than $170bn. The merged entity, which will operate as National Bank of Abu Dhabi, with FGB’s shares being de-listed, is likely to become a major regional powerhouse. Some are also predicting that the deal could signal the start of a domino effect of mergers and acquisitions within the Gulf region.
“Gulf banking markets may have entered an important phase of consolidation, with the potential to dramatically reshape both the role and the intermediation capacity of the industry,” Pietro Calice, a senior financial sector specialist at the World Bank, wrote in a blog post in July.
A new powerhouse?
The merged NBAD, which would be the first major merger in the UAE banking sector since Emirates Bank International and the National Bank of Dubai combined to create Emirates NBD in 2007, is set to rival Qatar National Bank as the largest bank in the Middle East in terms of total asset size. It would also benefit from FGB’s strength in retail banking and NBAD’s lower funding costs as well as the latter’s strong wholesale and advisory operations.
“We’re going to have a very strong player in the domestic market, and that is going to put a lot of pressure on the other banks,” says Jaap Meijer, managing director and head of equity research at Arqaam Capital. “It is going to be a powerhouse with low funding costs and also very strong single-party exposure; the combined balance sheet basically doubles. It will be able to compete and take on very big tickets, and given the limited number of big corporate accounts in the region that is a real competitive edge.”
Two other banks in the Gulf Co-operation Council (GCC), Bank Dhofar and Bank Sohar in Oman, are also expected to merge in the near future, creating a new bank that would have a 19% share by assets of Oman's banking market, behind only Bank Muscat, which currently has a 41% market share.
In March, Reuters reported that Qatari lenders Ahli Bank, Al Khalij Commercial Bank and International Bank of Qatar were in early-stage talks on a possible merger that had the potential to create the third largest lender in Qatar, with assets of more than $30bn, though Ahli Bank chief executive Salah Murad was quick to deny the rumours that his bank was involved in an "impending merger" with its two rivals.
Making savings
It is easy to see why mergers are being considered in the Gulf region right now. With oil prices struggling, economic growth slowing, reduced government spending, liquidity pressures and low interest rates affecting profits, banks are looking at ways to reduce costs and better position themselves in their respective markets. Domestic mergers, which typically generate a lot of cost synergy, are one way to do this; some have suggested that the merger between NBAD and FGB could result in cost savings of up to 28%.
“Consolidation could help to create fewer but stronger banks that would have more capacity to finance the economy,” says Mohamed Damak, the Dubai-based hlobal head of Islamic finance at Standard & Poor's. “And for the banks themselves it could create more efficiency and more sophisticated banks that could provide sophisticated financing solutions for the economies.”
There is also a sense that the GCC region is overbanked; the UAE in particular has an estimated 50 financial institutes serving a population of just 9 million. “Bahrain and the UAE are definitely overbanked,” says Chiradeep Ghosh, research manager at Securities & Investment Company in Bahrain.
Mr Damak says: “The UAE is a country where bank consolidation makes sense. [Whereas] for Saudi Arabia, Oman, Qatar and Kuwait we are of the view that consolidation is not really a relevant issue at this stage because in these countries there are few banks and the banking sector has a rather oligopolistic structure.”
He also highlights Bahrain as a place where consolidation makes sense, and would benefit domestic banks, “given the fact that the market is small and there are a number of banks operating there.”
Crowded house
In crowded markets, reducing the number of banks would allow those that remained to better compete for customers and contracts. While this may have been obvious in the past, the strong growth banks in the region experienced in previous years made this kind of decision unnecessary. Now, however, that has changed.
"There is lots of room for consolidation,” says Arqaam Capital’s Mr Meijer.“The growth environment is ideal right now for consolidation. You don’t have spectacular growth like we’ve seen in the past few years but there is no real panic either, as oil prices have rebounded from the $27 level to $45 levels. We’re facing a slowdown, so [as a bank] you have to think about inorganic growth.”
Also, with public and private sector deposits down across the region, access to funding remains a major issue for banks. "The funding side of things is very important,” says Mr Meijer. “National champions – NBAD, National Bank of Kuwait, Qatar National Bank – are in a fantastic position as their funding costs are much lower, they have a stronger deposit base and access to wholesale markets. This forces other banks to consolidate."
Merging difficulties
However, others are not so sure that even with the current economic situation there will be a strong rise in the numbers of mergers and acquisitions in the region.
"There does seem to be a trend towards mergers and acquisitions in the banking sector given the pressures that they face, but I don’t expect to see a wave of merger activity," says Daniel Kaye, senior macroeconomic editor and head of Middle East at analyst Oxford Economics.
"There are challenges related to mergers across the Gulf, especially in the banking sector,” he adds. “These include restrictions on foreign ownership, high valuations, cumbersome regulations and legal processes, as well as perhaps a reluctance to cede or dilute control by some shareholders. The government also holds stakes in some banks in the region, which probably adds an extra layer of complexity. These types of factors have probably deterred mergers in the past, and I don’t see them disappearing soon.”
Still, he says: “It isn’t difficult to see where the pressures for mergers – the collapse in oil prices, weaker growth, low interest rates and strains on profitability – have come from."
The benefits for banks if they get the deals right is clear, but there are also risks when it comes to mergers, both for the banks themselves and the banking systems in general.
In a report in early August, Moody’s analyst Mik Kabeya wrote that the proposed merger between Bank Dhofar and Bank Sohar in Oman would bring long-term benefits, but in the short term would generate implementation challenges, made worse by the current weak operating environment.
"The merged entity will face significant short-term challenges while realising the long-term benefits," he wrote, pointing out that lower oil prices are negatively affecting the macroeconomic environment and investor confidence in Oman “creating challenging conditions for the banks".
"While this may ultimately deepen Dhofar's investor base over the long term, it will initially give the combined entity a weaker, more confidence-sensitive funding profile than Dhofar's alone in a tightening liquidity environment," he added.
Keeping the competition
There are also potential risks for general banking sector competitiveness.
Writing in July, the World Bank’s Mr Calice said that in the context of banking sector mergers, “there may be a risk that state-owned banks consolidate their preferential access to funding as a result of explicit or perceived government-backing,” pointing out that the banks that had so far agreed to merge were directly or indirectly controlled by the state. “This may weaken the level playing field, potentially resulting in lower benefits for consumers and firms,” he added.
However, with banking sector growth expected to stay low for the near future, and access to funding increasingly competitive, mergers and acquisitions may be the best way for some of the banks in the region to maintain their growth or in their attempts to become regional powerhouses, and this in turn could trigger other banks to consolidate in order to keep up.
"We have these two mergers happening [NBAD with FGB and Bank Dhofar with Bank Sohar], and I think there will be deals going forward," says Mr Meijer. “But it is like a chess game; one move will trigger another. Not like a big blow, but a slow process.”
