Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
Middle EastMarch 1 2019

Smaller and stronger: will consolidation shake up Middle East banking?

A wave of consolidation is hitting banks operating within the Gulf Co-operation Council, strengthening balance sheets and in some cases creating regional 'mega-banks'. However, as James King reports, the appetite for M&A in the rest of the Middle East remains stilted.
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
QNB

Merger activity is sweeping across the Gulf Co-operation Council’s (GCC's) banking markets as a host of economic pressures hit the region’s lenders. Over the past 18 months a number of deals have been agreed or executed that are likely to reshape the region’s banking landscape. Meanwhile, other mergers and acquisitions (M&A) – that are subject to ongoing discussions – point to a continuation of this trend over the next two years.

“Consolidation is being driven by a combination of lower oil prices, which has slowed economic growth, and stiff competition as numerous banks serve small populations. We believe the trend will be beneficial for the sector, boosting profitability through operational synergies and giving the banks greater pricing power,” says Ashraf Madani, vice-president and senior analyst at ratings agency Moody’s.

Belt tightening 

These developments would appear to be long overdue. Data from Bloomberg indicates that the Middle East boasts 73 listed banks for a population of about 51 million. When oil prices were high and business cycles were supportive, the overall market was large enough for most lenders – big and small – to post strong returns. But conditions have deteriorated.

In the GCC, economic headwinds have hit the regional economy hard. In 2017 the bloc's collective economy contracted by 0.4% after years of sustained growth, according to the International Monetary Fund. Though it is expected to recover in 2018 and 2019, expanding at rates of 2.4% and 3%, respectively, these figures still fall below recent historical norms.

As a result, Gulf lenders are adjusting to a new normal in which government spending is being tightened and public sector deposits have shrunk. “Banking sector growth is largely dependent on gross domestic product (GDP) growth and government spending in these economies. Low oil prices in 2014 and through 2016 hit government budgets and slowed economic growth across the region, intensifying competition for deposits and borrowers, consequently dampening GCC banks' profits,” says Mr Madani.

Though on an aggregate basis the region’s banking sector is in rude health, the structure of most banking markets is such that a handful of larger institutions tend to dominate. This leaves smaller and mid-sized lenders more vulnerable to turbulent economic conditions and less able to compete with their larger peers.

Meanwhile, the growth of regional ‘mega-banks’, including Qatar National Bank and First Abu Dhabi Bank, which is the result of a merger between First Gulf Bank and the National Bank of Abu Dhabi, is a contributing factor behind a growing number of tie-ups between larger institutions looking to remain competitive.

A Saudi switch 

Looking ahead this wave of consolidation is expected to contribute to stronger and more profitable financial services sectors across the region. “Though the GCC’s banking systems aren’t under any stress, there is clearly a push to optimise the structure of some markets,” says Nassib Ghobril, chief economist at Lebanon’s Byblos Bank.

Indeed, one of the standout deals among lenders in this segment is the agreed merger of Saudia Arabia’s Alawwal Bank, the country's oldest lender, and the Saudi British Bank (SABB). Once executed, the deal will create Saudi Arabia’s third largest lender with total assets to the tune of $72bn and a market share of about 12% to 13%, according to research from Moody’s.

The transaction remains subject to shareholder and regulatory approval but it is expected to be completed inside the first half of 2019. Under the terms of the binding merger agreement, signed in October 2018, SABB’s current shareholders will own 73% of the new entity, with Alawwal’s shareholders owning the remaining 27%. Meanwhile, all of Alawwal’s assets and liabilities will be transferred to SABB. The deal also represents the first merger in Saudi Arabia’s banking sector in more than 20 years.

But the Saudi banking sector, on first appearances, is not an obvious market for consolidation to occur. Prior to the agreement reached between SABB and Alawwal, the country had 12 local banks catering to a population of close to 33 million. “I am surprised about the degree of consolidation occurring in Saudi Arabia’s banking sector. [There is enough business] for each lender to remain profitable,” says Chiradeep Ghosh, research manager with the Securities and Investment Company (SICO) in Bahrain.

The SABB-Alawwal merger does, however, give the bank additional scale to support Saudi Arabia’s Vision 2030 development agenda, which includes massive infrastructure projects and a vast home building programme. It also better positions the merged bank relative to the domestic competition in light of its increased size, as well as its peerless international connectivity. This is due to HSBC’s current ownership of a 40% stake in SABB and its expected 29.2% ownership position in the merged bank. HSBC will thus become the largest shareholder, with three of the 11 board seats in the new bank, according to the Financial Times.

The rise of the mega-bank 

Groundbreaking though it may be, the SABB-Alawwal tie-up has since been overshadowed by the December 2018 announcement that National Commercial Bank (NCB), Saudi Arabia’s largest bank, and Riyad Bank, the country’s fourth largest bank, have entered preliminary merger discussions. If a deal were to be reached in the future, the combined entity would have total assets of about $180bn, according to research from Moody’s. Its market share in the Saudi banking system would be close to 30%.

“The proposed merger between NCB and Riyad Bank will give the new entity a much bigger balance sheet and make it more competitive compared to domestic peers. And with this increased size the bank would also become competitive at the GCC level and be able to take on larger banks in the region. This might be the rationale behind the deal,” says Mr Ghosh.

Indeed, in the event of a deal, Saudi Arabia would become the third Gulf state that is home to a ‘mega-bank’. The other two are Qatar, with Qatar National Bank, and the United Arab Emirates, with First Abu Dhabi Bank. In the future these regional mega-lenders will not only be exceptionally well placed to play outsized roles across the Gulf’s banking landscape but they are also likely to assume commanding positions in the wider financial services landscape of the Middle East, south Asia and Africa region.

“GCC banks are ambitious and over the coming years their presence across south Asia and Africa is likely to grow. If they can figure out a business model that serves the local populations in these markets, the growth opportunities will be huge,” says Mukund Bhatnagar, principal with consultancy AT Kearney in Dubai.

It is worth noting that Saudi Arabia’s largest sovereign wealth fund, the Public Investment Fund, is a sizeable shareholder in both NCB and Riyad Bank, meaning that the progress of any prospective deal could be somewhat eased by the banks’ ownership structures.

All change in the UAE? 

Beyond Saudi Arabia, consolidation is also playing out in the UAE. And, unlike that of its neighbour, the Emirati banking sector is widely considered to be in dire need of change. Currently, 23 local banks are operating in the country, alongside 28 foreign lenders, in a market with a population of just over 9 million. The groundbreaking merger of the National Bank of Abu Dhabi and First Gulf Bank, to produce First Abu Dhabi Bank, has also contributed to the further concentration of banking revenues to a handful of lenders.

“In the UAE, the largest three banks control more than 50% of the market and the remaining 57 banks compete for the rest,” says Mr Madani.

In September 2018 Abu Dhabi Commercial Bank (ADCB) and Union National Bank announced they had entered preliminary discussions to merge, a deal that would also include small Islamic lender Al Hilal Bank. This proposed deal would deliver significant benefits in terms of balance sheet diversification as it combines the UAE-focused business lines of ADCB and Union National Bank, both of which boast strong corporate and retail offerings, with Al Hilal Bank’s proposition in the Islamic finance market. Al Hilal is, according to data from Maris Strategies, the Gulf region’s 21st largest Islamic bank in terms of total assets.

“The big advantage that consolidation can deliver is that it allows banks to diversify their loan books. The loan books of smaller lenders can easily become concentrated on one customer class or market segment,” says Mr Ghosh.

This three-way transaction would, if completed, create an entity with about $113bn in assets, according to research from Moody’s. This compares with First Abu Dhabi Bank’s $188bn of assets and Emirates NBD’s $130bn. Any agreement would be eased by the fact that all three banks involved in the merger have a common shareholder in the Abu Dhabi Investment Council. The council has a 63% position in ADCB, a 50% stake in Union National Bank, and 100% ownership of Al Hilal, according to Moody’s.

Beyond borders 

Meanwhile, against this backdrop of domestic consolidation, the region’s first cross-border banking merger is progressing. This involves a deal between Kuwait Finance House (KFH), Kuwait’s second largest bank and its largest Islamic financial institution, and Ahli United Bank of Bahrain, which is also sharia-compliant and boasts a large footprint across the region.

If the deal were to go ahead it would create the region’s second largest Islamic bank, after Saudi Arabia’s Al Rajhi. But more importantly, the merged institution would be an Islamic champion with a genuine regional and global profile. A combination of the two institutions would see a merged entity, with Ahli United Bank’s strong Middle East footprint coupled with KFH’s global operating profile and its market-making status in the realm of global sukuk.

“The proposed merger between Ahli United Bank and KFH makes sense for a number of reasons. For one, about 40% of Ahli United Bank’s lending book is based in Kuwait. KFH is the country’s biggest Islamic bank, while Ahli United Bank’s Kuwait unit is its second,” says SICO’s Mr Ghosh.

The gulf away from the GCC 

While the GCC has emerged as the standard bearer for banking sector consolidation in the Middle East, the same dynamics have not emerged elsewhere in the region, or even in north Africa. It is notable that, even in the most overbanked markets outside of the Gulf such as Lebanon, there has been very little movement towards M&A. This is significant because even though few of these markets are energy exporters, their economic trajectories have remained relatively subdued.

“If you look outside of the GCC, in Lebanon, Tunisia, Morocco or Egypt, for example, you don’t see any consolidation. Tunisian banks, for instance, are experiencing a number of pressures including high loan concentration and elevated non-performing loans, so it would make sense for some consolidation to occur,” says Mr Ghobril.

In Lebanon, the country’s central bank, the Banque du Liban, has been encouraging consolidation among smaller banks for some time. At present there are 52 commercial banks operating in a country with a GDP of about $54bn, according to the World Bank. But, according to Byblos Bank’s Mr Ghobril, there have been a number of obstacles impeding consolidation in Lebanon’s banking sector, which include differences in valuations of the banks and their respective management control.

This is in sharp contrast to some of the deals being executed in the GCC, where common shareholders (in some cases government entities) are helping to ease mergers through the pipeline. In addition, the rationale for these deals, though stemming from new economic pressures, is not emerging as a result of any material stress. As a result, more consolidation is expected in the coming years as this process of adjustment unfolds. 

“In other parts of the world we have seen mergers occur when one bank has asset quality issues. None of the GCC banks have this issue. All the deals appear to be purely from a point of view of strengthening the balance sheet and diversifying their books. If that is the aim I won’t be surprised to see more mergers, especially among the smaller banks,” says Mr Ghosh.

Was this article helpful?

Thank you for your feedback!

Read more about:  Middle East