Eight years ago, the financial crisis crippled the American banking industry, and the devastating affects rippled across the world. The banking sector has undergone major changes from realigning business models to the changing environment, restructuring of assets, raising capital and liquidity buffers to adopting stringent risk management practices. These measures taken by the banks across the globe has enabled them to withstand recent market turbulences such as a Chinese slowdown, Fed tightening, Brexit, a Turkey coup attempt and among many others.
Although the banks have become more resilient to economic shocks, the modest recovery and possibility of a further slowdown in economic growth has once again forced the banks to further strengthen their capital ratios and diversify revenues amid stiffer competition. Hence, starting a consolidation wave to either buy-in growth or merge to strengthen their position is a viable option in this environment.
Strengthened balance sheets
Post the financial crisis, the banking sector in the Mena region has strengthened its balance sheets and capital ratios, primarily driven by strong government support. Regional banks, especially in the GCC countries have taken prudent steps in improving their risk management platforms and controlled slippages to improve the profitability of the overall sector. Additionally, banks have also relied on wholesale funding to further capitalise on the favourable macroeconomic environment. However, since mid-2014, the persistent decline in oil prices has changed the dynamics of regional economies, which are now staring at twin deficits and witnessing a number of reforms to offset dwindling government revenues. Moreover, rising budget deficits have also resulted in withdrawals of government/public deposits, which have over the past few years been the main source of funding for the banking sector, especially the public sector banks. 2015 has been a challenging year for the regional banking sector, which has moved away from excess capital and liquidity to moderate asset and profitability growth, limited capital market activity and tighter liquidity with a greater emphasis on cost reduction.
Important phase
Regional banks are actively seeking opportunities beyond their borders triggering a number of cross border mergers and acquisition deals in recent years. The region’s banking sector has entered an important phase of consolidation, with the potential to dramatically reshape both the role and the intermediation capacity of the industry. The sector has seen a number of key mergers to create regional powerhouses in the past few years. For example, the merger of Emirates Bank International (EBI) and National Bank of Dubai (NBD) in 2007 and National Bank of Kuwait acquiring a controlling stake in Boubyan Bank to further strengthened its position in Islamic banking. Most recently, the news is that one of the two largest UAE banks, National Bank of Abu Dhabi (NBAD) and FGB announced a merger valued at $170 billion (Dh624 billion) in total assets.
Given the commanding positions of the two banks in commercial and retail space, the merger will not only create the largest bank in the UAE but also a powerhouse within the regional banking sector. Moreover, the bank will have a competitive edge by capitalising on their respective areas of expertise, which will improve the efficiency and competitiveness within the sector. Although, the UAE has the highest banking intermediation in the region, further consolidation in the banking sector will largely depend on the strategic nature of shareholding and alignment of business models. In Oman, the central bank has indicated that the sector needs to consolidate in order to create larger banks, which will be imperative given the slowdown in economic activity.
Big ticket projects
Specifically, for the banking sector, the size of the bank plays an important role. Firstly, it enables the bank to fund big ticket projects, especially the projects which are launched and pushed by the government as part of their long term strategic plans. Secondly, it enhances profitability by cost rationalisation and synergies between the two institutions. Thirdly, it will strengthen the banking sector’s ability to support the broader economy by improving liquidity in the system. Lastly, bigger banks will have the ability to tackle the slippages and absorb them with a large capital base, which reduces systemic risk for the broader economy. Moreover, bank consolidations that are being driven by governments, such as EmiratesNBD also reduces government burden to infuse capital as well as helps with the issue of allocating public funds to shore up funding base. Further, the Government’s diversification program involves a large pipeline of planned infrastructure and projects that requires much needed size to fund big ticket projects in order to achieve economies of scale and operational efficiency. In the current scenario, size is the key with respect to project execution and scalability and to fund such large ticket projects at competitive pricing.
Inevitable
Although consolidation within the banking sector has not been a new phenomenon within the region, it has resurfaced once again with the proposed merger of NBAD and FGB to create a regional powerhouse. The consolidation becomes inevitable in challenging times as slowdown in earnings and rise in slippages would mean that banks would need additional capital to continue lending to support the broader economy. Hence, consolidation always augurs well for the sector as well as economy, especially within the region, which is already witnessing a high level of banking
penetration.
The writer is founder and CEO, Al Masah Capital