Big bank theory

As an institution that markets itself as ‘The number one bank', it might be expected that National Bank of Abu Dhabi (NBAD), for years the largest bank in the UAE by assets, might feel threatened by the merger of Emirates Bank International (EBI) and National Bank of Dubai (NBD). Industry observers have predicted that NBAD could join forces with Abu Dhabi Commercial Bank (ADCB), the emirate's second largest lender, or even with Abu Dhabi Islamic Bank, in order to regain its title.

Michael H. Tomalin, chief executive of NBAD, will not be drawn on merger speculation, but says that the bank is confident it can continue to compete as a standalone entity.

"Number one doesn't necessarily mean size," he says. "It could be number one in terms of customer service, business excellence, international network, profit or rate of profitability.

"We acknowledge that with the merger of the two banks in Dubai we will not be the largest bank in the country in terms of size. Actually, in terms of capital we haven't been the largest bank in the country for quite a long time, but we hope that we will retain our number one position in various other dimensions and we shall work hard to do that."

Tomalin says it is important that the UAE grows bigger banks, citing the case of Singapore, which has a smaller economy than the UAE but much larger banks, having already gone through a process of consolidation.

He points out that the number of banks in the UAE is likely to increase, rather than decrease, in the coming years, with the establishment of two new Islamic banks, Noor and Al Hilal, and the probable entry of more foreign banks. Tomalin has no problem with the number of banks in operation, since most of them are generating strong profits, but says that size is crucial in the long term.

"The top three banks have something like a 30% market share and the top five banks have something like a 45% market share," he says. "That is unusual. If you take the top three banks in France, Singapore, Malaysia, Hong Kong, or Australia, you'll find they have much bigger market shares and therefore much more dominant positions in their own markets."

He adds: "The economies of scale that produces for them, in terms of their ability to exercise their muscles around the region they inhabit or around the world, are much greater. I think it's not the number of participants that is the issue, so much as the size of the largest banks in that particular pool and their relative undersize relative to the importance of the UAE economy today."

Tomalin also believes that overseas institutions account for far more of the UAE's banking activity than statistics might suggest.

"In the domestic marketplace, the foreign bank market share is running at round about one-quarter but that understates the size and dominance of the foreign banks in our very open economy," Tomalin says. "In fact, they represent a much bigger share of the market than the quarter that appears in the national statistics because for so much of the business that they do, the revenue and the assets are booked not in the UAE but somewhere else."

He cites project finance, asset management, private banking, corporate finance and corporate advisory work as areas of banking that are dominated by foreign banks in this region.

"For example, private banking. There are estimated to be very large sums of money routed from this part of the world and the Gulf generally sitting in banks in Switzerland and London. I would guess that the market share that local banks have of that is probably less than half of 1%," Tomalin says. "So we have a situation in the UAE where the foreign banks are very large and growing very fast, and the local banks are relatively small in a very crowded market place.

"We've seen in other markets where this happens, it's not good news for local banks. You can see in the Baltic, the Balkans, parts of Latin America, that local banks have been marginalised away almost altogether. I don't think that's going to happen here, but that's one of the reasons why I welcome the merger of NBD and EBI."
UAE banks are also likely to increase the amount they have to spend to generate income, something Tomalin says has already started to happen, although NBAD continues to be disciplined when it comes to cost-efficiency.

"As far as costs are concerned, we are a very efficient bank," he says. "Our cost-income ratio is very low, possibly too low in this competitive environment where you need to spend more money on IT, people, brand and infrastructure.

"When I first came to the Gulf, the cost-income ratio of Gulf banks was very low indeed, and it has risen substantially over the last five to 10 years. It will continue to rise, in my judgement, substantially and move towards international norms. A retail banking operation normally runs on a cost-income ratio of 40-45%, a wholesale banking operation maybe 60-70%.

"In our business, the cost-income ratios are lower than that in both the wholesale side and the retail side, but I think this will change. We have to manage our cost base, that's rather different from controlling it. Managing our cost base, in my mind, is making sure we get value for money, so we make every dirham we spend work well for us, and we differentiate clearly between what we call good costs and bad costs. Good costs are building the brand and training people; bad costs are doing things twice when you only need to do them once."

As of the end of 2005, NBAD had the highest rate of profitability of any UAE bank, and has maintained steady growth, despite a decline in profits last year when its brokerage and asset management lines lost ground in tandem with local stock markets. Its asset management business, while producing some well-performing regional and international products, has yet to reach its true potential.

"I'm surprised that we haven't received better sales results," Tomalin says. "So there is something about investing in mutual funds that perhaps doesn't suit the climate, and maybe part of it is that people feel that if you're working and living in the UAE, there are so many things you can invest in, such as real estate, which has held up much better."

However, he expects the mutual funds business to pick up as regional stock markets continue their recovery and local investors discover the importance of diversifying their portfolios.

Even if there have been some slight disappointments along the way, NBAD has shown dramatic growth over the past eight years, something that looks set to continue. "Speaking from a position of chief executive of this bank, I believe that this bank needs to get bigger and I've believed that since I came here in 1999," Tomalin says. Since he took over as CEO, the bank's profits have increased by around seven times, and its assets have quadrupled. He anticipates further brisk growth in the future, but not necessarily from M&As. In his time in charge, NBAD has grown organically, and without asking shareholders for more funding.

"There are other ways of growing," he says. "The price of acquisition is very high in the region. You'll have seen acquisitions in Egypt and other places in the region where the price to book has been in excess of five, which means from a shareholder point of view that these acquisitions are extremely expensive for the acquirer - prohibitively so.

"So although we're alert to acquisition, this is something that will depend very much on being the right strategic bit at the right price."

NBAD has also chosen to build its operations outside the UAE, from its private bank in Switzerland, to its branch networks in other Middle East countries: at the last count, it had branches in Kuwait, Bahrain, and Oman. In addition, it has a branch in Sudan and more than 20 in Egypt, with wholesale offices in London, Paris and Washington D.C.

"Other banks have taken a different view," says Tomalin. "Other banks have said, ‘We're not in Egypt, let's go and buy a business in Egypt'. They've paid a very high price for that business. They get a flying start, but it's expensive from the shareholder point of view. So we have taken the view of building organically."

In another development, NBAD will open an Islamic window on January 1, 2008, in response to the huge demand in the region for Shariah compliant finance.

"There's no doubt that a growing percentage of the retail market wishes an Islamic financial solution," says Tomalin. "My personal view is the share of the market that will belong to the Islamic banks will continue to rise, but that the conventional share will continue to dominate. The current position is that something like 15-20% of the business in the country is Islamic and 80-85% is conventional. That might over the next two years move to one-third/two-thirds, something like that.

"At the end of the day, we are in the service industry, so we do what our customers want, and we have positioned ourselves in such a way that we will look after our customers how they want to be looked after."

NBAD's stated goal is to be one of the top five Arab banks, and as part of this strategy it will continue to expand. "In the Arab world we are looking at other markets in North Africa and the Levant on an opportunistic basis for growth, and you will see signs of that during 2008," Tomalin hints. "You will see in the course of the next 18 months or so us opening in new places as part of our in-country strategy, but that shouldn't be confused with our wholesale strategy, which might take us in a totally different direction - East."