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Thu 18 Aug 2011 05:22 PM

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Finance mergers hard to crack in overbanked Gulf

Region's banking industry frozen in its tracks by barriers to size, profitability

Finance mergers hard to crack in overbanked Gulf
There have long been calls for consolidation in the Gulfs banking sector to build size and profitability

The planned merger of two Bahraini banks, intended to create
the largest Islamic lender in the Gulf Arab kingdom, could pave the way for
more consolidation in a regional industry frozen in its tracks by unrealistic
valuations and ownership limits.

The proposed tie-up between Bahrain Islamic Bank and smaller
rival Al Salam Bank to create a $4.5bn entity, unveiled this month, is a litmus
test for the region after the last attempted merger, between two Qatari banks,

The two Bahraini lenders said late on Tuesday that they had
received approval from the central bank for their planned merger and have hired
KPMG Fakhro as advisor.

If successful, the merger would be a first for two
Gulf-based Islamic banks but bankers say that its greater significance could
lie in helping break down psychological blocks to dealmaking in the region.

"The Bahrain merger would probably lower the barriers
and get people thinking about the need to consolidate," said Sameer Abdi,
M&A and financial services partner at Ernst & Young in Doha. "If
that goes ahead, there's a possibility we could even see one or two mergers by
the end of the year."

There have long been calls for consolidation in the Gulf
Arab banking sector - lenders, particularly Islamic ones, need to build scale
and profitability. But strict ownership restrictions, stark valuation
disparities and an unwillingness to lose control hamper bankers' ability to
execute any deals.

"A lot of these banking mergers in the region makes
sense on paper but reality is often harsh when you try to get the deals
done," said a Dubai-based banker advising on financial deals, who asked
not to be identified.

"People have put on a mental block against bank mergers
and as a firm, we have stopped pitching these ideas unless we see some clear
light at the end of the tunnel."

Markets such as the UAE are significantly overbanked with 51
financial institutions - 23 local and 28 foreign lenders - in a country of five
million people. The tiny Gulf state of Qatar has 18 banks despite the largest
player having a more than 20 percent market share.

Adding to woes of smaller local players, foreign banks have
beefed up their presence in the region and taken away lucrative investment
banking business.

Abdi said Islamic banks in particular are struggling for
growth and will need to create larger institutions in order to compete with
conventional banks.

The UAE's last successful bank merger was the 2007 union of
National Bank of Dubai and Emirates Bank to form Emirates NBD. Qatar's Al
Khaliji Commercial Bank and International Bank of Qatar (IBQ) called off a
planned merger in June after failing to reach an agreement on terms.

"Politics and economics have held up consolidation in
the sector," said Waleed El Amir, Middle East North Africa (MENA)
investment banking head at Bank of America-Merrill Lynch.

"National ownership rules in certain Gulf countries
restrict foreign ownership to 49 percent or below, making it difficult for
foreign acquirers to seek control."

UAE's Noor Islamic Bank, which once predicted it would
expand through aggressive acquisitions, has changed its model since the
financial crisis and political turmoil hit the region.

"The market for M&A is very difficult in this
region right now," said Hussein al Qemzi, Noor's chief executive.
"People are just not interested in M&A."

Bankers also blame a lack of transparency related to the
quality of corporate assets for the drop-off in activity.

"What you see is not necessarily what you get," said
BofA Merrill's El-Amir.

Total value of completed deals in the Middle East stood at
$14.18bn in the first half, a 65 percent slump versus the year-ago period. No
bank mergers have been completed in the last two years in the region.

"These [banking] mergers have to happen in multiple
jurisdictions to have a lasting impact on the industry," said an Islamic
banker, adding that the Bahraini deal would be good first step.

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