A quick stroll down Bank Street in Dubai (formally known as Khalid Bin Waleed Street) and, despite the hustle and bustle of everyday activity, and the infamous traffic, it is hard to avoid seeing bank signs every other step. This is one of the few places in the world where you will find an Iranian bank next door to Citibank, along with the UAE-based banks, from the known (Mashreq, First Gulf Bank) to the more obscure (National Bank of Umm Al Quwain). At first glance the many banks give consumers the illusion of choice, but the fact is that small banks are unattractive (less stable, fewer ATMs and branches) and most flock to the giants. This is why in the UAE the top five banks are worth twice as much as the combined market cap of the next fifteen finance houses.
Banking consolidation is lagging behind the positive economic growth we have, and as it continues, we will see more [mergers]… In the next five years there will be only a few mega banks in the region.
"We have too many banks, too many local banks. We are also over-banked by foreign banks," said Abdullah Mohamed Saleh, chairman of National Bank of Dubai (NBD), during a press conference last week. He was there along with HE Ahmed Humaid Al Tayer, chairman of Emirates Bank International, to announce the terms of the merger between the two Dubai-based institutions. The new entity will be the largest bank in the UAE (by market cap), and the largest in the GCC (by assets).
Saleh explained the underlying rationale: "The banks in the UAE are small and the challenges are growing every day. There are more challenges, and more competition from foreign giants... We need this amalgamation, we need this consolidation, and we hope others will follow our example." The mega projects and the economic boom in the region have created the demand for financial institutions capable of servicing the growth.
"It is a good beginning, and you are going to see some of the other countries in the region go through consolidation in the banking sector." So predicts Dr John Sfakianakis, the group chief economist at Saudi Arabian British Bank (SABB). He sees this is as an inevitable trend. "Banking consolidation is lagging behind the positive economic growth we have, and as it continues we will see more [mergers]... In the next five years there will only be a few mega banks in the region."
While there has been an influx of international banks into the region, Sfakianakis views them as filling a void that the smaller banks in Saudi Arabia have ignored, most importantly the inability of the smaller banks to finance mega-projects.
This dynamic will change, he agrees: "The size of the projects is so big they force the banking sector to think about how they can cater to these projects. Any market that operates freely have to create banks that cater to infrastructure projects."
The path to creating large banks is predictable. In addition to mergers, "local banks will naturally grow with the economic boom over the next five years; smaller banks will be bought out by larger banks... Banks need to become aggressive in acquisitions."
Two obstacles stand in the way of acquisitions. The first is regulatory, and the second is the quality of some smaller banks. Sfakianakis says: "The regulatory framework has to be looked at because there hasn't been a trend [of acquisitions]. The private sector in the region consistently outpaces regulations, and the framework has to adjust at the same pace."
Governments in the region have been active on this front, and increased liberalisation and sophistication are on the agenda of all economic ministries, not only in the GCC, but in the rest of the Arab world.
The qualitative problem is more difficult to overcome. The UAE is not the only over-banked country. Throughout the Middle East, there are a plethora of small banks that are undercapitalised and that operate a single branch.
The private sector in the region consistently outpaces regulations, and the framework has to adjust at the same pace.
These banks are not attractive targets for acquisition, as they lack the market share, market knowledge, and necessary skills to complement the larger organisation. This is why Sfakianakis believes that finance houses in the region will need to look east for acquisitions, as the "growth potential in Asia is greatest".
Banks in Asia can use a capital influx from other regional players, but can lend considerable market knowledge and skilled management that surely optimises the transaction.
When asked about the Saudi scene, and if the banking sector is lagging behind its neighbours, Sfakianakis adds: "When the giant moves the shockwaves are felt throughout the world." He illuminates the point by contrasting the recent deals conducted by other entities in the GCC, and SABIC's US$11.6bn acquisition of GE Plastics. The potential of Saudi should not be ignored.
The Arab banking giants will emerge, but not without two important catalysts: international bankers to act as advisers, and M&A legal experts to rework the regulatory framework.
Goldman Sachs, the world's most powerful investment bank, acted as the sole adviser for the Emirates NBD merger, but it did not have the final say.
Morgan Stanley was also on deck to lend a fairness opinion on the merger terms. Bertrand Valet, a managing director at Morgan Stanley told Arabian Business: "global investment banks are well positioned in advising on financial institution mergers and acquisitions, because of their independence."
He sees the advisory role as suited to international firms. "In larger transactions you would typically want to retain advisors who were involved in large and complex situations before, and so far the track record in the region is still relatively limited."
Valet also believes that the regional banking sector will see more mergers, especially as cost synergies are so attractive. "Domestic mergers do lead to significant synergies, and this is not necessarily people synergies, especially in a region where talent is scarce. It is more about optimisation of the branch network, IT, real estate, and possible funding synergies. As you know banks are essentially people, money, and IT - and IT is increasingly a significant cost component given, not just the requirement of the higher level of customer service, but also for compliance in terms of monitoring ‘know your client' procedures. As you gain scale, you can leverage the same system to do twice the amount of business, and the amount of synergy you can extract from that is quite significant."
Real estate synergies are very attractive in domestic mergers as "real estate portfolios can be optimised, which leads to substantial savings.
This is easier to execute in domestic combinations than on a cross-border basis, where the respective stakeholders would want to keep a significant HQ in each country." As demand for services forces the banking sector to consolidate and expand, and the cost synergies become difficult to ignore, the legal system in the region must adapt to accommodate growth.
Niall O'Toole, an Abu Dhabi-based partner at the international law firm Clyde & Co, who has advised on a number of M&As in the region, has witnessed first hand the advances in the legal framework in the Gulf region. He explained to Arabian Business the main obstacles to completing a merger. "First, the main regulator will have to grant clearance, and then shareholders will have to approve of anything as fundamental as a merger."
These obstacles are easily overcome in a local merger, but cross-border mergers require multiple regulators and shareholders approval which makes deals more difficult to complete. The GCC monetary union is one way in which legal regimes are normalised. As the single economic bloc emerges, competition must be fostered, but regulated.
A few years ago, Saudi Arabia was lagging behind other countries in the GCC, but has now come from being behind to being ahead of the UAE.
"We don't have a competition or anti-trust regime, but there will be a need for one as the market gains in sophistication," says O'Toole. Progress on the monetary union has been slow, and states have been advancing at their own pace.
For upcoming mergers, companies will make decisions based on markets and regulations. "From a regulatory viewpoint, Saudi Arabia is an interesting case. A few years ago it was lagging behind other countries in the GCC, but has now come from being behind to lead the way in certain cases. The possibility of 100% foreign ownership is an important advancement," O'Toole adds. As for the banks that are looking to merge, aside from regulatory concerns, O'Toole highlights the issues that must be examined during the due diligence period.
Companies have to examine "employment terms, financial and IT systems. Banks are heavily reliant on IT and must ensure that systems are compatible and synergies don't lead to loss of data or data corruption," he says. Bank consolidation in the Arab world and the emergence of Arab banking giants is something that we will continue to see. While there are obstacles, the demand to create larger banks is inexorable. The regional banks will take the first steps, however governments will need to play catch-up if they wish to foster institutions that can compete both regionally and globally.
Nothing will stop the next giants.
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