Banking on banks: How are they faring?
How has the Covid-19 pandemic impacted investor attitude and what are the key trends shaping the world of tomorrow? Christian Gattiker, head of Research at Swiss wealth manager, Bank Julius Baer, reveals more details
For as long as people have existed, banking has existed, even in its most non-descript form. Prior to the first currencies being minted, merchants granting grain loans to farmers and traders transporting goods through various cities were touted as the first prototypes of banks. The first proper bank too was no more than a series of vaults for people to store valuables in. Since then, banking worldwide has graduated from bullions in a vault to a plethora of financial products and offerings for consumers and corporate entities, nurtured and propelled by ingenuity, innovation and digitalisation.
GCC’s banking landscape
The GCC’s banking landscape is as diverse as it is sheer. On the heels of regulatory reforms, customer-centric approaches, consolidation, technological investments and omnichannel approaches, the regional ecosystem in recent years has exploded. There are more than 70 listed banks across six GCC countries; Qatar National Bank remains the biggest lender in the GCC by assets – which total $262bn – followed by the UAE’s First Abu Dhabi Bank ($227bn), according to data published by Bloomberg in July.
In recent years, the Gulf’s banking sector has shown resilience, recording formidable growth in terms of assets and profitability, despite political and economic headwinds.
GCC banks recorded an increase of 16.9 per cent in net profits in 2019, totaling $36.5bn, while total assets went up by 12.8 per cent to $2.3 trillion, a KPMG report, summarising the performance of select 55 GCC-based listed banks for the year-ended December 31, 2019, revealed. Meanwhile, bank share prices trended upwards with an average increase of 9.5 per cent over 2019, it found.
Islamic banks in the GCC have also maintained sound assetquality and hold encouraging profitability indicators, funding profiles, and capitalisation. The 2019 Islamic Banking Index by Emirates Islamic bank, which polled more than 900 respondents with a UAE bank account and a minimum monthly income of Dhs5,000, revealed that 60 per cent had at least one Shari’acompliant product, up from 55 per cent in 2018. Meanwhile, non-Muslim respondents’ interest in Islamic products also grew since 2018, including a 9 per cent increase in Islamic current accounts, and a 6 per cent hike in Islamic savings accounts. “The UAE headed into 2020 with renewed confidence. However, the twin effects of the Covid-19 pandemic, leading to the postponement of Expo 2020 and the collapse of crude oil prices have caused substantial economic disruption in the UAE and across the oil-rich Gulf,” says Matthew Escritt, partner, Banking at Pinsent Masons Middle East.
“As the region moves beyond the acute phase of the crisis and takes tentative steps to reopen, it is clear that the region’s banks will be front and centre in that recovery. Strong capital buffers together with recent consolidation in the sector have meant that the UAE’s banks are better placed than financial institutions elsewhere to come through this crisis.”
The ‘Covid’ effect
The Covid-19 pandemic has dealt a strong blow to the regional and global banking sector. Although the fallout of the outbreak in the region was mitigated by the quick measures taken – including government support – the impact was felt along the length and breadth of the regional banking ecosystem. GCC banks’ share prices, which had trended upwards in 2019, witnessed an average decline of 18.9 per cent between December 31, 2019 and April 30, 2020, the KPMG report noted.
“The global banking sector has faced a number of challenges as a result of subdued economic activities due to the twin shocks of falling oil prices and the impact of the Covid19. In the GCC, the extent to which the banking sector will be impacted is likely to be country related; if you look at the two largest economies in the GCC, it is likely that the impact in the UAE is more compared to Saudi Arabia. One indicator that is followed is the NPL (non-performing loans) ratio. This ratio – for the 10 largest banks in both countries stood, at the end of
Q1 2020, at 5.2 per cent for UAE compared to 1.9 per cent for Saudi Arabia,” says Asad Ahmed, managing director and head of Financial Services ME, Alvarez & Marsal.
To offset the economic onslaught brought on by the pandemic the UAE Central Bank launched the Targeted Economic Support Scheme in March this year, which included Dhs50bn of zero-interest, collateralised loans for UAE-based banks and allowed for Dhs50bn funds to be freed up from banks’ capital buffers.
Earlier this year, the Saudi Arabian Monetary Authority also boosted liquidity in the market by injecting SAR50bn ($13.3bn) into the banking sector.
“The global nature of this crisis has provided an opportunity for transformative change in the sector as banks rethink all aspects of their business and operations not only to ensure their survival, but also to allow them to emerge from the crisis stronger and more resilient than before,” notes Escritt at Pinsent Masons Middle East.
“From a retail perspective, the transition towards an online service model and cashless transactions can be expected to accelerate. Banks will also be looking to cut costs substantially and this will require a comprehensive assessment of all bank operations as they respond to lasting social and economic changes accelerated by the pandemic. New working practices will also cause many banks to reconsider the size of their real estate footprints, branch network and ATM distribution.”
Similarly, the Islamic finance industry is also expected to witness low-to-mid-single- digit growth in 2020-2021, after 11.4 per cent growth in 2019 supported by a strong sukuk market performance. However, the Covid-19 pandemic offers an opportunity for more integrated and transformative growth within the sector, with a higher degree of standardisation and meaningful adoption of financial technology, S&P Global Ratings suggests.
Merging strengths
The virus outbreak and the crash in oil prices has also had implications for banks’ core operating models in the region, pertaining to employees, customers, and subsequently, their bottom lines. Many regional institutions have paused to reassess their long-term viability plans, further underpinning a recent consolidation trend that had been gaining ground.
The consolidation wave had begun in the GCC a few years ago, even as lenders faced pressure from technological innovation, the need for stronger corporate governance and increased costs. The pandemic may accelerate this trend.
The possible merger of Saudi’s National Commercial Bank (NCB) with Samba Financial Group may well be a step in that direction. The merger, which will result in the formation of a combined entity with reportedly $213bn in assets, will not only create the kingdom’s largest lender – and the third largest in the GCC by assets – but also potentially stir a next wave of mergers and acquisitions.
“It [the merger] could create the largest bank in Saudi Arabia, which would help the government implement Vision 2030. A bigger bank means a bigger capacity to finance the economy and to underwrite bigger loans,” notes Dr Mohamed Damak, senior director, Financial Sector lead, Middle East and Africa at S&P Global Ratings.
“This merger is similar to what we’ve seen in other Gulf countries, with government institutions the biggest shareholders in both entities. That should help the transaction succeed. However, in our view, Saudi isn’t the primary Gulf market for further bank M&A – that’s the UAE, which is fragmented and overbanked.
“With Covid-19 and its negative impact on banking sector profitability, we might see a second wave of mergers that won’t be driven by common shareholders re-organising their assets, but instead based on a purely economic rationale,” he explains.
Ahmed at Alvarez & Marsal, adds: “The merger of National Commercial Bank with Samba Financial Group will continue the consolidation trend that is happening within the GCC. The amalgamation will allow customers and businesses alike to reap the benefits of larger banks being scaled up and this efficiency being passed on to customers in the form of improved turnaround and lower overall costs.
“We believe that rising competition, reduced lending opportunities, along with an increased focus towards digitisation will continue to drive the consolidation agenda.”
The Gulf banking ecosystem has witnessed a notable consolidation phase in the years prior to the virus outbreak. In 2007, UAE-based Emirates Bank International and National Bank of Dubai merged to form Emirates NBD, followed by National Bank of Abu Dhabi and First Gulf Bank, which combined to create First Abu Dhabi Bank in 2017. Last year, Abu Dhabi Commercial Bank merged with Union National Bank and the combined entity acquired Al Hilal Bank. Regionally, in 2019, International Bank of Qatar and Barwa Bank also merged, and so did Saudi Arabia’s Alawwal Bank and Saudi British Bank.
“Even before the Covid-19 pandemic, the region had seen significant bank consolidation with around 20 banks with assets worth an estimated $1 trillion negotiating mergers. The Emirates leads in terms of both volume and value with the highest number of mergers. With tougher market conditions and a more competitive retail environment, it seems likely there will be further consolidation amongst the region’s financial institutions in the future,” says Escritt at Pinsent Masons Middle East.
As regional banks navigate through the current crisis, adopting several measures to deliver top-line growth, the industry looks set to see several major changes – including further consolidation in the market – which may well see the emergence of a robust and leaner banking landscape.
“Even before the pandemic, the region had seen significant bank consolidation with around 20 banks holding assets worth an estimated $1 trillion negotiating mergers”
How would you describe the current investment scenario even as the world continues to tackle the challenges presented by the pandemic?
The current investment regime is a globally synchronised and mostly V-shaped recovery, helped by heavy monetary and fiscal stimuli. The world economy entered a synchronised shock-like recession in the first half of 2020 and is now recovering at different speeds. The main divergence in the speed of the recovery is the amount of fiscal and monetary stimulus available. The US, China and Japan have experienced a 10 per cent downswing in economic output, with the figures rising to 15 per cent in continental Europe and 20 per cent in the UK. Emerging markets have been hit hard but at varying degrees by the pandemic, with Latin America still in doldrums.
We expect most of the mature economies to compensate for about half of the shortfall during Q3, with a much slower pace thereafter. China is the exception, since the world’s second largest economy is back at pre-crisis levels as we speak in terms of economic output.
Has Covid-19 impacted the way investors view their portfolios?
A flight into quality was the major move of private investors worldwide in reaction to the economic breakdown in H1. The main focus was on safe-haven assets, such as US treasuries and German bunds, as well as US dollars, euros and Swiss francs. The cash ratio shot up markedly. On the corporate side, the preferred stocks and bonds were from companies that are less cyclically sensitive, such as those in the healthcare and food sectors. There was a certain reluctance to chase the crisis winners in the new economy, such as in information technology and communications, whereas biotech and other healthcare-related issuers attracted more interest.
Do you see any major impact on investment behaviour as a result?
Most investors are caught in a psychological trap, because they, by and large, missed the recovery in financial markets as of March 2020 or even sold into the downturn. Now, after many financial assets have made a tremendous comeback, they think it is too late to buy and maybe too early to sell. So ‘animal spirits’ are at work, and this usually has a negative impact on investor behaviour, leading to self-inflicted damage to their portfolios. A lot of uncertainty is still around, in particular when it comes to cyclically sensitive or ratesensitive stocks such as banks. Overall, private investors are in a ‘freeze’ mode rather than a ‘fight’ or ‘flee’ mode.
What are the key trends that have surfaced as a result of the market changes due to Covid-19?
We observe an acceleration of existing long-term trends overall, such as in digitalisation at all levels, spanning from
retail consumption to healthcare. In investment terms, the trend towards investing along environmental, social and governance ( ESG) criteria is experiencing further tailwinds. Many investors have realised the vulnerability of many business models and appreciate the benefits of good governance and environmentally and socially sound behaviour from economic agents. Furthermore, the trend towards more active government spending is unbroken. The biggest shift has happened in Europe, where mutually guaranteed bonds were announced on a European Union-wide level. In our view, a move towards major fiscal spending globally is one of the biggest wildcards as a consequence of this health crisis.
Are there any particular sectors that have been pushed to the forefront given the current circumstances?
As this is a health crisis, the healthcare sector immediately stood out as a central area of response to the crisis. The race for a vaccine is one of the fiercest ever in human history. The funds being spent and the speed at which innovation is taking place are unprecedented.
At the same time, recent progress in terms of medical analysis and treatment has been put to work quite effectively. This is to the benefit of biotech companies in particular.
Outside healthcare, the technology sector also stands out.
New economy businesses could leapfrog traditional brickand-mortar businesses by proving their superiority in times of lockdown – look at online retail, streaming services and video gaming.
What future impact do you see from the developments over the last six months from a global perspective?
The boost in innovation and the change in economic policies in response to the crisis will likely last far beyond the next six months. Ten years from now, we might look back and say that the positive after-effects of this pandemic were a major wave of innovation, plus a booming world economy.
“Private investors are in a ‘freeze’ mode rather than a ‘fight’ or ‘flee’ mode”