The Good Times Are Back For GCC Bankers

Published in Bloomberg Businessweek, 1 June 2014

There is an unmistakable air of optimism among Gulf bankers these days. As they look around the traffic-clogged roads of Riyadh or wander among the shaded paths behind the Dubai International Financial Centre (DIFC), they can see plenty of reasons to be cheerful. Stock markets are on the rise, governments and consumers are spending freely, project activity is robust and economic growth is once again strong. The net effect is an improvement in lenders’ fortunes. According to Kuwaiti investment company Markaz, profits among GCC banks were up 9.9 per cent last year.

All in all, the dark days of the economic crash appear to be firmly in the past. “Investor confidence is back. It hasn’t been this high in years,” says one investment banker in Dubai.

But the rebound is not being felt equally around the region. The bigger, stronger economies of Saudi Arabia, the UAE and Qatar are attracting disproportionate attention from investors, while the other three members of the GCC club — Bahrain, Kuwait and Oman — are either languishing or simply being overlooked.

Ashok Aram, chief executive of Deutsche Bank in the Middle East and North Africa, summed up the mood at an event at the Dubai Economic Council in early May when he said: “The market is in love with the GCC.”

Aram told the audience that his bank was at times finding it difficult to cope with the number of investors coming to the region from Asia, the US and Europe, but he added “there’s a laser like focus on Saudi Arabia, the UAE and Qatar … these are the three countries which are going to be the biggest beneficiaries”.

There are a few underlying trends behind the resurgence. High oil prices mean government coffers are bulging and they have shown plenty of enthusiasm for spending that money. That is partly a legacy of the Arab Spring, with governments keen to redistribute their oil income to keep their citizens quiescent. Linked to that is the ongoing push for economic diversification, the need to create more jobs for locals and a recognition that heavy investment is needed in infrastructure to keep pace with fast-growing populations.

All that adds up to a very positive operating environment for banks, a fact highlighted by the decline in non-performing loans in most countries. Returns on assets are also at decent levels, albeit not as good as they were before the crash.

The situation in Saudi Arabia is emblematic of the broader trends impacting the region. “Saudi Arabia has a solid economy and it’s doing pretty well on the macro side,” says John Sfakianakis, chief investment strategist at Masic, a privately owned investment group. “The government is spending a lot of money, inflation is low, the currency is not faced with any headwinds, and oil prices are high enough to ensure another fiscal surplus. So it has a good story to tell.

“There is pent-up consumer demand and disposable incomes are rising as a result of more Saudis joining the labour force, so that’s positive too.”

According to Riyadh-based Jadwa Investment, bank lending to the private sector in Saudi Arabia posted its highest gains in 11 months in March, with annual growth reaching 12.8 per cent. Deposits are growing even more quickly, at 14 percent, and  monthly profits were at  five-year highs in January and March. “The industrial diversity is much greater than it has been in the past, in terms of everything from telecoms to infrastructure to metals,” says one expat banker in Riyadh. “And there has been great government investment in infrastructure. The Riyadh metro has generated all kinds of ancillary business for banks, everything from long-term letters of credit, to underlying trade finance and performance bonds.”

It is a similar story in Qatar, with huge infrastructure investments driving the non-oil economy. There have, however, been signs of strain, with the development of the new airport suffering long delays and the government recently announcing a surprise reduction in the number of stadiums that will be built for the 2022 World Cup. That raises questions about the country’s ability to deliver the rest of its infrastructure programme, which includes a new port and the Doha metro, but as yet no-one seems unduly concerned.

“Qatar is passing through a root-and-branch transformation. It’s a huge project management challenge and there will inevitably be roadblocks and pinch points along the way,” says Simon Williams, chief economist of HSBC Middle East.

Even if there are more project delays, the amount of money being invested means the growth prospects for Qatar’s banks are extremely positive. For one thing, the infrastructure build-out is leading to a surge in the population, which was up 11 per cent year-on-year in April, according to Qatar National Bank (QNB). That in turn is leading to growth in other areas of the economy, including finance, real estate, hotels, trade and transport. In 2013, loans by Qatari banks were up 13.3 per cent year-on-year and deposits were up 19.7 per cent says QNB.

Qatar might have the World Cup to look forward to (assuming the award is not revoked), but the UAE has also won the rights to host a big international event in the shape of World Expo 2020, which Dubai was awarded in November. That win helped to cement the feeling in Dubai that the economy had recovered. “The Expo award closed a dark chapter in Dubai’s economic history. The announcement of the Dubai World debt standstill [in November 2009] marked the start of the downturn; the winning of Expo 2020 marked the end of it,” says Williams.

Now the mood among bankers in Dubai is almost unremittingly positive. “I would say there’s a little boom right now,” says one investment banker based in the emirate. But there are some clouds on the horizon, in the shape of a housing market, which some fear is in danger of over-heating, and the still large amount of debt owed by Dubai government and its related entities.

Optimists in the city point out that the UAE Central Bank has introduced new regulations to take some of the heat out of the housing market and there are some signs it is cooling. At the same time, Abu Dhabi seems content to continue supporting Dubai — it rolled over $20bn of debt for another five years in March.

Even so there are clearly still some problems and the rate of non-performing loans is higher in the UAE than anywhere else. Some observers think banks will need to be restrained in the coming years.

“Five years on from Dubai’s debt crisis, the UAE’s banking sector appears to be returning to health, which should open the way for an improvement in credit growth,” said Jason Tuvey, assistant economist at London-based Capital Economics, in a research note published in late March. “However, the large overhang of debt from the pre-crisis boom years means banks are likely to remain cautious.”

The UAE financial sector is becoming a story of two centres though, with Abu Dhabi trying to boost its credentials by setting up the Abu Dhabi Global Market as a potential rival to the DIFC. Whether it proves to be a direct competitor to Dubai or manages to find its own niche remains to be seen, but either way there is little sign of concern about it in Dubai.

“Many GCC countries have tried to set up an international financial centre, but the DIFC has established itself as the most successful one to date,” says Peter Baltussen, CEO of Commercial Bank of Dubai. “Abu Dhabi, Qatar, Bahrain: they’re all trying, but I think financial institutions have a desire to be in a location that can serve as a genuine regional platform. Clearly wealth managers want to be in Abu Dhabi and Qatar and that will continue because they are substantial investors, but if your target is to be a regional private or investment bank you might as well be in Dubai.”

Another sign of the UAE’s strong position in the region can be seen in the bond and sukuk market. According to Kuwait-based research firm Markaz, the value of new issues across the GCC last year was $97.7bn, a 14.5 percent increase on the year G G before. That was partly because central banks were issuing far more debt, but corporate issues were also up 12 per cent to $42.9bn. The brightest spot was the UAE, which accounted for $18.8bn or 41 per cent of all corporate issues. Saudi Arabia was not far behind with $17.2bn, followed by Qatar with $6.7bn.

Banks have been among the most enthusiastic issuers, raising $19.8bn through 122 issues last year as they tried to beef up their capital adequacy ratios. Activity is likely to be strong this year too, given the interest from investors.

“You can’t imagine how much demand there is from regional institutions for sukuk,” says the Dubai-based investment banker. “There is so much liquidity in the market it is unbelievable.”

If the talk in Dubai, Doha and Riyadh is of vibrant economies, the outlook is far more pessimistic in Bahrain, once the regional financial hub but these days mired in political unrest and repression. Bankers tend to shake their heads in despair when talking about what has happened there and the prospects for the future.

“Without reconciliation in Bahrain there is no future,” says one senior international banker in the region. “There are some good companies and some good businessmen, and confidence will come back eventually, the question is when. They have to reinvent themselves. If they have political stability and safety they might be able to develop as a low-cost alternative to Dubai.”

As it is activity levels are weak. Total local deposits at Bahrain’s banks rose by 4.1 per cent in the 12 months to the end of March this year, while loans were up 3.2 per cent.

The weakness of the political system is also hampering activity in Kuwait. It has the benefit of huge oil revenues, but the sort of capital spending that is pushing other economies forward is not happening.

The ongoing failure of the parliament and the government to develop a decent working relationship has meant grand plans go nowhere. National Bank of Kuwait reports that in the first 10 months of the current fiscal year the government’s capital spending was KD0.8bn, its lowest level in five years.

Despite, this banks are doing relatively well. Total credit was up 8 per cent year-on-year in January, while total bank deposits grew by 7.7 per cent. Even so, the banking sector, like the rest of the economy, effectively has one hand tied behind its back. At the other end of the Gulf, in Oman, banking activity is stronger but it is a small market. The combined balance sheet of the country’s commercial banks grew by 10 per cent in the 12 months to February this year, to reach RO2.7bn ($7bn). Deposits were up 14 per cent over that time while credit grew 8.5 per cent.

The Central Bank of Oman (CBO) has been encouraging banks to offer more credit to sectors such as SMEs to boost diversification, but it has also been striking a note of caution. At a meeting of bankers on 28 April, Hamood al-Zadjali, executive president of the CBO, expressed satisfaction at another year of rising profits, deposits and advances, but he advised the banks not to get too carried away and to strengthen their risk management systems.

Such warnings are sensible given the recent crash. As the region’s economies rebound, there is always the danger that the lessons learned during the downturn will be forgotten.

That risk is probably greater in Dubai than anywhere else. In mid-May, there will be another reason for confidence there to grow a little bit more after the UAE and Qatar were upgraded from frontier market to emerging market status by global stock market indexing company MSCI. That change, which was first flagged a year ago, has already led to a rise in investor interest in the two countries, but the real long-term significance may be the perception that the two countries are gradually evolving into more mature financial markets.

If the authorities can keep the old hubris in check, Dubai’s bankers will have the chance to enjoy another period of expansion, as will their peers in Riyadh and Doha and even Muscat. For those in Manama and Kuwait City, however, the future does not look quite so bright.