Gulf Region Economies Opening Slowly

On September 30, 2015 · 0 Comments

greThe opening up of Gulf economies promises a range of new financing opportunities, and even some potentially hectic merger activity as Gulf Co-operation Council banks prime themselves to survive in a more competitive environment.

An opening to private investment in key sectors of the Saudi Arabian economy is exciting considerable interest across the Gulf Co-operation Council (GCC) region. Speculation that investment in the Saudi gas sector could require some $25bn in the next few years alone is just the sort of talk Gulf bankers and their international rivals and associates like to hear.

Opening up the world’s biggest oil exporter could have considerable impact on Bahrain, whose financial services sector, just across the causeway from Saudi Arabia’s Eastern Province, houses nearly 200 financial institutions with a $100bn-plus consolidated balance sheet — a significant part of which is sourced from Saudi Arabia.

But the impact of any real Saudi opening will be felt across the wider Gulf region, where project financing, new Islamic products and other instruments are fast becoming commonplace in one of the world’s most conservative markets.

One obvious consequence of market liberalization in Saudi Arabia would be for major mergers involving Saudi banks, says a senior Arab banker in Manama. Across the region, over-banked domestic markets are coming to understand they must consolidate their resources to survive and in some cases they are being pushed into mergers. Efforts to clear up past debt problems in Saudi Arabia have seen banks’ asset quality improve; consolidation started with the 1999 merger of Saudi American Bank (Samba) and United Saudi Bank.

Strict controls on lending imposed by the Bahrain Monetary Agency (BMA), the islands’ central bank, are forcing banks to look at ways to expand their turnover beyond their traditional deposit business. In 1998, the BMA raised its requirement for an 8 per cent Basel capital ratio to 12 per cent.

The need to build its business in an increasingly constrained domestic environment was one reason why Bahrain’s Al-Ahli Commercial Bank (ACB) is merging with the London-based United Bank of Kuwait (UBK), according to ACB deputy chief executive Abdul Rahman Fakhroo. The new Bahrain-incorporated Ahli United Bank (AUB), under ACB head Mohammed Jalal, has $323.5m capital and a range of synergies to work on, based on ACB’s commercial base and UBK’s investment banking, asset management and Islamic products.

Mergers are also starting in the region’s current boom sector, Islamic banking. A recent one in Bahrain involves Faysal Islamic Bank of Bahrain (FIBB) and Islamic Investment Company of the Gulf (Bahrain), now joined under the name Shamil Bank of Bahrain, with total assets of $2.9bn and more than $230m equity.

Even with oil prices high — usually a cue in the Gulf for economic reform measures to slow down — Saudi Arabia and other GCC states are pushing ahead with reforms which could transform state-led economies that offer cradle-to-grave social support. However, the pace of this change will be dictated by social pressures; the imposition of taxes, essential to cleaning up public budgets, and subsidy cuts are deeply unpopular in polities where rulers govern by a degree of consent. The pace of change will also be affected by the vested interests who have traditionally dominated business life in Gulf monarchies.

According to a senior Western diplomat, the gradual transition to rule by Crown Prince Abdullah in Saudi Arabia is being felt at a number of levels, from the settlement of long-standing border disputes to policies to better control economic balances. Budget and spending controls are needed, with domestic debt now around 115 per cent of gross domestic product. Crown Prince Abdullah is also expected to lean more heavily on corruption and middlemen — a key demand of many Saudis, as well as foreign business — but the Saudi system’s structure makes it unlikely he will be able to eradicate abuses which can make doing business in the kingdom so difficult.

A more prudent economic policy, which includes cutting a range of subsidies, must be complemented by projects which help to break Saudi Arabia’s oil export dependence and create jobs for a potentially fractious youthful population. “Crown Prince Abdullah is no economist but he is aware of the problems and has decided to act on them,” says the Western diplomat.

Other GCC states have already moved along the same lines, with differing, and sometimes indifferent, results. But slowly, a new business environment is being created where GCC nationals play a much bigger hands-on role in management, and Gulf banks and businesses structure themselves to cope with the challenges of globalisation.

In Bahrain, still the region’s financial powerhouse, a blend of aggressive pricing and efficient regulation combines to suck in money from around the world — a status which has placed it in category two of the Organisation for Economic Co-operation & Development’s (OECD) recent, controversial classification of tax havens.

According to the BMA, Bahrain’s offshore banking units (OBUs) draw 28 per cent of their assets from CCC countries (excluding Bahrain). Western Europe accounts for 33.4 per cent, the Americas 15.3 per cent and Asia 14.3 per cent.

The BMA has borrowed experience in large measure from the British system and the Bank of England, although Bahraini regulators also look closely at the US, Luxembourg and other international examples. The BMA’s stern attitude to regulation is widely recognised by international financial institutions and is perceived to be fundamental to the country’s continued role as a regional banking centre. As one BMA official put it: “The foreign banks understand the rules.”

A new law to tackle money laundering is going through the works; it was drawn up in consultation with the OECD’s Financial Action Task Force on Money Laundering. Although Bahrain is not widely noted as a problem area, no explicit code exists to counter the practice. Existing legislation coupled with tight banking supervision, including the forced closure of suspect accounts, have helped Bahrain crack down on offenders in the past, however.

The new Bahraini law creates the specific crime of money laundering and also includes obligations on persons to report suspicions of money laundering, more extensive powers to freeze property and greater exchange of information with foreign financial authorities.

For BMA governor Abdulla bin Khalifa AlKhalifa, it is important not only to join in the fight against money laundering operations, but also to be seen to have joined. BMA officials argue that the defence of Bahrain’s reputation and the continuing long-term success of the financial sector depend on attracting and retaining legitimate funds and reputable individuals to manage the financial operations.

Implicit in their comments — and sometimes, in not so-guarded whispers — there is criticism of rival centres, above all Dubai. No centre has worked so hard as the booming city-state to challenge Bahrain’s dominance as a regional banking centre. These aspirations have been met by many institutions moving to the United Arab Emirates’ (UAE) commercial hub.

In a cut-throat battle for market share, issues like regulation are playing a key role. Following a highly publicised affair in which a British passport-holder, Madhav Bhaghubhai Patel, fled the UAE with an estimated Dh1bn ($272m), taken from clients with whom he had long cultivated a relationship of trust, the UAE Central Bank has moved to tighten conditions in the sector. This includes raising the capital reserve ratio to 14 per cent on a variety of accounts.

To stimulate banks’ interest in the UAE, Dubai’s partner and sometime rival for influence and business, Abu Dhabi, has been promoting an offshore banking zone at Saadiyat island. Banks here will be under Abu Dhabi Free Trade Zone Authority, not the UAE Central Bank, and they will not be taxed.

This year should see whether the Saadiyat free zone works — a senior UAE-based diplomat recently said the project “has not moved ahead quite so smoothly as had been hoped”. An initial public offering to be led by Nomura did not take place, leaving the Abu Dhabi authorities to produce the $400m initial funding. There is speculation in the Emirates that the project might now become more real estate and e-commerce focused than being a purely financial play.

Islamic banking has truly arrived when conservative European private banks offer Islamic savings funds and major players, such as Citibank and Arab Banking Corporation, emphasise their Islamic operations’ roles in complement to project financing and other conventional structures. This trend reflects popular demand for products which can perform efficiently but also meet religious criteria — products which, in bankers’ terms, can please both the credit committee and the Sharia (Islamic law) board — and which can channel the undoubted liquidity this investor base provides into longer term instruments.

One of Bahrain’s senior bankers, Citibank Middle East regional director Mohammed Al-Shroogi, says the market is driving the Islamic banking boom, with a solid, older investor core and a new generation of investors: “kids in the Gulf and Asia who want a clean way of doing investing”. This sentiment has led other market leaders, such as Bank of Bahrain & Kuwait, which is also among those taking a lead in Internet banking and other online operations, to establish Islamic arms. By tapping Islamic liquidity, funds could be channelled into other growth sectors, such as project financing.

To harness this growth, the BMA has been pioneering a new regulatory approach to Islamic banking, working with the Accounting & Auditing Organisation for Islamic Financial Institutions to produce a globally recognised Islamic banking capital adequacy standard equivalent to the Basel Capital Accord. Draft regulation on the issue, which requires maintaining a delicate consensus between the supervisors, the Islamic banks and the accounting profession on a set of criteria covering key areas of risk, is now being discussed.

Most Islamic banks welcome greater regulation. Although some hardliners argue that regulation by a non-Sharia body is, in itself, un-Islamic, a proper regulatory framework would allow them to compete overseas with conventional rivals.

Niche Islamic banks in the Gulf are preparing themselves for globalisation. Al Baraka Banking Group is the reorganised version of Shaikh Saleh Kamel’s business empire, now Bahrain-based with authorised capital of $1.5bn. Underlining the rationalisation of the sector now under way, nine Al Baraka subsidiaries are being brought into the new structure, regulated by the BMA. Arthur Andersen, the external auditor, is expected to produce the group’s first ever consolidated balance sheet by the end of 2000. Behind the move, executives say, is a recognition that Al Baraka must come into the age of globalised banking.

Shamil Bank, too, is looking to compete on a global stage. Announcing its creation, chairman Prince Mohamed Al Faisal Al Saud said: “With its increased capital base and operations, Shamil Bank will be able to play a more effective and dominant role in the Islamic-banking sector.”

Another sector exciting Gulf bankers is project finance. All agree that the opening up of Saudi Arabia and the potentials offered by other GCC states create big opportunities. Citibank’s Bahrain operation has brought the group mandates to work on big ticket schemes such as Oman LNG, Bahrain’s Hidd power and water project and Kuwait’s massive Equate petrochemicals schemes, along with financings for Saudi Aramco, Sabic and other major regional corporates. A major operation now going through the works is for Bahrain Petroleum Company’s estimated $600m Sitra refinery rehabilitation and upgrade financing.

Others are competing hard for this business, including Chase Manhattan, which has carved out a substantial aircraft financing business. Among regional banks, Gulf Investment Bank has a big project financing department, which took key arranging and underwriting roles in deals such as Oman LNG, Qatargas, Yanbet, Taweelah A2 and Q-Chem.

Arab Banking Corporation (ABC), meanwhile, is boosting its project finance team, including recently poaching sector specialist Mark Yassin from GIB. Developments at ABC say much for what is going on across the region: it, too, has been busy in Oman, with arranger mandates in high-profile schemes such as the Oman-India fertiliser project and Oman LNG.

This is part of a strategy developed since late 1997, focusing on niche business where ABC can add a “differentiating edge” and leverage business.

The policy shift is intended to take ABC beyond its traditional core trade finance business and towards project finance and other value-added operations. In the past two years, it has increased its controlling stake in ABC Jordan and opened an Algerian subsidiary; this year it has bought Egypt Arab African Bank and is opening a Tunisian domestic subsidiary and an Egyptian securities company. It is also looking at a Lebanese opportunity.

Once that deal is in place, executives believe the bank will have a solid platform across the Arab world, although more activity in the Gulf region itself is expected. Gulf states’ recent liberalisation suggests further developments, leading to the tantalising thought that ABC might involve itself in a merger, potentially with a Saudi or other major Arab partner.

Meanwhile, some banks are harnessing technology to cross borders. This includes the slow development of a GCC-wide ATM network. Such developments are to be welcomed by regular travellers but so far have been little used.

This points to the reality that, although Gulf institutions are coming closer together, the region’s markets — exceptions like Bahrain and Dubai apart — remain very much national entities.

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