Gulf Banks Set To Continue Merger Trend, Says Moody's

A wave of mergers and acquisition activity among banks in the GCC will ultimately beneficial for the region’s banking sector as it helps ease overcapacity and boost profitability through synergies and increased pricing power, according to a new report from Moody’s Investors Service.

The GCC’s banking sector – which Moody’s called “overcrowded” – has seen a number of M&A announcements in the last year as falling oil prices hit government budgets and slowed economic growth.

In the UAE for example, First Gulf Bank and National Bank of Abu Dhabi in 2017 created the largest lender in the UAE, First Abu Dhabi Bank, while in September 2018 Abu Dhabi Commercial Bank and Union National Bank confirmed that they were entering preliminary talks about a possible merger, potentially also involving Al Hilal Bank.

Additionally, in neighbouring Saudi Arabia National Commercial Bank and Riyad Bank announced in December that their boards of directors have approved the commencement of merger discussions, while in October, Saudi British Bank and AlAwwal Bank signed a binding merger agreement in October 2018 that will see the creation of the third largest bank in Saudi Arabia.

“Slow growth and subdued credit demand in the region is one of the biggest drivers of consolidation,” said Ashraf Madani, vice president and senior analyst at Moody’s.

“This has intensified competition for depositors and borrowers, dampening profits at GCC banks.”

The report noted that GCC banking sector consolidation will help increase banks’ pricing power when competing for deposits, as deposit growth is sluggish and largely concentrated with a few large depositors dominating the market.

“In most GCC banking systems the government is the largest depositor and, together with related government bodies and service providers, in some countries contribute half of total deposits. As oil prices declined in 2014, some governments tapped into their deposits to fund their deficits creating funding shortages for the banks,” the report notes.

In response, banks began to increase deposit rates to attract more deposits. Additionally, interest rates in the GCC were also rising because of hikes in US Fed rates owing to the current banks, causing increased funding costs.

The report also noted that bank mergers will help create cost efficiencies by removing duplication in certain functions which benefit the banks’ overall profitability, as in the past competition has been forced to reduce lending rates, particularly for large corporates.

“This has in some cases led to risk mispricing and dampening bank profitability,” the report said.

In the near future, Moody’s said it expects that further consolidation is likely as GCC economic growth remains subpar, even if improving.

“Nevertheless, we expect market participants will need to see successful execution of the currently planned mergers,” he said. “There are encouraging signs as evident in the increase in potential M&A activity that shareholders are coming to realise that mergers can create value for them in the long run.”