Prior to the emergence of the global economic crisis, Gulf Cooperation Council states were reaping the economic fruits of a regional diversification movement that saw the meteoric rise of new non-oil growth industries such as real estate and construction. Fueled further by rocketing oil prices, the GCC emerged as the MENA region's fastest-growing economic bloc. Curious position The Gulf's banking sector played a huge part in facilitating the upsurge and handling the region's teeming wealth. Although the early phases of the downturn slowed down economic activity, overall the crisis has had a minimal effect on the region's finances. Banks still continue to benefit from the Gulf's economic resilience, although the industry does find itself in a curious situation: despite its key role in handling the region's wealth, the Gulf banking sector is relatively underpenetrated. Deposits and loans outstanding accounted for less than 80 percent of the Gulf's GDP in 2009, compared to over 100 percent in countries such as Germany and the UK with more established banking sectors. Even the regional service distribution network is underdeveloped, with only 10 bank branches and 50 ATMS available per 100,000 residents; in contrast, the US alone has 35 branches and 175 ATMS. Given the Gulf's rapidly growing and youthful population, expanding middle class and diverse economy, the growth potential for broader distribution of banking products is enormous. Risks and challenges Gulf banks will have to address various risks and challenges to tap into the huge opportunities offered by the region. Throughout the process of global economic recovery they will have to contend with slow economic growth, restrained margins due to low interest rates, and non-performing loans which climbed from 2.5 per cent in 2008 to 4.3 per cent throughout the region in 2009. Low investor confidence in local capital markets will also complicate product and service sales. The key for players is to balance between effectively handling these issues and strategically investing for future growth. First steps Early adapters have taken various approaches to face present and near-term hurdles, such as focusing more on liquidity management rather than the bottom line. They are also taking a more cautious stance on lending and closely monitoring risk indicators such as the loan to deposit ratio, which slid region-wide to 92 percent in 2009 from 99 percent in 2008. The old practice of basing lending decisions on the established reputation of clients is also being set aside in favor of a safer due-diligence mindset. Trends to watch Four trends are expected to dictate the Gulf's banking landscape as the sector pursues growth opportunities: 1. Optimized efficiency – Assuming ample regulatory backing, several bank consolidations are expected in a bid to improve efficiencies of scale. The region's banking industry is generally scattered, with banks dwelling more on already saturated local markets and consolidations very limited. Alliances will enable players to share internal strengths, optimize coasts and improve processes and technologies on the way to achieving long-term sustainability. 2. Market segmentation & targeted value – Gulf banks traditionally divide its customers into individual and institutional or corporate accounts. Increased competition will influence more segmentation and a shift in focus to the right group of customers to dedicate the most resources and attention. Retail customers, for example, could be further segregated into ‘affluent' and ‘ultra-high net worth.' Banks could also enhance international banking products and services for expatriates, who represent more than 40 percent of the Gulf population. Small and medium-sized enterprises (SMEs) are another critical yet underserved category. The next step after zeroing in on high-potential customer groups is to develop tailored products and services that meet their unique needs. More access to products available in other markets such as debt funds, exchange traded funds and Real Estate Investment Trusts would be highly attractive to the region's investors. 3. Network growth – Gulf banks are already engaged in expansion activities aimed at establishing branches and networks beyond their home markets. Bank branches in the UAE, Saudi Arabia and Oman have grown by 9 per cent per annum over the past two years, despite the recession. The last priority is to adopt the best delivery channel. Online banking and ‘light-retail' branches are expected to gain more popularity in this regard, as local players leverage advanced back-office technology and the Gulf's expanding internet infrastructure. 4. Focus on fee-generating businesses – More bank executives are turning away from riskier non-investment and interest income to more stable fee-generating businesses. More new business lines including those covering asset management and corporate and investment banking are expected to be established. This trend will require a recruiting team with substantial knowledge of local markets and advanced management and technical skills. A surging population combined with an underdeveloped banking sector is putting a strain even on MENA countries lacking the resources that have fueled the GCC's affluence. Gulf banks will need to look towards the Levant region, Iraq and North Africa in order to retain their leadership within the MENA market. They will also need to be highly motivated and armed with the right service capabilities. Julien Faye and Jad Zerouali are Bain & Company partner and manager, from the firm's Financial Services practice. Both are based in Dubai.
