A robust oil and gas sector, high interest margins and fintech innovation will help drive banking sector growth across the Gulf Cooperation Council region in 2024 and beyond, a new report shows.
Analysis by global consulting firm McKinsey & Co. found that despite global macroeconomic volatility, the region’s financial institutions outperformed their international peers in 2023 thanks to a unique operating environment. The sector is poised to perform well this year.
Global banking faces significant challenges in the wake of COVID-19, including rising prices and rapid monetary policy tightening.
The US Federal Reserve quickly raised interest rates, which boosted bank profits but also increased the risk of unrealized losses, as evidenced by the collapse of Silicon Valley Bank and the takeover of Credit Suisse.
Tensions in the Middle East and persistently high U.S. interest rates could continue to pressure global prices. These issues have led to a 10 percent decline in the price-to-book ratio, reducing the global banking market capitalization by $900 billion.
The McKinsey & Co. report was bullish on the GCC banking sector, stating that it “boasts exceptionally high returns on equity and some of the highest multiples in the world.”
The report added: “The regional financial sector has delivered strong shareholder returns over the past decade, outperforming the global average.”
McKinsey & Co. highlighted that the Total Shareholder Return Index, which tracks the dividend-adjusted share prices of over 80 GCC financial institutions, consistently showed excellent growth trends compared to global benchmarks over the period 2010-2024.
This highlights the sector’s ability to deliver solid shareholder returns in the face of global economic volatility.
GCC banks also maintained higher levels of return on equity and stronger market multiples globally. Despite the recent contraction, their ROE consistently outperformed the global average by three to four percentage points from 2022 to 2023, reflecting their efficient capital management and profitability in a challenging global banking landscape.
Elevated interest rates have played a significant role in driving record profits for regional and international banks and helping GCC banks create significant value for shareholders.
In addition, according to the company, GCC banks boast higher net interest margins and income-to-asset ratios than the global average. With net interest income at 2.3 percent, above the global norm of 1.4 percent, they point to wider profitability margins in the region.
Despite higher impairment costs compared to other banks globally, GCC banks operate with lower operating costs, demonstrating effective cost management strategies. Their average ROE of 10.9 percent reflects solid capitalization, above the global average of 9.0 percent.
Overall, the favourable macroeconomic environment, characterised by high hydrocarbon prices and strong economic growth, contributed to the strong balance sheets of the GCC banking sector and a stable growth path.
Resilience in the face of global threats
GCC banks have demonstrated resilience to recent global shocks, which contrasts with the challenges facing the broader international banking sector.
McKinsey & Co. report stressed that while global economic connectivity creates opportunities for growth, it also increases the risk of instability, as reflected in rising geopolitical tensions and regulatory scrutiny.
The company said these trends occur against the backdrop of accelerating climate change – a global risk multiplier that also creates a multi-trillion-dollar opportunity to finance the transition to low-carbon growth.
McKinsey’s macroeconomic scenarios predict that global banking conditions will deteriorate in the coming years, leading to a peak and subsequent decline in the return on equity of GCC banks.
Despite this, the region’s sector is better equipped to deal with these challenges compared to its counterparts. Their banking metrics are expected to diverge positively from global trends, highlighting their resilience and relative strength in dealing with future economic uncertainties.
According to a 2023 study by Ernst & Young, rising demand for banking services, the rise of digital banking and regulatory reforms such as the introduction of Basel IV are expected to help spur growth in the sector.
Liquidity management
However, GCC banks face challenges despite the favourable environment, particularly due to interest rate volatility. The firm noted that global tight monetary policy and faster growth in funding than deposits require prudent liquidity management.
The analysis showed that financing grew by 14 percent annually in the Kingdom from 2019 to 2022, outpacing the 9 percent growth in deposits. High interest rates are driving mortgage lending as governments promote home ownership, which is impacting GCC banks’ retail loan portfolios.
The average loan-to-deposit ratio for Saudi banks rose 18 percentage points from 2020 to 2022, suggesting potential liquidity problems ahead. High interest rates could also change consumer and business behavior, affecting non-interest-bearing liabilities and saving and investment patterns.
The report showed that total loans in Saudi Arabia are estimated to reach SR5.04 trillion ($1.34 trillion) by 2030, growing by 10 percent annually between 2024 and 2030.
Wholesale loans will have the largest share (69%), followed by mortgage loans (21%) and consumer financing (11%).
On the other hand, deposits are expected to reach SR3.54 trillion by 2030, growing by 5 percent annually. Wholesale deposits will account for 53 percent, and retail households the remaining 47 percent.
The total loan-to-deposit ratio is expected to increase by 142 percent from 104 percent in 2024, indicating that deposit growth in Saudi Arabia is not keeping pace with financing, increasing pressure on liquidity.
Since 2020, GCC banks have significantly increased their activity in international debt capital markets. This strategic move is aimed at strengthening their funding growth strategies, diversifying funding sources and, more recently, mitigating the high cost of liquidity in the country.
According to a recent report by Fitch Ratings, emerging market dollar debt issuance excluding China exceeded $200 billion in the first five months of 2024, with issuers from the Kingdom leading with 18.5% of total issuance.
Despite their difficult financial situation, these banks have successfully navigated their liquidity challenges, supported by increased access to government sukuk and liquidity management tools provided by central banks.
These measures aim to ensure a constant level of liquidity, enabling banks to meet their financial obligations and maintain operational stability in changing market conditions.
Innovation and technology
McKinsey & Co. highlighted the key transformation drivers shaping banks in the GCC region, including innovation, machine learning and generative artificial intelligence, as well as high levels of digital penetration and the impact of financial technology in transforming the industry.
Additionally, GCC regulators are actively developing the open banking framework to further drive the evolution of the sector.
Abdulla Al-Moayed, CEO of Tarabut, praised Saudi Arabia’s embrace of open banking in an interview with Arab News in May.
He highlighted the joint efforts of banks and fintechs to innovate and expand their market reach, signalling a significant evolution towards digital transformation in the Kingdom’s banking industry.
Generative AI and other advanced technologies are set to revolutionize banking by increasing customer engagement and operational efficiency.
In the GCC, fintech advancements such as digital payments and sophisticated financial products are gaining traction, driven by rising demand for personalized digital services.
McKinsey & Co. noted that fintech companies are expanding their portfolio beyond their core offerings, serving both the consumer and business sectors. These are supported by significant funding and widespread adoption of digital solutions in the region.
At the same time, traditional banks are introducing new digital initiatives to remain competitive, underlining the dynamic and evolving banking landscape across the GCC region.
An example is provided of how regulators in Bahrain and Saudi Arabia are supporting innovation through open banking frameworks aligned with global standards. This has boosted local start-ups and prompted established institutes to adopt new technologies.
The report says open banking increases competition and IT costs and offers benefits such as expanded customer reach and new services. It also requires banks to adapt to seize opportunities while managing profitability risks.
McKinsey & Co. Recommendations
The report warns that Gulf Cooperation Council (GCC) banks are prepared to cope effectively with global economic uncertainty, but they need to be proactive and not complacent.
Key priorities for bank CEOs in the region include dealing with volatility around interest rates through sound asset-liability management and stress testing.
Actions should also be taken to increase operational efficiency by digitizing processes and automating routine tasks that will optimize human resources.
Transforming customer experiences by offering personalized products in real time to a digitally savvy community is critical, as is maintaining focus on environmental, social and governance initiatives that support global climate change efforts.
Additionally, creating shareholder value through strategic mergers and acquisitions and restructuring allows banks to take advantage of changing market dynamics, free up capital by divesting non-core assets and focus on core operations.
These priorities underline the proactive stance of GCC banks in the face of a changing economic landscape.