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GCC banks outperform global peers and poised for exceptional years: report

RIYADH: A robust oil and gas sector, high interest margins and financial technology innovations will drive banking sector growth across the Gulf Cooperation Council region in 2024 and beyond, according to a new report.

Analysis by global consulting firm McKinsey & Co. found that despite global macroeconomic volatility, the region’s financial institutions outperformed their international peers in 2023 due to a unique operating environment, and the sector is poised for a strong performance this year.

Global banking faces significant challenges in the wake of the Covid-19 pandemic, including rising prices and rapid tightening of monetary policy.

The US Federal Reserve quickly raised interest rates, which increased 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 continued high interest rates in the U.S. could further pressure global prices. These issues have led to a 10 percent decline in the price-to-book ratio, reducing global banking market capitalization by $900 billion.

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: “Over the past decade, the regional financial sector has delivered strong shareholder returns, above the global average.”

McKinsey & Co. highlighted that its total shareholder return index, which tracks the dividend-adjusted share prices of more than 80 GCC financial institutions, has consistently shown excellent growth trends compared to global benchmarks over the period 2010-2024.

This underlines the sector’s ability to deliver solid shareholder returns in the face of global economic volatility.

GCC banks also maintained higher ROE and stronger market multiples globally. Despite the recent narrowing, their ROE consistently exceeded the global average by three to four percentage points from 2022 to 2023, reflecting their effective capital management and profitability in a challenging global banking landscape.

Elevated interest rates have played a significant role, driving record profits for regional and international banks and supporting GCC banks to create significant shareholder value.

Moreover, GCC banks boast higher net interest margins and revenue-to-asset ratios than the global average, according to the company. With a net interest income of 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 global peers, GCC banks operate at lower operating costs, demonstrating effective cost management strategies. Their average ROE of 10.9 percent reflects solid capitalization, exceeding the global average of 9.0 percent.

Overall, a favorable macroeconomic environment characterized by high hydrocarbon prices and strong economic growth underpins the GCC banking sector’s strong balance sheets and continued growth trajectory.

Resilience to global threats

GCC banks have shown resilience to recent global shocks, contrasting with the challenges facing the broader international banking sector.

The McKinsey & Co. report highlighted that while global economic interconnectedness creates opportunities for growth, it also increases the risk of instability, as seen in rising geopolitical tensions and regulatory scrutiny.

The firm said these trends are occurring against the backdrop of accelerating climate change – a global risk multiplier that is also creating a multi-trillion dollar opportunity to fund 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 return on equity for 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 from interest rate fluctuations. 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 between 2019 and 2022, outpacing the 9 percent growth in deposits. High interest rates are driving mortgage lending as governments promote home purchases, impacting GCC banks’ retail loan portfolios.

The average loan-to-deposit ratio for Saudi banks rose 18 percentage points between 2020 and 2022, suggesting potential future liquidity problems. High 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 at a rate of 5 percent annually. Wholesale deposits will account for 53 percent and retail holdings will account for the remaining 47 percent.

The total loan-to-deposit ratio is expected to rise by 142 percent from 104 percent in 2024, indicating that Saudi Arabia’s deposit growth is not keeping pace with funding, 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 the latest report from Fitch Ratings, dollar bond issuance in emerging markets excluding China exceeded $200 billion in the first five months of 2024, with issuers from the Kingdom accounting for the largest share of total issuance, accounting for 18.5%.

Despite their difficult financial situation, these banks are skillfully coping with the challenges of lack of liquidity, supported by increased access to government sukuk and liquidity management tools provided by central banks.

These measures aim to ensure a stable level of liquidity, enabling banks to meet their financial obligations and maintain operational stability in volatile market conditions.

Innovation and technology

McKinsey & Co. highlighted the key transformation drivers shaping GCC banks, including innovation, machine learning and generative artificial intelligence, as well as high digital penetration and the impact of fin-tech in transforming the industry.

Additionally, Gulf Cooperation Council regulators are actively developing an open banking framework to further accelerate the sector’s evolution.

Abdulla Al-Moayed, CEO of Tarabut, praised Saudi Arabia for introducing open banking in an interview with Arab News in May.

He highlighted the joint efforts of banks and fintechs to innovate and expand market reach, signaling a significant evolution towards digital transformation in the Kingdom’s banking industry.

Generative AI and other advanced technologies will revolutionize banking operations, increasing customer engagement and operational efficiency.

Financial technology advances such as digital payments and advanced financial products are becoming increasingly popular in the Gulf Cooperation Council (GCC) countries, driven by growing demand for personalized digital services.

McKinsey & Co. noted that fintech companies are expanding their portfolios beyond core offerings to serve both the consumer and business sectors, thanks to significant funding and widespread adoption of digital solutions in the region.

At the same time, traditional banks are launching new digital initiatives to remain competitive, underscoring the dynamic and evolving banking landscape across the GCC.

It cited how regulators in Bahrain and Saudi Arabia are fostering innovation through open banking frameworks aligned with global standards. This has spurred local startups and pushed established institutes to adopt new technologies.

The report said open banking increases competition and IT costs and offers benefits such as greater 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 while Gulf Cooperation Council (GCC) banks are prepared to effectively deal with global economic uncertainty, they must be proactive rather than complacent.

Key priorities for bank CEOs in the region include coping with interest rate volatility through robust asset-liability management and stress testing.

Steps should also be taken to increase operational efficiency by digitalizing processes and automating routine tasks, thereby optimizing the use of human resources.

Transforming the customer experience by offering personalized products in real time to a digitally savvy community is critical, as is maintaining a focus on environmental, social and governance initiatives that support global climate change efforts.

In addition, creating shareholder value through strategic M&A and restructuring allows banks to benefit from changing market dynamics by freeing up capital through the divestment of non-core assets and refocusing on core businesses.

These priorities underline the proactive stance of GCC banks in the face of a changing economic landscape.

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