Gulf banks' consolidation should boost lenders' profitability, Moody's says

Bank mergers to increase pricing power and stem increase in funding costs

Abu Dhabi Commercial Bank on Tuesday said it will exit its offshore operations in Jersey. Stephen Locke / The National

The spate of bank mergers in the Arabian Gulf should reduce overcapacity in the overcrowded sector and boost lenders' profitability through increased pricing power, according to a report by Moody's Investor Service.

Consolidation among Gulf banks will help stem the increase in funding costs and improve lenders' earnings in the long run, credit rating agency Moody's said in a report on Tuesday.

"Slow growth and subdued credit demand in the region is one of the biggest drivers of consolidation," Ashraf Madani, a vice president and senior analyst at Moody's, said. "This has intensified competition for depositors and borrowers, dampening profits at GCC banks."

Bank merger activity in the Gulf intensified over the last two years after low oil prices hit state budgets, increased bad loans and squeezed lenders' profit margins amid slowing economic growth in the oil-rich region. The latest in a series of merger announcements was Saudi Arabia's largest lender National Commercial Bank announcing on December 24 that is in preliminary talks to merge with rival Riyad Bank in a move that could create the third-biggest bank by assets in the GCC.

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"Despite integration challenges in the early stages, merged banks will gain market share, have better pricing power and cost synergies," Moody's said in its January 15 report. "Consolidation will help stem rising funding costs and improve profitability in the long run.

The GCC banking sector has many banks serving small populations, driving intense competition and aggressive pricing policies, Moody' said.

In Oman, for example, there are 20 licensed banks serving a population of 4.6 million people. This compares with Saudi Arabia where only 27 banks serve a population close to 33 million.

NCB and Riyad Bank’s proposed tie-up follows Saudi British Bank and Alawwal bank’s merger announced in early 2018. Boards of the two lenders in October approved a merger agreement that will create a financial entity with $73bn in combined assets.

In the UAE, the second-biggest Arab economy, Abu Dhabi Commercial Bank, the second largest lender in the capital, is in talks for a possible three-way merger with Union National Bank and Sharia-compliant Al Hilal Bank, which could create the Gulf’s fifth largest banking entity with about $114bn in combined assets.