Banks must mind their own back yards

Banks must resist the quick-fix temptation to combine resources and weather the financial storm.

If the UAE's banks have learnt anything from the financial crisis, they ought to have cottoned on by now to the idea that lending to a narrow range of sectors and staying firmly in their home markets is, well, unwise.

Having felt the brunt of the bursting property bubble in Dubai, where prices have fallen by half, on average, since the peak in 2008, banks are keenly aware of their need to diversify away from that embattled sector.

And with trouble at financial institutions in the Middle East concentrated in the Gulf, particularly in the UAE, Kuwait and to some extent Bahrain, they also know that putting all of their investment eggs in the Gulf's basket makes for inadequate and ultimately dangerous geographical narrowness.

And yet it remains far from clear the country's bloated banking sector - there are about 50 banks operating in the UAE - will pursue what policymakers and economists have pointed to for years as the solution: mergers and the creation of regional champions.

Why not? The main reason, analysts say, lies in the UAE's banking culture and ownership structure. Many banks - Mashreqbank in Dubai, for example - are owned by prominent families who would probably be loath to relinquish control. The economic and political power of family businesses, and by extension of the families behind them, rests in the size of their empires.

Numerous other banks - Emirates NBD and National Bank of Abu Dhabi, for instance - are owned by emirate governments either directly or through conglomerates controlled by them. And that means government involvement is often necessary to effect mergers, bringing in another layer of complexity and political difficulty.

To be sure, there have been some mergers, and there appears to be more commotion about consolidation on the horizon. Emirates International Bank and National Bank of Dubai merged in 2007, forming what is now the country's largest bank by assets.

A few other, smaller banks in the Gulf have also either merged or entered into merger talks in the past year or so. Rumours have been kicking around for some time that Dubai Bank and Emirates Islamic Bank are in talks about merging, but denials from those banks' owners appear to diminish the likelihood of that happening soon.

If mergers are to happen, regulators and the banks themselves will have to find ways around all the obstacles. It may turn out to be a self-fulfilling prophecy: if a group of banks get together and form a regional giant, others may follow in quick succession. Al Baraka Banking Group in Bahrain is already trying to go down this path, pledging to create an Islamic superbank by the end of the year.

There could also be a wave of acquisitions in north Africa, where Gulf bankers see a lot of opportunity despite a tangle of regulatory red tape. Many of the UAE's banks are already in north Africa and are vying for licences to open further operations in places such as Libya, Tunisia, Egypt and Morocco.

Given the Gulf's unique circumstances, though, it may make more sense for banks to sell off lines of business where they are weak and acquire parts of other banks where they want to become stronger, according to Philippe De Backer, a partner and director of global financial services at the consultancy Bain & Company.

"You'll see an increased number of some form of merger, not necessarily at the institution level but at the business line level," Mr De Backer said. "I for instance will mutualise my asset management portfolio with another one because in asset management I don't necessarily have the critical mass.

"I think it's a hypothesis for the region whereby you can keep institutions in the current shareholder structure but you can say in some lines of business we need to gain scale, and one of the ways we can do that is in thinking not in terms of just the complete business but in terms of single business lines."

Whatever form it ends up taking, everybody seems to agree that consolidation would, in the long run, help to cure chronic balance sheet ills and sagging profits. Bank profits have fallen during the financial crisis largely because they lacked the scale to deal with a rise in loan defaults without taking big bottom-line hits.

The US$24.9 billion (Dh91.45bn) debt restructuring at Dubai World, a major conglomerate owned by the Dubai Government that counts many local banks among its creditors, has not helped matters. As a group, the UAE's publicly listed banks' profits fell in the third quarter by 2.9 per cent, compared with the same period last year.

"Banks have much weaker balance sheets compared to the rest of the emerging markets, so you can see the GCC as similar to the US," said Turker Hamzaoglu, an economist at Bank of America Merrill Lynch.

"Even if you've got these lower interest rates and expansion in liquidity, the credit growth is not picking up because of the underlying weakness in banks and the real estate sector."

But whatever the benefits, the bottom line is that no rash of mergers is likely to happen before Gulf economies improve and banks can show a return to rising profits.

In normal times, a poorly performing bank might seem like a good buy if it can be snapped up on the cheap. Nowadays, many banks are struggling hard enough to patch up their own leaky ships, leaving them little time or patience to think about fixing someone else's.