Is it time to consolidate finance companies?
According to a report issued by the UAE Central Bank in 2019, the number of active finance companies operating in the UAE dropped during 2018 from 27 to 21, of which five finance companies were owned by commercial banks.
The total assets of finance companies operating accounted for only 1.4 per cent of the total UAE banking system assets, 2.7 per cent of nominal GDP, and 3.6 per cent of nominal non-oil GDP, reflecting their limited role in the overall financial system and economic development of the country. Are these finance companies losing their role and relevance in the new age financial ecosystem?
Need for a defined presence
Finance companies play a key role in the overall financial system in any developing economy. Despite their limited scale of operations, they do promote competition within the financial services industry and provide multiple alternatives to transform economic savings into capital creation. And they act as a second line of defence should the primary form of financial intermediation fail.
For instance, certain finance companies specialise in a particular sector or target a certain client segment, which are not necessarily on the radar of regular commercial banks. Therefore, continued growth and development of this key pillar of financial system is vital to support SMEs and other under-privileged sections of the economy, which cannot access financing through regular banking channels.
Key challenges traditionally faced by finance companies across any market are the higher cost of funds, subdued investments in technology, and an inability to attract the top talent. Given the lack of access to retail deposits, they are forced to rely heavily on corporate deposits and other forms of market borrowings, which tend to be costlier in nature and their tenures remain shorter.
This clearly places them in a disadvantageous position compared to commercial banks, which have access to their retail segment with a stable deposit base, coupled with the inherent benefit of housing CASA deposits, with zero or near to zero cost of funding.
Always short on funds
Secondly, with limited capital resources and constraints on overall investment outlay, finance companies are not in a position to expend a lot in implementing a fully integrated core banking system or continually upgrade their technology infrastructure. In contrast, most commercial banks’ operational spend at present are mostly geared towards technology and developing its human capital.
A persistent focus on process improvements through use of technology, increased customer outreach programmes through product innovation, and multiple customer touchpoints give a distinct advantage to banks compared to finance companies in terms of overall customer experience and reduced servicing costs.
A finance company’s struggle currently does not just end with the suboptimal cost of funding and higher cost of servicing. They are also faced with the Herculean challenge of attracting and retaining the right talent among top- and middle-level management with relevant expertise in financial services.
Not surprisingly, the nature of risks faced by commercial banks and finance companies are exactly the same — credit risk, market risk and operational risk. However, we seldom find many experienced bankers or accomplished finance professionals in finance companies. This could party be due to affordability or perception of finance companies in the employment market.
Need for change
As per Central Bank stats, the total assets of UAE finance companies declined by about 11.1 per cent in 2018 to Dh40.5 billion in 2018 compared to Dh45.6 billion in 2017. The decline was partially due to the reduction in the number of finance companies and an overall drop in the assets of the existing companies compared to 2017.
This trend is likely to continue in the near future, if we do not see some fundamental changes in the way finance companies operate. Considering additional business pressure and competition emanating from a range of fintech companies, peer-to-peer lending platforms and crowd funding structures, finance companies will have to consolidate their market positioning and operate at a certain scale to continue to be a relevant player in the overall financial market.
Going forward, we foresee two likely scenarios, a finance market with eight to 10 adequately capitalised large players making meaningful contributions rather than several smaller players. A second scenario wherein the finance companies will continue to get marginalised year-on-year, with a dwindling share of assets and a fall well below 1 per cent of the overall UAE banking system assets.
- Anand Ramani is with UHY James Chartered Accountants.