From the darkness into the light

There's a brighter dimension to report alongside the relative gloom which has afflicted the Middle East and Gulf region's banking picture amid the global crisis.

True, a study released last month by The Boston Consulting Group (BCG) revealed that within the Middle East, loan-loss provisions (LLPs) in the banking sector have been at peak levels this year. While the overall growth rate of banking revenues was still positive in the first half, banking profits fell further below 2005 levels as a result.

Nevertheless, the region's banks have continued to be less affected than international banks are by the international financial crisis.

The study was part of BCG's annual banking and retail banking indices measured by the development of banking revenues (operating income) and profits for leading global banks.

In April 2009 BCG launched the first edition of the banking performance index in the Middle East, creating a customised index specifically for the Middle Eastern banking markets, with 2005 revenues and profits as starting benchmarks. The index covered the largest banks in Bahrain, Kuwait, Qatar, Saudi Arabia and the UAE. October's second edition of the index covered 25 banks, and includes the biggest banks from all GCC states, including Oman.

The new BCG index revealed that Middle Eastern banks have increased LLPs very significantly, often exceeding an annual growth rate of 100 per cent over the past four years. Many banks reached a peak in this regard in the first half of 2009.

The top 25 banks alone built LLPs of almost $7 billion (Dh25.7 billion) in total. Banks in Kuwait and the UAE had to build the highest share of their revenues as provisions.

Commenting on how the high levels of LLPs will impact Middle Eastern banks in the near future, Dr Reinhold Leichtfuss, Senior Partner and Managing Director, BCG Dubai, and leader of BCG's financial services business in the Middle East, said, "It is likely that LLPs will remain on a high level during the next few quarters, owing to the impact of the financial crisis on the real economy — both in the corporate and retail segments. Still, when compared to some Western countries such as the UK, where, according to estimates, the banking system may have to reserve £130 billion (Dh788.6 billion) of LLPs, this figure [$7 billion] still seems low."

Varied results

As with similar studies in other parts of the world, there is variance amongst the market participants in BCG's later study: 20 banks still grew in terms of revenues, 17 banks incurred a reduction in profit growth, while eight banks still were able to grow their profitability. Out of the banks with a separate retail and corporate segment, in retail four grew in terms of revenue, while eight incurred revenue losses. In corporate banking, seven banks grew while three shrank.

A segment analysis of banks in the GCC shows that retail banking revenues stagnated in the first half of this year, but retail banking profits fell less strongly than total banking profits. Thus, retail banking has been a stabiliser of revenue and profit development for banks in the Middle East, which was also the case around the globe.

By now, most banks have realised that more than one per cent of their loans are non-performing — others will have to follow soon.

Dr Leichtfuss remarked, "It will be interesting to see how banks will cope with the Middle East-specific risks during the next 18 months. Needless to say, upgrading the risk management systems along all risk dimensions has become a matter of urgency for banks — together with restructuring capabilities. Well-functioning credit bureaus are a must, and they are overdue."

When launching the first edition of the banking performance index in April 2009, Dr Leichtfuss pointed out five major areas of action for Middle East banks, namely: to get risks under control, become an efficiency champion, maximise sales power, try to come out a winner, and carry out selective acquisitions as prices are down. "The first half results of 2009 proved that the right strategies and concepts — combined with decisive and consistent implementation — really make a difference," he said.

"The bank which probably adopted the most rigorous and systematic transformation of its retail banking division and sales force effectiveness programme in 2008 led revenue growth among all Middle Eastern banks on a half-year comparison (first half 2009 versus first half 2008), at close to 20 per cent.

Third quarter

As third-quarter results emerge, Financial Review spoke to Dr Leichtfuss on the key data and impact upon the Gulf banking sector.

He disclosed that BCG has carried out some further analysis, comparing the latest figures from some major banks to those from the second quarter. The study shows that around two-thirds of banks have increased LLPs in the third quarter.

However, it also points out some key positive signs, highlighting two banks that were able to reduce LLPs considerably. Commenting on the 2010 outlook, Dr Leichtfuss said "LLPs will remain high next year, but hopefully lower than this year for most banks if — as international forecasts suggest — economies are picking up again."

Approximately half of the banks in the most recent review experienced decreases in revenues during the third quarter compared to the second quarter. However, others increased their revenues between two and four per cent."We expected the second half of this year to remain similar to the first half, but are optimistic regarding an improvement in 2010. Long-term revenue and profit margins will, however, be under pressure," he predicted.

Reflecting overall on the financial crisis and overall banking outlook in the Gulf, Dr Leichtfuss remains positive, explaining that a financial crisis always causes banks to become more prudent and upgrade risk management systems. Thus, banks will inevitably take a tougher look at risks before lending.

On the international comparison, he added, "Middle East banks are less hurt by the crisis, even though in 2009 their LLPs are at their peak. Also, cost-income ratios have always been lower in the Middle East than in international banks; thus, there is a bigger buffer."

In a challenging environment that's a comforting thought to keep in mind.