Mergers are increasingly becoming common in the UAE’s banking sector as the industry seeks to reap the benefits of economies of scale in a market place that is crowded, fragmented and expensive.

Confirmation of talks of a three-way merger of UAE banks such as Abu Dhabi Commercial Bank, Union National Bank and Al Hilal Bank last Tuesday has come at a time when the UAE banks in general are seeking to improve their cost-to-income ratios in a highly competitive market.

Presently, 49 banks fiercely compete in a market where credit penetration is quite high and macro outlook is challenging, resulting in lower margins. The room for meaningful growth for such large number of banks is very limited amid challenging regional economic headwinds.

Changing economic conditions are resulting in margin compression in many industries including the banking sector. Clearly, mergers of organisations in same lines of businesses make sense if these deliver efficiency in operations such as staffing, training, marketing and technology adoption.

Recent experience of mergers in the UAE, particularly in the banking sector, has proved that well-executed deals such as the Emirates Bank’s merger with National Bank of Dubai in 2007 to form Emirates NBD and subsequent consolidation of Islamic banking business of the Group in 2009 through the merger of Dubai Bank with Emirates Islamic Bank (EIB) have delivered the desired results.

The completion of merger between National Bank of Abu Dhabi and First Gulf Bank last year — creating First Abu Dhabi Bank, the largest bank in the UAE with an asset size of Dh692 billion — has reinforced the scale and scope of banking sector consolidation.

For long, multilateral agencies such as the International Monetary Fund and Institute of International Finance, a global association of financial services companies, have argued for banking sector mergers in the UAE and Gulf Cooperation Council in the context of relatively large number of banks serving small target markets. Also, the sector has been relatively elusive to M&A activity.

It is common that in times of economic boom, riding high on favourable business conditions, companies tend to expand rapidly, but not necessarily in a cost-effective manner. When the tide turns, it becomes imperative for companies to rationalise on costs and seek efficiency in order to maximise margins and remain ahead of the competition.

Financials for the second quarter of 2018 shows, overall costs for the UAE banks continued to move up with the cost -to-income ratio at 33 per cent — up 70 basis points from the first quarter of 2018 (32.3 per cent) for the top ten banks (by assets) in the UAE. Data also reveal that an increased level of sales and general and administrative expenses were the main reasons behind this increase.

While all the economic conditions support the UAE banking sector’s growing urge to merge, the consolidation cycle in the sector in all likelihood will remain a slow and evolving process.