GCC: An Economic Powerhouse of Oil-Rich Middle East - Essay Sample

Introduction

The economic characteristics of the oil-rich Middle East provide a robust landscape for one of the fastest-growing markets for the banking industry and capital markets. The umbrella body, Gulf Cooperation Council (GCC) founded in 1981 which constitutes six nations; Bahrain, Oman, Kuwait, Qatar, Saudi Arabia, and the United Arab Emirates, form an economically impeccable block strategically located on the largest recognized global oil reserve (PwC Middle East, 2019). Besides the lucrative oil commodity, nations under the GCC have continued to exploit other economic alternatives through innovation to diversify their investment portfolio (World Bank, 2010). This combination of the lucrative oil commodity exported from the region and other alternative investment portfolio has made the Middle East a financially vibrant region due to an increased Gross Domestic Product (GDP), hence, providing one of the largest potential markets for the banking sector and capital markets. The lifeline for the banking industry in this region comes from growing investment needs, which is essential in the acceleration of key transformations critical for economic growth and development. For instance, as reported by the International Monetary Fund (2013), at the back of the 2003 to 2008 boom in oil prices which led to a rise in GDP for Middle East nations, there was a corresponding increase in credit demands by private sector players majorly for construction and real estate development. Towards the end of 2008; however, the time around the global financial crisis, the period of economic prosperity came to an abrupt stop for the GCC economies. The consequence was a plummeting of real estate stocks, a fall in asset prices. As a result, there was a looming threat of credit defaults, one of the most significant vulnerabilities of the banking sector.

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The bankers in the Middle East nations, in particular, are perceived to primarily suffer from concentration risks in their loan portfolio and the consequent the need to retain a huge buffer capital (International Monetary Fund, 2014). Buffer capital loosely implies a mandatory capital a financial institution must hold besides their minimum capital reserve requirement. The concentration risk for banks in this region is widely attributed to the enormous dependence on oil by their economies. This is because most of the sectors the banks lend to are dependent on government expenditures, which, to a large extent if not fully, are dependent on income from oil. As a result, the benefits commonly realizable form diversified lending is not feasible for banks in these economies due to chain-relationship between the oil and nonoil sectors. Fortunately, as quoted by World Bank (2010), the GCC economies braved the global financial crisis, becoming more integrated into the world economy, given the cruciality of gas and petroleum in global trade coupled with their ambitious economic goals. As of 2014, GCC banks had excellent liquidity, capital structures, and realized a rise in profits. The banks had an improved asset quality in the form of loans as a result of a decline in non-performing loans.

From 2015, however, the GDP of GCC nations experienced some decline, effectively undermining banking industry growth and profitability through items like increased non- performing loans. In response to this, some banks in the region opted to adopt a traditional strategy employed by their peers. The strategy of merging during economic contractions to maximize on economies of scale and growth opportunities. A classic example is the all-time mega-merger between National Bank of Abu Dhabi (NBAD) and First Gulf Bank (FGB) that created the First Abu Dhabi Bank (FAB) with an estimated asset valuation above 175 billion dollars (Gencoglu, 2016). Mergers between big banks in developed economies, as Fraise, Hombert, and Le (2018) argue, often has resulted in banking market dominance.

External Analysis

At the back of the financial crisis, several banks are emphasizing on outstanding debts recovery, new customer acquisitions for asset growth, risk mitigation, and investment diversification. However, a decade after the crisis, an analysis of the banking industry reveals that despite policies to raise capital requirements for banks and improve asset to equity ratio, the industry is still weaker than before the crisis. Fortunately, or otherwise, the global economy today is experiencing significant dynamics that are largely affecting businesses and industries, including the banking sector in a competitive way.

Technological Environment

Foremost, the most prominent external environmental factor affecting banks in contemporary is technology. More advanced technology is giving birth to competitors for bankers in the form of new internet firms who offer web-based financial services. A classic example would be Robo-advisors, new entrants in the financial market who are posing competition for client's traditional bank savings through the automation and improvement of accessibility to complex financial advisory functions like investment management.

More so, technology is imposing a challenge on traditional banking and reconstructing the relationship between banks and their customers. Digital banking is not only becoming a new phenomenon in the banking sector, but it is becoming an effective competitive tool with those banks adopting the latest technology and innovation, attracting a growing number of customers. As Giridhar, Notestein, Ramamurty, and Wagle (2011) argue, today, many financial institutions are utilizing information to create new products and cement relationships with partners, suppliers, and customers. Consumer banking patterns are evolving fast in response to the growing pace of sophisticated technologies. In response, banks are exploiting opportunities in this new consumerism patterns by reengineering and improving their services to become more agile, efficient, and responsive to gain a competitive milestone. Australia's NetApp, the global leader in direct savings, for instance, through the integrated Bank in a Box project, gained a competitive edge by bringing in new banking products and services to the market.

Today there is a rise in internet use, online banking amongst consumers of bank products, albeit this trend, as Smith (2014), argues is minimal among the elderly and is positively correlated with levels of education and income. For GCC nation banks, in particular, FAB, this provides a great opportunity given the citizens of these nations are ardent internet users, with countries like UAE having internet penetration rates above 90 percent. This, coupled with a surge in e-commerce, will provide a promising market for the banks through the innovation of financial products and services suited for such platforms. On a downside, however, technology can have far-reaching consequences on banking systems.

For instance, as quoted by Magee (2012), at the back of implementing a software update in its system, a failure of the same at Ireland's Ulster Bank inconvenienced an excess of 600,000 clients, when they could neither access their account status nor funds for over a month. Information Technology (IT) based business operations, especially for banks, are vulnerable to several security threats like hacking and identity theft. As quoted by Norton Cyber Security Insights Report (2017), 978 million bank consumers in over twenty nations lost 172 billion dollars to hackers, of which an excess of 3.72 million consumers from the UAE lost over a billion.

Competitive Environment

Secondly, the competitive landscape in the banking sectors for GCC nations, albeit marked by several global banks, is supportive of growth for local banks. According to The World Bank (2016), banking competition in these nations is relatively lower in contrast to the rest of the world owing to strict requirements for new entrants, regulations for foreign players, and inadequate information on credit. Apart from this, GCC nations' government-owned banks are relatively advantaged compared to peers due to reduced funding costs and more preference by investors and depositors who perceive them as less risky. Moreover, there can be high costs inherent with switching banks by clients coming especially from huge settlement fees on loans and charges for account closing. A combination of these factors serves to minimize threats of new bank entrants into the industry, albeit other non-bank players still threaten bank margins in more specialized areas of the financial market. Examples of such players are insurances, trust funds, and fixed income securities, who provide investment management services.

Economic and Political Environment

Another critical item for the growth banking industry in the GCC nations is the oil and gas industry. An increase in the revenues from the latter raises domestic credit demand. The model works by triggering increased government expenditure from the realized revenues, improving the GDP, and consequentially aggregate demand. However, when the global oil prices fluctuate, reducing realizable revenues, the government cuts its expenditures. The ripple effect becomes an increased risk of credit default on bank loans with higher non-performing loans leading to tightened liquidity. These high-risk loans often lead to slowed loan growth and reduced profitability for the banking sector in the short run. Combined with political standoffs between the GCC nations, the cyclical economic cycles have created challenges for banks like FAB in these nations. For instance, as quoted by World Bank (2018), the standoff that has pitted Saudi Arabia, Bahrain, and the UAE against Qatar that saw the former ban all travels to the latter, affected the financial markets in Qatar with non-resident deposits declining significantly in the country.

In UAE, however, the banking sector has received a boost from the government and stable socio-economic and political environment. As of 2018, as quoted by UAE Banks Federation (2018), the gross assets for all banks in the country rose to 780 billion dollars, the biggest in the Arab World. The growth of banks in the country is attributed to the oil boom as they mushroomed to help secure and invest realizable wealth form the increased economic growth. At the back of the oil price plummet, local banks received another boost through a reduction of competition when some international banks ceased their operations in the country.

With the existence of several other domestic banks, however, consumers in the UAE banking industry still hold a considerable amount of bargaining power. Consumers use items like customer experience on touchpoints like branches, call centers, internet banking, and mobile banking to choose a banker. As quoted by UAE Customer Satisfaction on the Rise (2017), however, customer satisfaction remains lower in the banking sector relative to other industries and not every bank is emphasizing on customer satisfaction across every channel, although as Souqalmal (2018) cites, 32% of the bank consumers reveal high satisfaction and mostly recommend Emirates National Bank of Dubai (ENBD), Dubai Islamic Bank (DIB), and Abu Dhabi Commercial Bank (ADCB).

Other Macro-Environmental Factors

Currently the corona virus (COVID-19) pandemic is causing widespread concern globally for consumers, banking industry, and capital markets. Forecast is that the COVID-19 could slow down economic growth by a least 25% (Lee, 2020). The biggest concern for Banks amidst this situation today is consumer behavior and risk management of their outstanding loans assets. The big question for banks as Lee (2020) argues is "will their capital and liquidity buffers be enough to see them through the most dramatic economic crush in history. Consumers are pulling down their i...