GCC banks stand out from global peers, poised for exceptional years ahead: report
RIYADH: A strong oil and gas sector, high interest margins and fintech innovation will help drive growth in the banking sector in the Gulf Cooperation Council region in 2024 and beyond, according to a new report.
Analysis of global management consulting firm McKinsey & Co. showed that, despite global macroeconomic instability, financial institutions in the region outperformed their international peers in 2023 due to an exceptional business environment, and the sector is set for a strong performance this year.
Global banking faces significant challenges in the wake of COVID-19, including rising prices and rapid monetary tightening.
The US Federal Reserve quickly increased interest rates, which increased bank profits, but also increased the risks of unrealized losses, as evidenced by the collapse of Silicon Valley Bank and the takeover of Credit Suisse.
Tensions in the Middle East and prolonged high interest rates in the US could further weigh on global prices. These problems led to a 10 percent decline in the price-to-book ratio, reducing the capitalization of the global banking market by $900 billion.
Report by McKinsey & Co. struck an upbeat note for the GCC banking sector, saying it “boasts exceptionally high returns on equity and some of the highest multiples globally.”
The report added: “The regional financial sector has delivered healthy returns to shareholders over the past decade, outperforming the global average.
McKinsey & Co. pointed out that the Total Shareholder Return Index, which tracks dividend-adjusted share prices for over 80 GCC financial institutions, has consistently shown superior growth trends compared to global benchmarks from 2010 to 2024.
This highlights the sector’s ability to deliver strong shareholder returns amid global economic volatility.
GCC banks also maintained higher return on capital levels and stronger market multiples globally. Despite the recent decline, their ROE has consistently exceeded the global average by three to four percentage points from 2022 to 2023, reflecting their efficient capital management and profitability in a challenging global banking environment.
Elevated interest rates have played a significant role, driving regional and international banking profits to record highs and supporting GCC banks in creating significant shareholder value.
Furthermore, GCC banks boast higher net interest margins and income-to-asset ratios than the global average, according to the company. With net interest income of 2.3 percent, exceeding the global norm of 1.4 percent, they point to wider profitability margins in the region.
Despite facing higher impairment charges compared to global banks, GCC banks operate with lower operating costs, demonstrating effective cost management strategies. Their average ROE of 10.9 percent reflects strong capitalization, beating the global average of 9.0 percent.
Overall, a favorable macroeconomic environment characterized by high hydrocarbon prices and strong economic growth has supported strong balance sheets and a stable trajectory for the GCC banking sector.
Resilience in the face of global risks
GCC banks have shown resilience amid recent global shocks, contrasting with the challenges facing the wider international banking sector.
Report by McKinsey & Co. stresses that while global economic connectivity offers opportunities for growth, it also increases risks of instability, accentuated by heightened geopolitical tensions and regulatory scrutiny.
The company said these trends are occurring against a backdrop of accelerating climate change – a global risk multiplier that also represents a multi-trillion dollar opportunity to finance the transition to low-carbon growth.
McKinsey’s macroeconomic scenarios predict that global banking conditions will worsen in the coming years, leading to a peak and subsequent decline in returns on equity for GCC banks.
Despite this, the sector in the region is better equipped to manage these challenges compared to its peers. Their banking indicators are expected to deviate positively from global trends, highlighting their resilience and relative strength in managing future economic uncertainties.
According to Ernst & Young’s 2023 study, increased demand for banking services, growth in digital banking and regulatory reforms such as the introduction of Basel IV are expected to help boost growth in the sector.
Liquidity management
Nevertheless, GCC banks face challenges despite the favorable environment, especially due to interest rate fluctuations. The company noted that global tight monetary policy and faster growth in funding than deposits require careful liquidity management.
The analysis showed that financing grew by 14 percent annually in the Kingdom from 2019 to 2022, outpacing deposit growth of 9 percent. High interest rates are driving mortgage lending as governments promote home ownership, affecting GCC banks’ retail loan portfolios.
The average loan-to-deposit ratio for Saudi banks rose 18 percentage points from 2020 to 2022, indicating potential liquidity problems. High rates can also change the behavior of consumers and businesses, affecting non-interest-bearing liabilities and saving and investment patterns.
Total loans in Saudi Arabia are projected to reach SR5.04 trillion ($1.34 trillion) by 2030, with annual growth of 10 percent from 2024 to 2030, the report shows.
Wholesale loans will have the largest share with 69 percent, followed by mortgages with 21 percent and consumer financing with 11 percent.
In contrast, deposits are expected to reach SR 3.54 trillion by 2030, growing at a rate of 5 percent annually. Wholesale deposits will account for 53 percent, and households will account for the remaining 47 percent.
The total loan-to-deposit ratio is expected to increase by 142 percent from 104 percent in 2024, indicating that deposit growth in Saudi Arabia has not kept pace with funding, increasing liquidity pressure.
Since 2020, GCC banks have significantly increased their activity in international debt capital markets. This strategic move is aimed at strengthening their funding growth strategies, diversifying funding sources, and more recently, mitigating high liquidity costs in the country.
According to a recent report by Fitch Ratings, emerging market debt issuance in dollars, excluding China, exceeded $200 billion in the first five months of 2024, with issuers from the Kingdom leading with 18.5 percent of total issuance.
Despite the challenging financial environment, these banks have deftly managed liquidity challenges, supported by increased access to government sukuk and liquidity management tools provided by central banks.
These measures are designed to ensure a sustainable level of liquidity, enabling banks to meet financial obligations and maintain operational stability in the face of fluctuating market conditions.
Innovation and technology
McKinsey & Co. highlighted key transformational factors shaping GCC banks, including innovation, machine learning and generative artificial intelligence, as well as high digital penetration and the impact of fin-tech in reshaping the industry.
In addition, GCC regulators are actively developing an open banking framework to further drive the evolution of the sector.
Abdulla Al-Moaied, CEO of Tarabut, praised the adoption of open banking in Saudi Arabia in an interview with Arab News in May.
He highlighted joint efforts between banks and fintech companies to innovate and expand market reach, signaling a significant evolution towards digital transformation in the Kingdom’s banking industry.
Generative AI and other advanced technologies are poised to revolutionize banking operations, increasing customer engagement and operational efficiency.
In the GCC, fintech advances such as digital payments and sophisticated financial products are gaining traction, driven by increasing demand for personalized digital services.
McKinsey & Co. noted that fintech companies are expanding their portfolios beyond core offerings to serve both the consumer and business sectors, driven by significant funding and widespread digital adoption in the region.
At the same time, traditional banks are launching new digital initiatives to remain competitive, highlighting the dynamic and evolving banking landscape across the GCC.
An example is given of how regulators in Bahrain and Saudi Arabia encourage innovation through open banking frameworks aligned with global standards. This encouraged local startups and encouraged established institutes to adopt new technologies.
The report states that open banking increases competition and IT costs and offers benefits such as expanded customer reach and new services. It also requires banks to adapt to take advantage of opportunities while managing profitability risks.
Recommendations of McKinsey & Co
GCC banks are poised to effectively manage global economic uncertainties, but must remain proactive rather than complacent, the report warned.
Key priorities for bank CEOs in the region include managing interest rate hesitancy through robust asset and liability management and stress testing.
Steps should also be taken to increase operational efficiency by digitizing processes and automating routine tasks that will optimize human resources.
Transforming the customer experience by offering real-time personalized products to a digitizing population is key, as is maintaining a focus on environmental, social and governance initiatives that support global climate change efforts.
In addition, creating shareholder value through strategic mergers and acquisitions and restructuring allows banks to capitalize on evolving market dynamics, freeing up capital by shedding non-core assets and refocusing on core operations.
These priorities underscore the proactive stance of GCC banks amid an evolving economic environment.