Middle East banks' lending spree

Amongst a flurry of positive announcements from Gulf banks, borrowers are finding it increasingly easy to secure loans, but not all is well in the banking industry

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By  Barnaby Chesterman Published  March 27, 2001

Introduction|~||~||~|Vertical growth projections may have been relegated to history forever as last year’s reality check applied the brakes to the dot.com madness. But the hyper-competition of the New Economy means that the difference between long term winners and losers may well be defined by the speed of their growth over the next two years.

Growth, however, often comes at a price. New Economy venture capitalists were quick to grasp this and provided the cash injection that almost any high growth idea needs to get off the ground.
Now venture capitalists are throttling back and companies with high growth aspirations are being forced to turn to more traditional sources of funding for their businesses. Talking to your bank manager is back in fashion and, in the Middle East at least, bank managers are becoming more flexible in the way they evaluate business loan applications.

That is not to say the regional banking industry is about to start writing blank cheques to fund business ideas written on the back of a napkin. The reality is that the Middle East banking industry is maturing; it is learning from its mistakes; and it is learning from international best practices in the industry.

On top of this, the business climate for banks has never been better. Year 2000 financial results from banks in almost every GCC country are showing that a strong oil price has a massive positive effect on their bottom lines. “Things are changing because they are beginning to see that there is a little more stability here now,” says Shehab Gargash, senior manager for investment banking at Emirates Financial Services.

There is nothing like strong financial results to encourage banks to loosen their purse strings. The UAE Central Bank recently announced net profits had surged by 30% for the year 2000. Likewise, in Kuwait in February, Gulf Bank chairman and managing director Bassam Yusuf Alghanim presented shareholders with the highest profits, deposits and earnings per share in the bank’s 40 year history.

The good news even continued with the secretary-general of Arab Banks, Dr. Fuad Shaker, expressing his confidence that Kuwaiti banks can cope with globalisation, due to their highly efficient management of branches and investment portfolios abroad. It is perhaps this strengthening quality of management throughout the Middle East that will define the way businesses work with their banks in the future.
The Middle East banking industry is generally rated as stable by Moody’s Investor Services annual review, which also categorises individual countries. In September, only Lebanon was put on review for a possible downgrade, but Moody’s does express various concerns, even in the most stable of markets. While the current high oil prices have helped to ease fears that some of the region’s weaker banks might be on their last legs, Moody’s warns that Gulf banks can ill afford complacency.

Not all banks sailed through the turbulent times of 1998 and 1999 when oil prices took a tumble, and the fear in the Middle East is that industrialised countries may accelerate their development of alternative energy sources. According to Moody’s, this would threaten the underlying long-term strength of Gulf economies, upon which the banks are so dependant.

Legislation in several Middle East countries is also about to open the local banking industry to more intense competition from international banks. The new regulations have not come into effect yet, but they are plans that have been agreed and they will strip away much of the state-sponsored protection that local banks have enjoyed in the past.

||**||Fear of competition|~||~||~|If Middle East banks are afraid of increasing international competition, they are not showing it. Reza Habib, chief executive and vice-president of Habib Bank AG Zurich, says international banks will have a considerable amount of catching-up to do in order to rival local banking services. “Today, [foreign banks] have to compete with us, actually,” says Habib. “We’re offering more services than any of them are, so they have to catch up still.”

Mohammed Al-Jallaf, senior manager electronic banking services for Emirates Bank International, declares that his company has been preparing for years for greater competition. For example, EBI recognised the Internet as a new delivery channel in 1995 and has been working on it ever since. “We knew it,” he says. “We had a vision; we could see the future; my assistant is Nostradamus!”
Independent analysts, however, are not so confident. “Banks have to start preparing themselves for a totally new landscape when it comes to competition,” says Maher Khalil, senior manger at Accenture (formerly Andersen Consulting).

He says that smaller banks with only a handful of branches in countries like the UAE will soon be competing with the 400-branch Saudi banks, not to mention the giants from Europe and the US. The regulatory issues haven’t materialised yet, but Khalil believes that it’s only a matter of time before the defences are down and the rest come pouring in.

Habib argues that all the big foreign banks are already in the UAE, yet his bank has continued to post increasing profits with business doubling every 20 months on average. “I think we’ve seen all the big institutions come in already,” he says.

To an extent he is right, but it’s all a matter of scale.
“The foreign banks in the region are under a lot of restrictions,” says Abdelhamid Suboh, also senior manager at Accenture. “For example, in the UAE they’re limited to the number of branches and even ATMs that they can have.”

These banks may have a presence in the Middle East, as Habib points out, but currently it is little more than that. They are not competing on a level playing field. Local banks can ill afford complacency when foreign banks have so far had an arm tied behind their backs.

Habib argues, however, that there is plenty of room for competition, particularly in the UAE, which is a developing nation that continues to find new markets. “It’s a country where there’s new business being generated, so it’s much easier to grow than in a country that is stagnant,” he says.

In a buoyant market, banks don’t have to grab business from each other as there are frequent new opportunities to develop naturally. The danger, however, is that Middle East markets are already over-saturated.

The UAE, for example, has 50 operating banks in a population of just 2.5 million, while in Lebanon there are about 70 banks between 3 million people. Compare this to markets like the UK where consolidation looks certain to concentrate over 80% of the country’s 40 million banking customers into just a handful of institutions.

||**||Lack of streamlining|~||~||~|In today’s stable market, with high oil prices and government protection, there seems little cause for alarm for bankers. But another downturn in the economy will inevitably increase pressure for consolidation. “This will probably push the banks towards mergers and acquisition,” says Suboh.

So far this has not happened on more than a very limited scale. Mergers involving SAMBA, Gulf International Bank and Al-Ahli Commercial Bank of Bahrain are the exception, not the norm.

Two major banks in the UAE couldn’t come to an agreement on a merger. Negotiations between EBI and National Bank of Dubai broke down in the middle of last year, and that despite Mohammed Al-Jallaf’s belief that mergers are a “positive step.”

This streamlining won’t happen like it does internationally unless banks are almost forced into it. According to Moody’s, both the lack of consolidation and the protected environments that Gulf banks still enjoy are primary causes that restrict the development of competitive strengths.

Accenture identifies two key areas of competitive strength where banks have to improve: pleasing the customer base and using technology to streamline processes. The customer base is becoming more sophisticated in the Middle East and is putting more pressure on banks to offer better products and services. They want better ease of access, they want Internet banking, mobile banking and call centres.
The much talked “all-powerful customer of the New Economy” is beginning to apply pressure. “If you look at the customer base, a big part is happy with the basic services,” says Khalil. “But typically, the most profitable customers are the ones who are a lot more aware of what is happening elsewhere and they are the most demanding.”
Investment in technology is essential, says Accenture. The question for banks is when and how much to invest?

The UAE is fairly well advanced in terms of Internet infrastructure, but in Saudi Arabia there is still a lot of work to do to get the infrastructure to a level where companies can conduct e-commerce. “If you talk to any bank in Saudi Arabia, they will tell you that the Internet has to improve before they can do any serious business on the Internet,” suggests Suboh. “So there are infrastructure challenges that they have to overcome before they can offer reliable, secure Internet services.”

“If you look at the current e-commerce infrastructure in our part of the world, it’s not even in its infancy. In many cases it’s not started yet,” adds Khalil.

Another technical and also, business, challenge is formulating Internet strategies. While all banks will be well aware of the need to have an Internet presence and offer certain services through that medium, once again the main issue here is the amount of money they are prepared to invest at a time when banks in the Middle East are not sure about what they are supposed to offer.

Some are coming up with basic Internet services to check balances or perform simple transactions. But they need to look at how they can really win business by offering enticing new services. “They need to look at the Internet as something that they can integrate into the business and be able to deliver a lot more value to the customer through this channel,” says Suboh.

||**||Internet necessity|~||~||~|While the Internet is an integral value-add tool that very soon banks will not be able to do without, much like ATMs, it’s not just about the end service to customers. The whole e-business revolution has been as much about reducing costs within the internal workings of a company. “That reduction would come in the improvement of practices, automation, organisation and processes,” says Khalil. With those internal improvements and cost reductions, so comes a better service to the customer.

National Bank of Kuwait has made huge strides in the field of technology; systematically using technology to improve internal efficiencies. According to the latest Moody’s report, the bank has achieved cost savings of 40% over the last decade as a result of technology.

Management also needs to modernise, say analysts. “The mindset in operations has to change to a more customer-oriented culture, which you will not find in many banks,” says Khalil. “The traditional scenario is seller-centric. Many banks haven’t really matured enough in their understanding of their customers,” he adds.

This is not a view shared by Habib, however. In fact he believes that his bank, relatively small even by UAE standards, actually profits from its size in terms of customer relationships. “Our advantage is that our traditional banking method has been personal service,” he says. “You can afford to do this in a small institution.”

He also thinks that larger banks suffer from more complicated decision-making processes and interoperability problems. Habib Bank AG Zurich concentrated on implementing technology that can deliver services to all delivery channels through a central point. But Habib says that the bigger banks fall into the trap of trying to go for best of breed ‘point solutions’ but then struggle to make it all cohesive. In some cases, however, technology driven solutions like CRM and e-banking are hardly uppermost in bank manager’s minds.
How to stop rogue customers running off with the bank’s money assumes significantly more importance. Bankers assert that the legal framework of most Middle East countries does not provide them with enough protection.

On numerous other occasions, banks in the UAE have suffered losses when businesses have gone bankrupt or been unable to repay their loans. “That exposed very large weaknesses in our system that haven’t been addressed to date,” says Emirates Bank’s Gargash.
Husam Hourani, a partner at Al Tamimi & Company, an advocate and legal consultant, has identified three major reasons why banks are so vulnerable in the UAE, particularly in Dubai.

The first is a lack of participation by UAE nationals in the running of companies, he says. Most companies are managed by expatriates, but they are subjected to restrictions in UAE law, requiring that a UAE national is a 51% shareholder in the company. Often this leads the expatriate company to find a silent partner who is just happy to receive a lump sum every year. “His name is just there for legality,” says Hourani.

This doesn’t cause an issue until things take a turn for the worse. “If they go bankrupt, they [ex-pats] don’t feel that their reputation in the UAE is that important. They know that, at any time, they can leave the country,” says Hourani.

||**||Bounced-cheque syndrome|~||~||~|The situation is exacerbated by the bounced cheque syndrome. Because the laws of the country prohibit ex-pats from owning property or land, they don’t have much to offer banks as security against loans. One option is to put up stock or products as securities, but this causes innumerable headaches in terms of administration, so the most common securities are post-dated or blank cheques.

The problems then arise when such cheques bounce or are returned unpaid. The creditors, eager to recoup their funds, put pressure on the company or individual that issued the cheques, threatening to go to the police if the debt isn’t settled. All too often, debtors take the easy way out and flee. “These people who are threatened with being put behind bars would rather leave the country,” explains Hourani. And that’s exactly what they do to escape punishment.
A third reason for bank bad debts is a lack of corporate taxes. As companies don’t have to pay taxes, they don’t have to audit accounts and submit them to government authorities for inspection against irregularities.

Therefore, there’s no supervision and on occasions people have transferred large amounts of borrowed money out of the country back into their country of origin. As the government doesn’t supervise traders’ accounts, they can’t guard against fraud. There’s nothing to stop someone starting up a company in the UAE, borrowing off banks, transferring it into their home country and then leaving the company to collapse while they go and live off the money transferred.

The UAE Central Bank recently introduced a money laundering regulation that stipulates that if individuals or companies are trying to transfer more than AED 200,000 they have to fill in a form so the Central Bank can supervise the transaction. It’s a start and could help prevent the wide-scale losses suffered in the well documented case of Solo Industries in the UAE (who’s owner absconded with debts of Dhs 1 billion), but it’s hardly going to stop someone transferring AED 190,000 out of the country six times and then disappearing with the money.

The Central Bank is trying to tackle the problem, but, as Moody’s suggests, generally the Gulf’s Central Banks are not as forceful as elsewhere and a lot more still needs to change in the UAE. As Hourani points out: “The criminalisation of bouncing cheques encourages merchants to flee the country.”

These inadequate regulations have far reaching effects on the economy and at the end of the day, the companies that try to eek out an honest living in the country pay for the risk the banks have to take with ineffective securities.

Because the banks are taking a high risk in lending money, they have to keep interest rates high. “Due to this loophole in the law, merchants are paying a price, so there is greater pressure on them,” explains Hourani.

||**||Need for new laws|~||~||~|Banks are also limited in their ability to check the credit history of potential debtors. Here’s why. Only national UAE banks are required to report to the central bank. Hence, if a company applies for a loan, the bank making the loan can only check with the Central Bank to see if this company has any outstanding loans with other UAE banks. It has no way of finding out whether or not the company has borrowed money off foreign banks unless they choose to disclose this.
Add to this the fact that foreign companies are only allowed to set up limited liability companies and are not allowed to own any premises or land. So when a company goes bankrupt, creditors can only claim a share of its stock or products.

Unfortunately, however, cases can take between one and three years to go through court, by which time the products have been left to deteriorate outside in the uncompromising sun or in a warehouse that turns into an oven due to the lack of air conditioning. By the time the products are sold off in a public auction their value is negligible. “Many banks don’t even bother filing cases because it’s hopeless to recover anything from these,” says Hourani.

He believes that the UAE needs a new law giving creditors scope to go after the shareholders for unpaid debt, as is possible in certain cases in American and British law. That would encourage silent partners to take more of an interest in the running of the company, according to Hourani. “We need more co-operation between the Central Bank and commercial banks, and we need more regulations,” he says.
“We need the banks to get their act together. We need a society or organisation that looks after the interests of the banks. In this country, unfortunately they fight against each other, and don’t share information,” he adds.

That view is shared by Emirates’ Gargash. “What we need is a focused taskforce set up by the banks, with the government involved, to set guidelines as a first step towards establishing that necessary infrastructure,” he says.

There’s a definite lack of cohesion within banks in the UAE and indeed similar problems exist in other countries in the Gulf that are heavily reliant on expatriate workers. But the UAE also has a further issue that affects its banks.

The UAE is not a party to any international treaties for the enforcement of foreign judgements or awards. So when people leave the country it’s almost impossible for the UAE to enforce judgements against them. Again, people are encouraged to leave the country rather than stay and fight to save their company and pay their debts.
All these factors contributed to making the UAE a country seen as a soft touch when it came to fraud. The abuse of the system culminated in the UAE Solo Industries case and AED 1 billion in losses for banks. That in itself was the last straw for many banks who responded by tightening up on lending criteria.

For a couple of years profits slowed as banks became risk averse. But now, buoyed by oil receipts, they are starting to loosen the purse strings and take a few more risks.

For the moment it seems to be working as many Middle East banks announce increased profits. However, the issues that have dogged them in the past remain and until such time as these are addressed, not just by banks, but by central banks and governments as well, it is just a matter of time before the region’s industry suffers the same problems all over again.

“The risk hasn’t gone away,” says Gargash. “Steps towards a centralised credit bureau have not amounted to much. Therefore, banks still continue to manoeuvre in the dark.”||**||

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