Are there opportunities in an over banked market?
Even before the equity and real estate boom of the last 24 months, The Middle East banking industry has always been seen as over banked. Significant availability of capital due to oil revenues, combined with the return of capital invested abroad since 9/11, has always made it a borrowers' dream. The ability to borrow large amounts of capital relatively quickly, over and over again with different banks, has created the freedom to develop businesses, but also has become somewhat of a risk management issue for the lending banks. Combined with the availability of liquidity is a vast branch and ATM network that has created one of the highest branch and ATM networks per capita on the planet.
Cedar Consulting has been actively consulting with a large number of banks in the region since 1999, across all areas, and I would like to take the opportunity of sharing with you some of my observations of the current state of the industry today, and the potential challenges and opportunities going forward.
The region's banks have historically focused on the trade finance business followed by contracting finance. Both probably are equally important today. However, both of these businesses are significantly commoditized and the ability to generate income, both interest and fee, is relatively limited. Many banks have somewhat ignored the light manufacturing opportunity. True, most of this has been driven by the boom in the construction industry, but across the GCC, manufacturing tends to be at least 20% of the GDP. Additionally, most governments in the region clearly identify the importance of developing the manufacturing sector and the growth of industrial parks outside the UAE bears witness to the fact.
One of the key opportunities that has not been tapped is treasury. Globally, treasury generates at least 20%-30% of the banks' income. However, focus and expertise in this sector within the Middle East have been missing till recently. It is now beginning to pick up. Remember, a treasury business cannot be built if a bank cannot figure out how its treasury and corporate banking teams will work together to share the relationships. Over the years, I have seen banks with large corporate banking books but unable to drive treasury, as the corporate banking RMs simply blocked access to their clients.
Cross-border and structured finance opportunities are growing rapidly due to the equities and property/ infrastructure boom. This is also being driven by oil driven liquidity, where governments are launching large infrastructure projects and are seeking to diversify and syndicate risk and return (both debt and equities) to financial institutions outside their borders.
Commercial Banking - The hidden gem
It is less hidden than we all like to believe. In the UAE alone, there are over 10,000 businesses with annual revenues over 5 mm AED a year, and 160.000 in the 1mm-5mm AED range. These businesses need more timely banking support. and a range of customized products (e.g. factoring, small business credit cards) that, I believe, most banks in the region have ignored. The inability to define what is commercial banking. combined with incorrect organization structures. and credit policies that do not enable commercial credit, are sonic of the reasons why banks with decent commercial books have been unable to grow them. The general hesitancy comes from assuming that they are higher Credit risk, which is untrue. The spreads more than justify the risk of capital flight. It cannot be any worse than the mass retail asset approach that banks are taking. The second reason comes from the natural hesitancy of corporate bankers to deal with smaller accounts - sometimes viewing it below their esteem. The right team with a mix of retail and corporate banking skills, combined with fast turnaround processes, and unique products can turn this opportunity into one of the most attractive in the region.
Retail - How high is the ceiling?
Retail is In fashion like there Is no tomorrow. On the asset side. local banks have figured out the great profitability driver for international banks - credit cards - and cards are being handed out in large volume across all income levels. My belief is that there is still sonic ways to go here. Average cards/wallet in developed GCC economies are 2 compared to 4 in developed markets. This needs to be balanced against the reality of a missing credit rating system. and a large percentage of expatriate population. I think it is time now to go for a spend and loyalty strategy than a customer acquisition strategy. GCC residents still spend 25% using cards versus 60% in developed markets. Well developed loyalty programs combined with strategic partnerships in areas where share-of-wallet spend take place. 40% of card spends are to retailers. This area is growing but other areas need to be also focused on. Also, loyalty programs will have to get more sophisticated the airline mileage and restaurant spending loyalty programs are passe.
Automobile lending is no longer seen as innovative, though critical to the portfolio. Unsecured personal loans have become critical in the portfolio, as its risk profile is not seen as different from cards.
The big play is obviously In the mortgage space. Construction in the region, changes in government policy, attractive terms and conditions (interest rate being key) have resulted in a mortgage banking boom. Speculators play in every market. and this is no different. However one needs to ensure that speculators do not control a significant part of the market. I behove that threshold was crossed about 4 months ago. and what we are now seeing is a quiet correction, which is good for the industry. Every bank needs to determine its own threshold and risk/return expectation from this business. Not exposing more than 10% of one's retail asset book is not a bad place to start.
Private & Priority Banking
Over the years. I have been amazed when we have studied the retail liability profile of banks. as to how skewed they are. In a recent client situation. we found that 3% of clients accounted for 92% of the liability book. Talk about risk. What if those customers walked out tomorrow morning? In spite of this, most banks. till recently have done little to outside called Priority Banking! Some even don't hesitate to call it Private Banking. Its time for a reality check.
Priority Banking is a huge opportunity going forward. Middle East High Networth will be $1.5 trillion by 2009. One in every 80 citizens in the UAE is a $ millionaire. More importantly 40% of HNW Middle East customers in the $13nin-$5nins range have their wealth in the Middle East. not outside it. But accessing this opportunity is not going to happen by ignoring the high net worth customers within
your portfolio, or sticking a gold nameplate on a branch. Innovation in product and service is critical. Internal product development that maps customer needs. combined with an international product offering is essential for success. This needs to be combined with a strong investment advisory function. Domestic markets are growing rapidly. Is It too early or too late to invest. for which products. in which markets, what should my portfolio look like. my child will be studying In Canada how do you financially plan for It, etc. No rocket science here, but seine level of innovation in keeping with local needs is a given. Here is a simple innovation opportunity. Did you know that in spite of the equity market boons, less than 5% of funds are in Mutual Funds compared to 15% in developed markets. The fancier
Islamic Banking - the new gold rush
For the right and wrong reasons. Islamic Banking today is on everybody's minds. The Muslim component of the global high net worth piece is 9%. and the number is increasing every year There are over 41 Islamic Financial Institutions in the Middle East managing $ 40 billion in deposits, and $ 60 billion in assets. Some banks are pure Islamic models (e.g. Dubai Islamic Bank). and the others are Hybrid (e.g. HSBC Amanah). Many are starting Islamic windows. Ability and complexity to develop products is being underestimated. Additionally some products are being launched that may not be Sharia compliant. Also banks are nervous that in the process of pursuing the Islamic Banking opportunity with their customer base. they may cannibalize their customer base. My view on this is that if you do not offer your customers the option, somebody else will. It is expected that 50% of the Muslim population will participate in Islamic Banking in the next 10 years. Therefore I believe some form of participation is unavoidable.
Channel Innovation - the advent of the call center and DSAs
While international banks in the Middle East have used an asset light strategy with few branches (due to regulatory reasons). I believe that "storefront-/branches is still critical to business expansion. Even Charles Schwab. The I online US broker acquires 70% of its customers at their branches. However, the branch model will need to transform, Smaller and more friendlier looking branches. integration of the teller function into the customer service function. cross-selling targets, presence of investment advisors. and a lot of smarter machines will make the difference It is going to be more about innovating the over 1900 branches already in the GCC. than adding new ones.
Then there is the issue of Kiosks. I believe it is a great model with which the network can be expanded, duplicating trends in the retailing industry. Kiosks cost I/3rd to set up (approx. 5100K/kiosk), can be set-up easily in high traffic areas, can be moved around, and often generate 3 times the number of footfalls than a regular branch - that means more transactions and lower cost.per.transaction. While we are on the subject of channels. everybody needs the internet, but it is unlikely to drive efficiencies. I don't see the transaction volume exceeding 5% in the next 5 years. More important is the call center being leveraged for both inbound and outbound benefits. Cost-per-transaction at a call center (AED 4) tend to be half of a branch, and with rapidly reducing telecom costs, it is becoming a real option of having Arabic speaking centers consolidated in the Middle East and English/Urdu speaking ones outsourced to places like India. Lastly the role of Direct Selling Agents (DSAs) cannot be understated. There is only so much you can do with cross.selling your walk-in customers. You need "feet on the street" with a combination of variable and fixed costs, and DSAs are the only way to get there. However, a successful OSA program significantly depends upon a strong internal DSA management wain. A typical mid-market bank needs an average of 100 OSA, to sell retail asset products.
Credit & Risk Management - can we please business-enable credit?
Most banks are busy getting Basel II compliant. Others are setting up risk management departments. Fine. But what about business enabling credit? Too much authority sits with credit committees who are already overloaded. Why not look at the banks' exposure curve and design credit authority in a way that the committee manages most of the exposure (say 80%) and let the credit organization own the volume. This also allows the credit committee to study credits carefully without being overloaded, and credit learns how to own credit. This, along with customized documentation for corporate and commercial customers. new or renewal, will improve turnaround times, customer satisfaction and management of risk. And then there is the issue with retail credit. Parameterized and instantaneous, and out of the hands of corporate credit. That about says it.
Automation core banking is core.
Everybody knows this, but few as in a timely manner. A large percentage of banks are still operating with older systems, and those that are converting simply don't know how to manage the project some taking over 24 months to execute them. Too much customization, too little commitment from the business heads. and poor project management are making this a nightmare. Add to this the attempts to patch older systems into it rather than use one integrated model, If banks can get past this stage, the next stage of innovation in the area of CRM. data warehousing. and mobile banking will all get delayed - all critical in a highly competitive marketplace.
There is an old Hewey Lewis & the News song "The future is so bright, got to wear shades". Question is. who is going to wear then, in the Middle East banking market? The ones that segment customers well, grow their commercial banking book, provide an Islamic window, execute a strong retail asset strategy. innovate in the high net worth space. provide all the channels, and business enable risk all in a timely manner. Do you have it in you?