Banking consolidation in the GCC requires attention to competition

Gulf banking markets may have entered an important phase of consolidation, with the potential to dramatically reshape both the role and the intermediation capacity of the industry. A few days ago, two large banks in the UAE, National Bank of Abu Dhabi and First Gulf Bank, agreed on a tie-up to create a national champion and regional powerhouse with $170 billion in total assets. In Oman, Bank Sohar and Bank Dhofar are in advanced merger talks. Bank mergers are expected to take place in Bahrain and Qatar as well.

The protracted downward trend in oil prices is threatening economic growth and fiscal sustainability in the region. This is having an impact on the banking systems. Banks are increasingly facing pressure on liquidity in the face of both private and public deposit outflows. This coupled with a low interest rate environment in the context of pegged currencies is eroding margins. Capital buffers are strong yet asset quality may deteriorate if oil prices remain low for a prolonged period and economic growth decelerates further. Therefore, in a context largely characterized by fragmented markets, consolidation may help achieve efficiency gains and ultimately preserve financial stability.

However, it is important that banking consolidation in the Gulf does not come at the detriment of competition. International experience shows that healthy bank competition generally promotes access to finance and improves the efficiency of financial intermediation, without necessarily eroding the stability of the banking system. Bank competition in the region is traditionally weak largely due to strict entry requirements, restrictions to bank activities, relatively weak credit information systems, and lack of competition from foreign banks and nonbank financial institutions. While increased market concentration does not necessarily imply greater market power, there is a risk that the current and prospective wave of industry consolidation may have long-lasting negative effects on competition if left unchecked.

In a forthcoming report, we analyze the potential harm to bank competition in the Gulf Cooperation Council (GCC) originating from institutions and regulations. We identify several areas which may require investigation and remedy by the authorities. Two areas stand out in the context of bank mergers. First, there may be a risk that state-owned banks consolidate their preferential access to funding as a result of explicit or perceived government-backing. All the banks mentioned above which have agreed to merge are directly or indirectly controlled by the state. This may weaken the level playing field, potentially resulting in lower benefits for consumers and firms. It is therefore essential that a competitive neutrality principle is enforced across the board through, for example, debt neutrality and competitive procurement policies and procedures.

Second, the current competition law systems in the region may not be able to ensure that mergers do not negatively affect competition. State-owned banks (and the whole banking sector in the UAE) are exempted from the applicability of the general competition law. Neither do the financial sector regulators have a competition objective in addition to the traditional mandate of ensuring financial stability. Merger control rules are still at an embryonic stage and enforcement capacity is relatively weak. There is, therefore, room to strengthen the role and power of the competition authorities while at the same time establishing formal cooperation arrangements between the competition authorities and the bank supervisors to clarify the division of labor in the area of bank competition policy.

Important structural reforms aimed at diversifying the economy and create private sector jobs are under way in the GCC. In this context, the banking sector will be a key stakeholder, nurturing small businesses and facilitating the structural transformation of the countries. Therefore, financial sector reform should remain high on the policy agenda. While it remains to be seen whether building national champions will lead to increases in productivity and declines in prices, encouraging market contestability in a sound institutional and regulatory framework should be a priority.