The banking industry in the Middle East reflects the lagging development of the region's economies. Although generally healthy and reasonably profitable, it has yet to begin meeting the challenges of globalisation or joining the merger wave and the internet revolution.

In a region where economic reforms have moved at a snail's pace - and economic growth in the 1990s averaged 3.6 per cent, much less than other developing regions - the state remains the biggest player in the economy, including in the banking sector. Strong state control has bred a lack of dynamism and left the banks missing out on opportunities.

That evolution comes slowly for Arab banks is not surprising. With the Middle East home to more than half of the world's oil reserves, easy profits and protected markets have promoted complacency.

eanwhile, the concen-tration of the industry in the hands of family dynasties and the centralisation of decision-making have stifled creativity.

In many parts of the region businessmen complain that banks are unwilling to take sufficient risk to finance small and medium-sized companies.

Arab banks have benefited from a low cost of funds. For example, more than 40 per cent of deposits in commercial banks in Saudi Arabia, the largest market, do not bear interest. With a largely conservative management - capital-to-assets ratios are higher than the average for western banks - banks have learned to weather periods of low oil prices.

Analysts say 1999 results, now being reported, are showing a rise in profits, in spite of depressed oil prices in the first half of the year. With the subsequent rise in the price of oil, 2000 profits will pick up further.

"Year-on-year, there is an increase but it is nothing too exciting; and, anyway, growth is at times managed through reserves," says a senior Gulf banker. "Government officials are happy with this profit and happy that there aren't problems. It might be sad, but this is the state of affairs, especially in the Gulf."

Interestingly, the most vibrant part of the Arab banking industry is Islamic banking, a business attached to religious values and relying on a strict interpretation of the Koran, the Muslim holy book, that bans dealing in interest.

Islamic institutions are multiplying and conventional banks are opening Islamic "windows", leading to an estimated growth in deposits of more than 10 per cent a year. But the development of the Islamic banking industry is hampered by several factors.

Each bank has its own sharia board - the group of religious scholars who vet products for their Islamic credentials - and an instrument acceptable to one institution may be shunned by another. There is also no lender of last resort for Islamic banks, and the absence of an interbank market means most of the products are short-term.

But bankers warn that however much the Middle East has been insulated in the past, globalisation and internet banking from western institutions are bound to shake up the industry.

"There is a great threat from internet banking coming from international institutions," says Mahmoud Difrawy, managing director for the Middle East region at Chase Manhattan. "The banks here are a bit cocooned. Things are happening quite rapidly in the world and they're not paying enough attention."

Although some banks, such as National Bank of Kuwait, are already developing internet arms, most of the region is just beginning to wake up to the new economy. In several countries in the region the internet was introduced only in the past year.

A formidable challenge faces those countries planning to join the World Trade Organisation. Some bankers say the opening of domestic markets to foreign competition will keep retail banking shielded because domestic banks are well entrenched. They argue that, even in the high-end of the retail market, the personal relationships between banker and client will give domestic institutions an edge over the foreign competitor.

Internet banking, however, can break the barriers to entry. And, with more than 50 per cent of the population aged under 20 in many countries, the new generation of depositors and businessmen may put efficiency before personal touch.

Henry Azzam, a leading economist on the region, says banks should look at the WTO agreement on financial services as an opportunity and work to upgrade and modernise their competitive advantage and to shift from a "power" culture to a "performance" culture.

He says most of the banks operate through centralised decision-making in a strict hierarchy tempered by heavy doses of paternalism and an environment in which lending is based on relationships rather than risk assessment.

"Reaction to customer demands should be immediate in order not to give the competition the opportunity to attract a customer who is waiting for the bureaucracy to respond to his needs," he urges.

Privatisation and less government interference in the banking business are essential to prepare for a more competitive environment. Even in Egypt, which has opened up to foreign competition, the government still controls more than 50 per cent of the banking sector. "You need private sector shareholders to drive the process and provide incentives to managements,"
says a senior banker. "They are all talking about privatisation, but not moving fast enough."

Although generally strong central bank supervision has kept the industry healthy, it has been accompanied at times by what bankers view as excessive controls. Analysts say that in Saudi Arabia, for example, banks must seek the approval of the Saudi Arabian Monetary Agency before participating in loans outside the country.

Consolidation is seen as a necessity to meet the inevitable foreign competition and to compete for project finance business which now goes to international institutions. The largest Arab bank today - the Bahrain-based Arab Banking Corporation - has only $26bn in assets. The combined assets of all Arab banks, meanwhile, are less than $500bn.

The region has seen two big mergers in the past two years. In Bahrain, Gulf Internal Bank and Saudi International Bank created a single entity, and in Saudi Arabia, the 30 per cent-Citibank-owned Saudi American Bank merged with United Saudi Bank, which is controlled by the financier Prince Al-Waleed bin Talal.

Initial predictions that these deals would usher in a wave of consolidation have not materialised, however.

"The increase in the oil price gave banks some respite, and this might be one of the reasons why merger activity slowed down a bit," says Darren Stubing, senior bank analyst at Cyprus-based Capital Intelligence, a rating agency.

"We need more consolidation, but it is not easy to achieve," says Kheiry Amr, a senior official at Jordan-based Arab Bank. "Banks in the Arab world are still family businesses, there is not enough corporatisation. As banking dynasties play a big role, mergers become personality fits."

Further consolidation would also help banks build a regional franchise, at a time when cross-border activity remains timid. In addition to Arab Bank, the most active player regionally is Arab Banking Corporation. The bank, which focuses on facilitating trade and investment flows between the Middle East and other regions, was hard hit by its exposure to Asia, and is now
concentrating on the Middle East, with a new bank opened in Algeria and an Islamic bank started in Bahrain.

In the Islamic banking sector, Kuwait's The International Investor also is developing a regional strategy. It is trying to lend its expertise to conventional banks elsewhere in the region by setting up their Islamic banking windows.

"The banks don't have the size or capacity to operate internationally so it is more prudent to concentrate regionally," says Mr Stubing.














Shackled by tribal politics
Distinctions show signs of blurring
Technology proceeds at slow pace