GCC Islamic banks and Takaful companies are expected to be at the forefront of mergers and acquisitions (M&A) activity in the near to medium term. Many GCC banks are entering into merger talks and acquisition discussions in a bid to improve costs, deliver synergies and compete more effectively in the overbanked and fragmented markets within the region. On the GCC Takaful side, the UAE and Saudi Arabian health insurance markets have an unsustainable number of insurance and Takaful providers, so BASHAR AL-NATOOR and REDMOND RAMSDALE expect several insurers will cease operations or merge with competitors in the next few years.
The unprecedented wave of M&A activity in the GCC region evidences how Islamic banks are using M&A to boost their competitive positions. Consolidation could ultimately be positive for the Islamic banking sector by creating larger, stronger and more efficient Islamic banks. However, banks’ issuer default ratings will typically be unaffected, given that most GCC bank ratings are driven by our assumption that sovereign support will be provided to banks (directly or through a parent bank), if needed.
GCC Islamic banking M&A are driven by the search for a competitive advantage to access growth opportunities and build low-cost deposits, as well as by cost synergies. Deals usually need government backing given the significant stakes that governments hold in most banks. Most Islamic bank M&A are between Islamic banks or involve a conventional bank acquiring an Islamic bank as a subsidiary. Islamic banks cannot easily acquire conventional banks. Integration risks can be high, especially when both Islamic and conventional banks are involved.
Islamic banking has been a growth area for 10 years with most GCC countries trying to build their Islamic financing capabilities and create domestic Islamic finance hubs. Accessibility to Islamic products and instruments has grown rapidly with product innovation. However, in an overbanked region, some newer franchises have struggled to find good growth opportunities and attract cheap and stable deposits, given the strength of existing competition.
While many Islamic banks still lack a competitive market position, some strong Islamic franchises do exist. In Saudi Arabia, Al Rajhi Banking and Investment Corporation, the largest bank in the Kingdom with a 17% market share of domestic credit, is also the world’s largest Islamic lender, with total Islamic financing assets of US$97 billion at the end of 2018.
Saudi Arabia’s second-largest bank, National Commercial Bank, is another example of a strong Islamic franchise. It is almost entirely focused on Islamic financing, although not all other assets are Shariah compliant. It is pursuing a merger with a conventional bank, Riyad Bank, although it may have to abandon its plan to fully convert to an Islamic bank if the merger proceeds.
The development of Islamic banking is following various paths in the GCC region. Kuwait restricts Islamic financing to Islamic banks to ensure a clear separation between Islamic and conventional activities. This clarity has helped to develop a strong banking system split between five conventional and five Islamic banks, all with reasonable franchises and growth opportunities.
Kuwait Finance House’s aim to acquire Bahrain’s Ahli United Bank and its Islamic franchise in Kuwait, if achieved, would make Kuwait Finance House the leading domestic Islamic bank in Kuwait and a big Islamic player in the region. Outside the GCC, we expect a quieter front on Islamic banking industry M&A activities in countries like Malaysia, Turkey and Indonesia.
On the Takaful side, the UAE and Saudi Arabian health insurance markets, the two largest in the Middle East, have an unsustainable number of providers. Both markets are characterized by numerous companies with minimal market share, intense competition and weak profitability. We expect several insurers will cease operations or merge with competitors in the next few years.
This could be positive for the overall credit quality of the markets by removing smaller, weaker insurers and reducing competitive pressure on those that remain. We also expect the changing regulatory landscape in the insurance and Takaful sector to increase M&A activity and drive consolidation among smaller firms, with several deals already announced in the past 12 months.
This series of mergers and potential tie-ups evidences the increasing importance of M&A for gaining a competitive advantage, as GCC Islamic financial institutions seek not only to acquire or merge with their domestic counterparts, but are also looking at cross-border deals within the region and beyond. This has been an instrumental tool in developing Islamic finance outside the Gulf. For example, in Morocco, this could support the country’s efforts to attract foreign direct investments, in particular from the GCC.
Since the inception of Islamic banking activities, many of Morocco’s conventional banks have partnered with GCC financial institutions to establish Islamic banking subsidiaries. It is still too early to say if the recent launch of Shariah compliant insurance (Takaful) in Morocco could see further investments from GCC countries seeking to build partnerships with local insurers.
Bashar Al-Natoor is the global head of Islamic finance at Fitch Ratings. He can be contacted at [email protected]. Redmond Ramsdale is the head of GCC bank ratings at Fitch Ratings. He can be contacted at [email protected].