The COVID-19 pandemic has ignited the start of a consolidation wave for the Islamic banking sector. COVID-19’s significant adverse effects on the sector and the excessive number of small banks in certain countries, especially within the GCC region, have prompted further mergers and acquisitions (M&A) moves. Similar to 2020, slow economic growth, low oil prices and low profit margins had been the main indicators that pushed Islamic banks to consider M&A transactions in 2021.
The consolidation of Islamic lenders establishes more competitive financial institutions and consequently eases the introduction of Islamic finance tools to their customers. During the last two years, coping with the consequences of COVID-19 has been included in the list as an additional motivation for M&A moves. Therefore, in addition to the usual reasons for consolidation, the course of the COVID-19 pandemic should be closely watched to have an accurate assessment for 2022 and beyond.
Review of 2021
Almost more than two years following the initial outbreak of the pandemic, the Islamic banking sector has witnessed an increase in M&A activity, as financial institutions continue to struggle with the negative economic situation. While the COVID-19 pandemic was being brought under control around the world, there were doubts as to whether the current M&A activity will continue or not.
However, in addition to the harsh economic environment created by the pandemic, pressure on profitability, an overcrowded banking system and common government ownership had driven consolidation moves.
M&A activity was already on the rise in the GCC banking sector, even before the pandemic started to push the global economy into its deepest recession since the 1930s. The economic slowdown and the deterioration in asset quality, with a rise in non-performing loans, have especially forced smaller banks to consider M&A deals with larger banks.
In Qatar for instance, Al Khalij Commercial Bank (AKCB) and Islamic bank Masraf Al Rayan (MAR) agreed to merge which is expected to create Qatar’s largest Islamic bank by total assets and diversify MAR’s business model, which is predominantly wholesale-focused.
The agreed deal was the second merger in Qatar between an Islamic bank and a conventional bank after Islamic Dukhan Bank and International Bank of Qatar merged in April 2019. The AKCB and MAR merger, which was one of the significant deals of 2021, is a sign that Islamic finance M&A activity may increase within the following years.
Another noteworthy example was the announcement of the merger between the National Commercial Bank and Samba Financial Group. The said deal resulted in a combined entity with total assets of US$213.12 billion and created the largest bank in Saudi Arabia and third-largest bank in the GCC by asset value.
Preview of 2022
There are indications that the adverse effects of the economic situation resulting from the COVID-19 pandemic are likely to continue in the long term, especially in the UAE, Oman and Bahrain, and less so in Saudi Arabia and Qatar. A wave of M&A could sweep further across the region as the full impact of the subdued economic environment becomes more visible.
Additionally, a further factor is the proliferation of banks in the region. For instance, the UAE has long been seen as overbanked; there are currently 21 local banks and 27 foreign banks serving a population of fewer than 10 million people.
The expectation is that the M&A activity for the Islamic banking sector will continue to increase in 2022. The upside effect of the economic situation created by the COVID-19 pandemic on M&A deals and other similar factors such as overcrowded Islamic banking markets can be listed as among the reasons for increasing M&A deals in the Islamic banking sector.
Moreover, Islamic financial institutions still lack the market share that they desire to have a strong competitive power against their conventional counterparts in an overbanked post-pandemic era.
Therefore, together with government backing and shareholders’ trust in the M&A transactions, we will probably witness more M&A which will result in competitive Islamic banks and financial institutions.
In addition to the already completed or agreed deals in 2021, statements from Islamic lenders’ high-level officers indicate that 2022 may become a busy year in terms of M&A transactions in the Islamic finance area.
Abu Dhabi Islamic Bank, the biggest Shariah compliant lender in the emirate, is looking for M&A opportunities in the UAE, the GCC and markets beyond the region, as it seeks to broaden its asset base, its group CFO said.
Mergers driven by shareholders who held stakes in more than one bank, typically regional governments and their related entities, have already created larger, stronger financial institutions in the region that are better equipped to face any crisis.
Along with the worldwide introduction of COVID-19 vaccines, we feel that the effects of the pandemic have begun to diminish, although it is not completely over and is not expected to end anytime soon. While 2022 will most likely become a similar year to pre-pandemic years when compared with 2020 and 2021, it is almost certain that we will continue to see the effects of the pandemic in the global economy including in the M&A market in Islamic finance.
Burak Gencoglu is the co-founder of Gencoglu & Ergun Law Firm. He can be contacted at [email protected]