The consolidation wave for the Islamic banking sector has started due to the effects of the COVID-19 pandemic on the Islamic finance markets. The pandemic’s significant adverse effects on the sector and the excessive number of small banks in a number of countries, especially within the GCC region, prompted further mergers and acquisitions (M&A) moves. While slow economic growth, low oil prices and low profit margins have been the main indicators that pushed Islamic banks to be a part of M&A deals, the pandemic had also been an important factor to consider for the last three years.
M&A transactions among Islamic lenders establish a more competitive financial environment and consequently result in the introduction of relatively more favorable and varied Islamic finance tools for their customers. For the last three years, coping with the consequences of the pandemic has been included in the list as an additional motivation for M&A moves. As a result, in addition to the existing catalysts for M&A deals, the course of the COVID-19 pandemic had to be watched closely for an accurate assessment of the future of the markets.
However, while having long-lasting effects, beginning from the first quarter of 2022, the pandemic has significantly lost its impact on the financial markets including Islamic finance M&A transactions. Although it is true the pandemic was one of the catalysts for M&A deals, we expect Islamic finance M&A transactions will continue to develop as there are other macroeconomic shocks such as the Russia–Ukraine conflict. With the more supportive economic outlook for many Islamic finance countries, bank financing growth is expected to accelerate for 2023 and beyond.
Review of 2022
In 2022, economies in the MENA region rebounded strongly from the pandemic, boosted by higher oil and commodity prices, and the continued economic momentum also restarted M&A activity in the region.
The UAE has been one of the most dynamic countries in the GCC region in terms of Islamic finance activities. A report published by EY stated that the UAE was the most popular country regarding M&A in the MENA region during the first half of 2022, with 105 deals having taken place totaling US$14.2 billion.
According to the EY MENA M&A Insights report, 359 M&A deals took place in the UAE worth US$42.6 billion in the six months of 2022 which indicates an increase of 12% over the same period of 2021. This increase was driven by continued post-pandemic economic growth across the region fostered by high oil prices and growing confidence in corporate boardrooms.
A notable deal in 2022 was carried out in Kuwait where one of the largest Islamic banks was established through an M&A deal. The merger between Kuwait Finance House (KFH) and Ahli United Bank (AUB) created one of the largest banks in the Gulf region with over US$118 billion in assets. While the merger of KFH and AUB is a notable M&A transaction in the Kuwaiti Islamic banking sector, there may be more deals to come, especially in Kuwait, in 2023. The potential merger of Al Ahli Bank of Kuwait and Gulf Bank, with one converting to Islamic, also shows the strong demand for Islamic banking and financing in Kuwait, states a Fitch Ratings report.
Preview of 2023
M&A deals complying with Islamic finance principles will likely maintain and improve its significant importance for most of the sectors but significantly for the Islamic banking sector. The outlook for Islamic finance M&A activity is strong for the Islamic banking sector; it is projected to continue its growth in 2023 despite difficult macroeconomic conditions such as the Russia–Ukraine conflict.
However, it is important to note that most of the countries involved in the Islamic finance industry are relatively resilient to macroeconomic shocks resulting from the Russia–Ukraine conflict. Therefore, this will support the Islamic finance sector’s prospects for 2023.
On the other hand, different global developments may also result in different scenarios, for example the continuing and stubbornly high inflation, lockdowns related to COVID-19 and the US Federal Reserve and other major central banks taking measures against inflation.
The growth in the Islamic banking sector is expected to be supported by M&A deals which establish more competitive banks and financial institutions which will enable banks to reach out to more diverse customers.
Overcrowded Islamic banking markets, digitalization and a competitive sector can be listed among the reasons for increasing M&A deals in the Islamic banking sector. Moreover, Islamic financial institutions still lack the market share that they need to be stronger competitively against their conventional counterparts in an overbanked post-pandemic era.
Therefore, together with government backing and shareholders’ trust in the M&A deals, it is possible to witness more M&As which will result in competitive Islamic banks and financial institutions providing their customers with varied quality products.
Conclusion
Unless there is an unexpected life-threatening global virus outbreak, 2023 will most likely become a similar year to the pre-pandemic era when compared with the last three years. While the impact of the pandemic will not disappear completely, its effect will be less significant. However, the world economy, including the Shariah compliant M&A market, should carefully watch for global developments along with the local situations.
Burak Gencoglu is the co-founder of Gencoglu & Ergun Law Firm. He can be contacted at [email protected].