RIYADH: A robust oil and gas sector, high interest margins, and fintech innovation will help drive banking sector growth across the Gulf Cooperation Council region in 2024 and beyond, according to a new report.

Analysis by global management consulting firm McKinsey & Co. found that despite global macroeconomic volatility, the region’s financial institutions outperformed their international counterparts in 2023 due to an exceptional operating environment, and the sector is set for a strong performance this year.

Global banking faces significant post-COVID-19 challenges, including rising prices and rapid monetary tightening. 

The US Federal Reserve has increased interest rates quickly, which has raised bank profits but also heightened risks from unrealized losses, as evidenced by the collapse of Silicon Valley Bank and the takeover of Credit Suisse. 

Middle East tensions and prolonged high US interest rates could further pressure global prices. These issues have led to a 10 percent decline in the price-to-book ratio, reducing global banking market capitalization by $900 billion.

The McKinsey & Co. report struck an optimistic note for the GCC banking sector, saying it “boasts an exceptionally high return on equity and some of the largest multiples worldwide.” 

The report added: “The regional financial sector has yielded healthy returns to shareholders over the past decade, outperforming the global average.”

McKinsey & Co. highlighted that the total shareholder return index, which tracks dividend-adjusted share prices of over 80 GCC financial institutions, has consistently shown superior growth trends compared to global benchmarks from 2010 to 2024. 

This underscores the sector’s ability to deliver robust shareholder returns amidst worldwide economic volatility.

GCC banks have also maintained higher return on equity levels and stronger market multiples globally. Despite recent narrowing, their ROE has consistently exceeded the global average by three to four percentage points from 2022 to 2023, reflecting their efficient capital management and profitability in a challenging global banking landscape.

Elevated interest rates have played a significant role, driving regional and international banking profits to record highs and supporting GCC banks in creating substantial shareholder value.

Furthermore, GCC banks boast higher net interest margins and revenue-to-assets ratios than the global average, according to the firm. With a net interest income of 2.3 percent, surpassing the worldwide norm of 1.4 percent, they indicate broader profitability margins regionally.

Despite facing higher impairment costs relative to global peers, GCC banks operate with lower operational costs, demonstrating efficient cost management strategies. Their average ROE of 10.9 percent reflects robust capitalization, outperforming the global average of 9.0 percent.

Overall, a favorable macroeconomic environment characterized by high hydrocarbon prices and robust economic growth has underpinned the GCC banking sector’s strong balance sheets and steady growth trajectory.

Resilience facing global risks

GCC banks have shown resilience amid recent global shocks, contrasting with the challenges facing the broader international banking sector. 

The McKinsey & Co. report highlighted that while worldwide economic connectivity offers growth opportunities, it also increases instability risks, highlighted by heightened geopolitical tensions and regulatory scrutiny.

The firm stated that these trends are occurring against the backdrop of accelerating climate change – a global risk multiplier that also presents a multitrillion-dollar opportunity to finance the transition to low-carbon growth.

McKinsey’s macroeconomic scenarios project that global banking conditions will deteriorate in the coming years, leading to a peak and subsequent decline in return on equity for GCC banks.

Despite this, the region’s sector is better equipped to manage these challenges compared to its peers. Their banking indicators are expected to diverge positively from worldwide trends, highlighting their resilience and relative strength in navigating future economic uncertainties.

According to a 2023 study by Ernst & Young, increasing demand for banking services, growth in digital banking and regulatory reforms such as the introduction of Basel IV are expected to help boost growth in this sector.

Managing liquidity

Nevertheless, GCC banks face challenges despite a favorable environment, particularly from fluctuating interest rates. The firm noted that global tight monetary policies and faster growth in financing than deposits necessitate careful liquidity management.

The analysis showed that financing grew by 14 percent annually in the Kingdom from 2019 to 2022, outpacing 9 percent deposit growth. High interest rates drive mortgage lending as governments promote homeownership, impacting GCC banks’ retail loan portfolios.

The average loan-to-deposit ratio for Saudi banks increased by 18 percentage points from 2020 to 2022, suggesting potential liquidity issues ahead. High rates may also shift consumer and corporate behaviors, affecting non-interest-bearing liabilities and savings and investment patterns.

Total loans in Saudi Arabia are projected to reach SR5.04 trillion ($1.34 trillion) by 2030, growing annually at 10 percent from 2024 to 2030, the report showed.

Wholesale loans will comprise the largest share at 69 percent, followed by mortgages at 21 percent, and consumer finance at 11 percent.

Conversely, deposits are expected to reach SR3.54 trillion by 2030, growing at a rate of 5 percent per year. Wholesale deposits will account for 53 percent, with retail holdings making up the remaining 47 percent.

The total loans-to-deposits ratio is expected to increase by 142 percent from 104 percent in 2024, indicating that deposit growth in Saudi Arabia has not kept pace with financing, thereby heightening liquidity pressures.

Since 2020, GCC banks have significantly ramped up their activity in international debt capital markets. This strategic move aims to bolster their financing growth strategies, diversify funding sources, and more recently, mitigate the high costs of liquidity domestically.

According to a recent report from Fitch Ratings, emerging market dollar debt issuance, excluding China, surpassed $200 billion in the first five months of 2024, with the Kingdom issuers leading with 18.5 percent of the total issuance.

Despite challenging financial landscapes, these banks have adeptly managed liquidity challenges, supported by increased access to government sukuk and liquidity-management tools provided by central banks.

These measures are designed to ensure sustained liquidity levels, enabling banks to fulfill financial obligations and maintain operational stability amidst fluctuating market conditions.

Innovation and technology

McKinsey & Co. highlighted key transformational factors shaping GCC banks, including innovation, machine learning, and generative artificial intelligence, as well as high digital penetration and the influence of fin-tech in reshaping the industry.

Additionally, GCC regulators are actively developing an open banking framework to further drive sector evolution.

Abdulla Al-Moayed, CEO of Tarabut, praised Saudi Arabia’s adoption of open banking in an interview with Arab News in May.

He highlighted the collaborative efforts between banks and fintechs to innovate and expand market reach, signaling a significant evolution toward digital transformation in the Kingdom’s banking industry.

Generative AI and other advanced technologies are poised to revolutionize banking operations, boosting client engagement and operational efficiencies.

In the GCC, fintech advancements such as digital payments and sophisticated financial products are gaining popularity, driven by increasing demand for personalized digital services.

McKinsey & Co. noted that fintech firms are expanding their portfolios beyond basic offerings to serve both consumer and business sectors, buoyed by substantial funding and widespread digital adoption in the region.

Concurrently, traditional banks are launching new digital initiatives to remain competitive, highlighting the dynamic and evolving banking landscape across the GCC.

An example was given of how regulators in Bahrain and Saudi Arabia are fostering innovation through open banking frameworks aligned with global standards. This has spurred local startups and prompted established institutes to adopt new technologies.

The report stated that open banking boosts competition and IT costs and offers benefits like expanded customer reach and new services. It also demands that banks adapt to seize opportunities while managing profitability risks.

McKinsey & Co. recommendations

GCC banks are poised to navigate global economic uncertainties effectively but must remain proactive rather than complacent, the report warned.

Key priorities for banking CEOs in the region include managing hesitation around interest rates through robust asset-liability management and stress testing.

There should also be steps taken at enhancing operating efficiency by digitalizing processes and automating routine tasks that will optimize human resources.

Transforming the customer experience by offering real-time, personalized products to a digitally savvy population is crucial, as is maintaining focus on environmental, social, and governance initiatives that support global climate change efforts.

Additionally, creating shareholder value through strategic mergers and acquisitions and restructuring allows banks to capitalize on evolving market dynamics, freeing capital by divesting non-core assets and refocusing on core operations.

These priorities underscore GCC banks’ proactive stance amid evolving economic landscapes.