More consolidation is likely in the financial services sector in the United Arab Emirates over the next four years, especially among banks, according to a new KPMG report.

The accountancy firm's fourth annual report analysing results from banks in all six Gulf Cooperation Council (GCC) countries stated that it expects more mergers in the emirates between now and the end of 2023 as a result of "moderate economic growth".

"This will be driven by the higher cost of doing business in the UAE and the threat of new entrants disrupting the market," the report said.

"Currently, the UAE is overbanked for the current population as both retail and commercial banking customers in the UAE have a wealth of choice, ranging from international local lenders, specialist and commercial banks, and private banks," the report said, adding that there are currently 49 banks in the UAE, serving a population that stood at 9.5 million at the end of 2018.

Profitability of the UAE's banks increased by 11.1 percent last year, driven mainly by higher interest rates (as the UAE followed interest rate rises made by the US Federal Reserve given the country's currency peg to the United States dollar).

Overall, KPMG's analysis of 56 banks listed on the GCC’s seven main stockmarkets found that 2018 was a positive year for the sector, with combined net profits rising by 11.8 percent to $36.1 billion, total assets increasing by 4.5 percent to $2.1 trillion, and bank share prices increasing by an average of 25 percent over the year. However, net provisions made on loans increased by 4.9 percent to $10 billion.

A foreword to the report written by KPMG's chief economist and head of research in Saudi Arabia, Dr Hussain Abusaaq, said that overall, banking systems in the GCC remained steady and showed improvement in operating conditions.

"Despite some weakening, loan performance still remains strong, supported by a robust capital flow due to the recent increases in oil prices. Credit is expected to grow due to increased government spending, boosting economic activity," Abusaaq said.

Conditions within each marketplace differed, though. Saudi banks witnessed an 11.3 percent increase in profitability last year. Although major mergers such as the one completed between Saudi British Bank (SABB) and Alawwal on Sunday have been a feature, competition in the marketplace is expected to increase as more banking licences are issued to both international and domestic banks - particularly digital-only 'challenger' banks.

“Increased competition and disruption are also expected from fintech start-ups entering the market. The economic reforms (in line with Vision 2030), and resultant investment, have provided a platform for recent entrants, including PayTabs and BayanPay, which have been developing digital business models to challenge the traditional banks in the payment sector,” the report said. 

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Source: KPMG

Tougher markets

However, conditions are tougher both in Bahrain and Oman. In Bahrain, the report said that two firms have downgraded their licence category from a fully-fledged bank to an 'investment firm' within the past two years, with shareholders of another Islamic bank also approving a downgrade.

“This could be viewed as a result of challenging regulatory and economic conditions," KPMG’s report said. “This trend is expected to continue in the future, given the number of regulated institutions domiciled in Bahrain.”

In Oman, meanwhile, the report states that liquidity pressures on banks eased in 2018 as a result of higher oil prices, but warned that“future interest rate hikes and oil price fluctuations” could place more stress on liquidity.

A Moody's report on Oman's banks issued on Tuesday stated that it expects liquidity among Omani lenders to remain tight over the next 12-18 months as government spending is likely to outpace the level of oil receipts needed for its budget to break even.

"Project financing, corporate expansion and strong mortgage demand are driving lending growth, but deposits - primarily from the government - will lag," said Mik Kabeya, AVP-Analyst at Moody's. "The smallest banks will feel the impact most in higher funding costs and reduced profits."

KPMG's report states that Oman has 20 banks for a population of 4.6 million, compared to Saudi Arabia where 27 banks serve almost 33 million people. As a result, it also expects more mergers to take place in the Sultanate.

"As profitability levels come under pressure and regulatory demands increase, there is growing potential for more mergers and acquisitions over the medium term," it said.

(Writing by Michael Fahy; Editing by Mily Chakrabarty)

(michael.fahy@refinitiv.com)

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