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Gulf banks already scaling new challenges

Recent reports indicate that GCC countries – notably Saudi Arabia, Qatar, Bahrain and the UAE – are strongly positioned to meet the requirements of Basel III and are already making significant progress towards implementation. This should not be taken to mean, however, that Basel III is without its challenges for the GCC states and their domestic banks. BNY Mellon’s MARK FENNER discusses

There has been much debate over the potential effects of Basel III on banks and international trade, and the discussions show no sign of slowing as January 2013 – the date by which banks worldwide must begin implementing Basel III rules – approaches.

The Basel III rules, crafted in the wake of 2008’s global financial crisis, are chiefly designed to reduce risk and thereby strengthen the world’s financial system. They aim to do this by improving the quality, consistency and transparency of banks’ capital base, and introducing a set of global liquidity standards.

Mark Fenner head of developing
markets, EMEA at BNY Mellon
Treasury Services

Though established with the best of intentions, and to be lauded as a vital component in the efforts of the international community to create a less volatile and more mature financial industry, many banks globally may find particular elements of the accord’s stringent liquidity and capital rules difficult to absorb.

While the aim of Basel III is to increase bank security and reduce risk, banks face the consequence of diminished lending capacity and a limit on their scope of action. Not only this but, as the majority of banks will need to raise additional capital and are expected to be subject to a higher-than-warranted capital allocation of trade risk, it is likely the cost of borrowing and of traditional trade finance tools will increase – a real cause for concern for corporates dependent on bank funding.

There are differing views on the magnitude of the likely effect of Basel III implementation.  While the Institute of International Finance concludes that the impact will be relatively high with regard to increased credit spreads and, consequently, on GDP growth, analyses by the Bank for International Settlements and IMF conclude that the impact will be less severe.

Nevertheless, the combination of other dynamics such as deleveraging, increased cost of capital and the cost of Basel III may further dent bank profitability at a time when many are already struggling to reconcile growing expenses and diminished margins as a result of local and regional compliance initiatives, particularly in the US and Europe.

With regional regulations in mind, it is, perhaps, unsurprising that Gulf Cooperation Council countries have found themselves better placed than many Western economies to achieve a timely transition to the new regulatory environment.  Certainly, GCC states are well on their way to implementation: Qatar’s banks are set to meet Basel III’s rules on common equity capital ratios by the end of this year1, two years ahead of the January 2015 deadline; regional banks in the UAE have measures in place to hold 10 per cent of their liabilities in liquid assets by January 2013; and the quality and availability of capital in Bahrain is already sufficient to meet Basel III’s
stringent terms.

Most significantly, the most recent progress report by the Basel Committee on Banking Supervision shows the scale of the gap between Saudi Arabia’s progress, where final rules have been published, and that of the US and the European Union, where regulations are still being drafted.

Unlike banks in the West, those in the GCC have emerged from the 2008 crisis relatively unscathed; they are generally well capitalised and their business models are generally conservative. Not only this, but GCC banks have not been subjected to regulatory reform and economic realities  impacting business models to the same extent as banks in the US and Europe. As Basel III nears, GCC banks seem better placed to meet its terms and absorb its impact.

Looking at Islamic banks (a significant element of the regional banking sector), the existing capital structures and above-average capital ratios of the leading Sharia-compliant financial institutions mean they are inherently in a favourable position for compliance with the accord.

Although banks in the region seem well prepared to meet the demands of the Basel III framework, it in no way means that Basel III is worry-free for domestic institutions. The region’s banks ultimately face the same short and long-term challenges with respect to Basel III’s impact on trade finance as banks elsewhere. And they must address these concerns in similar ways.

Three levels of compliance

Basel, Switzerland

Compliance with Basel III requires all banks to respond on three levels: operational, tactical and strategic, which cover all aspects from operations to organisational re-modelling. This practical and high-level restructuring and business analysis ultimately boils down to making cost-savings and ensuring that the business is fit to compete in the face of future market challenges.

As a result of this, the majority of local and regional banks – including those in the GCC – will need to evaluate whether they can afford to support low-revenue or “non-core” lines of business.

Having said this, there are particular bank products and solutions-sets – such as trade and treasury services – that simply cannot be abandoned even though, under the terms of Basel III, they may become less profitable. This is because their importance is too great to commercial and corporate clients, meaning that local banks may lose ground to global players operating in their domestic markets if they do not strive to compete in the transaction-banking space.

Trade finance and trade services are prime examples, on which the impact of Basel III is of particular concern. Basel III is expected to increase the capital allocation of trade finance in line with arguably riskier instruments and contrary to the sector’s historical record of low default rates.

The predicted impact on profit margins in this sector will be all the more significant for local banks in the GCC states, where trade finance and services constitute a significant portion of business due to trade activity and the region’s heavy reliance on imports.

Furthermore, the socio-political unrest that has dominated much of the previous 12-18 months in the wider expanse of the Middle East – against the backdrop of broader global economic difficulties – means that trade and treasury solutions are under increased focus as the region’s buyers and sellers intensify their pursuit of greater supply-chain security while simultaneously increasing transaction-processing speed and efficiency.

GCC outlook is positive

Despite the financial implications associated with Basel III, the GCC’s long-term trade outlook appears positive. This is largely thanks to the continued strong performance of many of the region’s oil-exporting economies and the expanding trade flows between the Middle East and Asia. These growing trade connections are great cause for optimism both regionally and globally, as their increase helps to restore some momentum to the global economy witnessing softer trade activity in developed markets.

Even with healthy capital ratios and fewer regulatory or market pressures, regional banks are not immune to the industry impact of Basel III. As institutions concentrate on core competencies there will likely be an increased need to focus on global partners to support trade finance activities.

Such partnerships enable client banks to leverage innovative technology – as well as increased risk-mitigation and greater efficiency – without the investment cost of proprietary development; an arrangement that will become increasingly attractive as regulatory pressures mount.

Of course, the ultimate impact of Basel III remains to be seen. But it is expected that the regulatory initiative will have two key effects across the global trade industry. As the cost of credit increases in response to banks raising additional capital, there is likely to be a rise in the price of some services – as banks seek to pass on the cost – and a reduction in credit availability.

Just how these changes will manifest themselves is less apparent, but one thing is clear: GCC banks can retain their current strength by continuing to embrace innovation, working closely with trusted global partners and building collaborative networks. Such efforts to remain competitive without increasing expenditure will be crucial to success as Basel III takes hold.

Mark Fenner is head of developing markets, EMEA at BNY Mellon Treasury Services

Material contained in this article is intended for the purposes of general information only. It is not intended to be a comprehensive study of the subject matter, nor provide any treasury services advice, or any other business or legal advice, and it should not be relied upon as such. The views expressed herein are those of the author only and may or may not reflect the views of BNY Mellon. 

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