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RIYADH: A robust oil and gas sector, high interest margins and fintech innovation will help boost banking sector growth in 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 international peers in 2023 thanks to an exceptional operating environment, and the sector is poised for a strong performance this year.

The global bank faces significant post-COVID-19 challenges, including rising prices and rapid currency tightening.

The US Federal Reserve quickly raised interest rates, which boosted bank profits, but also increased 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 weigh on global prices. These problems led to a 10% decline in the price-to-book ratio, reducing the capitalization of the global banking market by $900 billion.

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

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

McKinsey & Co. pointed out that the Total Shareholder Return Index, which tracks the dividend-adjusted share prices of more than 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 returns for shareholders amid global economic volatility.

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

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

In addition, GCC banks boast higher net interest margins and income-to-asset ratios than the global average, according to the company. With net interest income of 2.3%, beating the global norm of 1.4%, they indicate wider profitability margins regionally.

Despite facing higher impairment costs compared to other global companies, GCC banks operate with lower operating costs, demonstrating effective 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, supported the GCC banking sector’s strong balance sheets and steady growth trajectory.

Resilience to global risks

GCC banks have shown resilience amid recent global shocks, in contrast to the challenges facing the wider international banking sector.

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

The firm said these trends come amid accelerating climate change – a global risk multiplier that also presents a multi-trillion-dollar opportunity to finance the transition to low-carbon growth.

McKinsey’s macroeconomic scenarios project that global banking conditions will deteriorate over 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 handle these challenges compared to its peers. Their banking indicators are expected to diverge positively from global trends, highlighting their resilience and relative strength in dealing with future economic uncertainties.

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

Liquidity management

However, GCC banks face challenges despite a favorable environment, particularly due to interest rate fluctuations. The firm noted that tight global monetary policies and faster growth in funding than deposits require careful liquidity management.

The analysis showed funding grew by 14% annually in the Kingdom between 2019 and 2022, outpacing deposit growth of 9%. High interest rates boost mortgage lending as governments promote home ownership, impacting GCC banks’ retail loan portfolios.

The average loan-to-deposit ratio for Saudi banks rose 18 percentage points between 2020 and 2022, suggesting potential liquidity problems ahead. High rates can also change consumer and business behaviours, affecting non-interest-bearing liabilities and savings and investment patterns.

Total borrowing in Saudi Arabia is expected to reach SR5.04 trillion ($1.34 trillion) by 2030, growing by 10 percent annually from 2024 to 2030, the report said.

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

In contrast, deposits are expected to reach SR 3.54 trillion by 2030, growing at a rate of 5% per year. Wholesale deposits will account for 53 percent, with retail accounting for the remaining 47 percent.

The total loan-to-deposit ratio is expected to increase to 142% from 104% in 2024, indicating that deposit growth in Saudi Arabia has not kept pace with funding, increasing liquidity pressures.

Since 2020, GCC banks have significantly stepped up their activity in international debt capital markets. This strategic move aims to strengthen its funding growth strategies, diversify funding sources and more recently mitigate high domestic liquidity costs.

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

Despite difficult financial landscapes, these banks have managed liquidity challenges with skill, supported by increased access to government sukuk and liquidity management tools provided by central banks.

These measures are designed to ensure sustained levels of liquidity, enabling banks to meet their financial obligations and maintain operational stability in fluctuating market conditions.

Innovation and technology

McKinsey & Co. highlighted the key transformative 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.

In addition, GCC regulators are actively developing an open banking framework to further stimulate the evolution of the sector.

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

He highlighted collaborative efforts between banks and fintechs to innovate and expand market reach, signaling a significant move towards digital transformation in the UK banking industry.

Generative artificial intelligence and other advanced technologies are poised to revolutionize banking, increasing customer engagement and operational efficiency.

In the GCC, fintech advances such as digital payments and sophisticated financial products are gaining traction, driven by growing demand for personalized digital services.

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

At the same time, traditional banks are launching new digital initiatives to remain competitive, highlighting the dynamic and evolving banking landscape within the GCC.

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

The report said open banking boosts competition and IT costs and offers benefits such as expanded customer coverage and new services. It also requires banks to adapt to take advantage of opportunities while managing profitability risks.

recommendations McKinsey & Co

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

Among the key priorities for banking CEOs in the region is managing interest rate hesitancy through robust asset-liability management and stress testing.

Steps should also be taken to improve operational efficiency by digitizing processes and automating routine tasks that will optimize human resources.

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

In addition, creating shareholder value through strategic M&A and restructuring allows banks to capitalize on evolving market dynamics, freeing up capital by divesting non-core assets and refocusing on core operations.

These priorities underline the proactive stance of GCC banks amid evolving economic landscapes.