Kuwait turns to deficit of 1.6 bln dinars in FY 2023/24, finance ministry says

RIYADH: Gulf Cooperation Council banks are aiming to diversify their business models and boost profitability by entering high-growth markets such as Turkey, Egypt and India, a new report has revealed.

Fitch Ratings attributed this growing interest to favorable economic conditions and attractive growth opportunities in these countries.

Notably, the appetite for expansion has increased in Turkey following macroeconomic policy changes, while interest in Egypt has been fueled by increased stability and privatization opportunities.

Despite high acquisition costs in these areas, the report said GCC banks are focused on leveraging the potential of these markets to offset slower growth at home.

The GCC banking sector has consistently delivered high returns on equity and impressive valuation multiples compared to global benchmarks, according to a McKinsey June report.

The strategic diversification of GCC economies beyond oil, coupled with a prudent regulatory framework, has strengthened banking stability and profitability.

Higher interest rates further boosted banks' profits, which contributed to their returns. Over the past decade, the region's banks have outperformed the global average in return on equity, or ROE, maintaining gains of three to four percentage points from 2022 to 2023.

Although global banking valuations are historically low, GCC banks continue to generate value with ROE exceeding their cost of equity.

Despite record profits driven by high interest rates for banks globally and in the GCC, McKinsey warns executives to balance short-term gains with long-term strategic objectives.

Investing in transformational change and efficiency is essential to maintaining a competitive edge when interest rates eventually fall.

GCC banks' primary exposure outside their home region was concentrated in Turkey and Egypt, where they collectively held $150 billion in assets by the end of the first quarter of 2024, according to Fitch Ratings.

This significant presence underscores the strategic importance of these markets to the growth ambitions of GCC banks.

Additionally, there is growing interest in India, particularly from UAE-based banks, driven by strong and expanding financial and trade ties between the two countries.

Turkey, Egypt and India each boast significantly larger populations than the GCC countries, presenting great potential for banking sector growth due to their strong real gross domestic product growth prospects and relatively small banking systems.

For example, the banking system assets to GDP ratio in these countries is less than 100 percent, while in the largest GCC markets, the ratio is more than 200 percent, according to the report.

Moreover, the private debt to GDP ratio in 2023 was significantly lower, at 27 percent in Egypt, 43 percent in Turkey, and 60 percent in India, highlighting considerable room for expansion in these banking sectors.

According to Fitch, GCC banks are looking to expand into Turkey due to a favorable shift in the country's macroeconomic policies following last year's presidential election.

These changes have eased external financing pressures and improved macroeconomic and financial stability, prompting Fitch to upgrade its outlook for Turkey's banking sector to “reform.”

Fitch forecasts Turkish inflation to fall from 65 percent in 2023 to an average of 23 percent in 2025, with GCC banks to stop using hyperinflation reporting for their Turkish subsidiaries by 2027.

Increased stability of the Turkish lira is likely to increase returns on GCC banks' Turkish operations.

At the same time, GCC banks are showing increasing interest in Egypt, given the favorable macroeconomic environment, opportunities from the authorities' privatization program, and the expansion of GCC corporations in the country.

Fitch recently upgraded its outlook on the operating environment score for Egyptian banks to positive, anticipating greater economic stability.

This improvement is attributed to Egypt's substantial foreign direct investment agreement with the UAE, a strong International Monetary Fund agreement, increased foreign exchange rate flexibility and a strong commitment to structural reforms.

Fitch expects the net foreign asset position of Egypt's banking sector to improve significantly this year, supported by strong portfolio flows, remittances and tourism receipts.

Egypt's inflation is projected to decline from 27.5 percent in June 2024 to 12.3 percent in June 2025, potentially leading to a policy interest rate cut from the fourth quarter of 2024.

Fitch noted that while Egypt's banking market presents high entry barriers, GCC banks may find opportunities to acquire stakes in three banks through the authorities' privatization program.

The expansion of GCC companies, especially those from the UAE, could also increase the presence of GCC banks in Egypt.

However, rising costs of bank acquisitions in Turkey, Egypt and India may pose a challenge to GCC banks' acquisition plans.

Price-to-book ratios have increased, particularly in Turkey and India, reflecting better macroeconomic prospects and lower operational risks. Acquisitions in these under-rated markets could potentially undermine the viability ratings of GCC banks, depending on the size of the acquired institution and the resulting financial profile.

However, the long-term issuer default ratings of almost all GCC banks are supported by government support and are unlikely to be affected by these acquisitions. In this context, economic forecasts play an important role in shaping these expansion strategies.

The World Bank has updated its growth forecasts for various countries in April, reflecting significant opportunities and risks.

For example, Saudi Arabia's economic growth forecast for 2025 has been raised to 5.9 percent, from the previous estimate of 4.2 percent, indicating strong long-term prospects.

For the UAE it is now 3.9 percent for 2024, up from 3.7 percent, with a further increase to 4.1 percent in 2025.

Kuwait and Bahrain are also expected to see modest growth, while Qatar's 2024 forecast has been cut to 2.1 percent but adjusted to 3.2 percent for 2025.

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