GCC Islamic banks likely to increase mergers: Fitch Ratings

Mergers and acquisitions (M&A) amongst Islamic banks are likely to increase as Islamic institutions look to compete with large established peers, said Fitch Ratings. This trend will be particularly prevalent in overbanked markets, such as the UAE.

The ratings agency said that consolidation will ultimately be positive for the Islamic banking sector as it will lead to larger, stronger, and more efficient Islamic banks. The agency added, however, that banks’ Issuer Default Ratings are likely to be unaffected as most GCC bank ratings are driven by the assumption that sovereign support will be provided if necessary.

GCC Islamic banking M&A is driven by a search for competitive advantage to access growth opportunities, build low-cost deposits, and exploit cost synergies, Fitch said. The agency added that most Islamic bank M&A is between Islamic banks or involves a conventional bank purchasing an Islamic bank as a subsidiary – Islamic banks cannot easily acquire conventional banks.

Government backing is also usually required for deals given the significant stakes that governments typically hold for banks in the region.

Further compounding the M&A task is that integration costs when Islamic and conventional banks are involved can be high, Fitch added.

“Islamic banking has been a growth area for the last 10 years with most GCC countries trying to build their Islamic financing capabilities and create domestic Islamic finance hubs. Accessibility to Islamic products and instruments has grown rapidly with product innovation,” said Fitch in its research note.

Given the strength of existing competition, however, newer institutions have struggled to find good growth opportunities and to attract deposits, especially in overbanked markets. According to Fitch, this dynamic has also confounded the ability of conventional banks to offer Islamic financing and take Islamic deposits.

While many Islamic banks lack a competitive market position, some strong Islamic franchises do exist, concluded Fitch. Saudi Arabia’s Al Rajhi Bank has a 17 percent market share of domestic credit, making it the largest bank in the Kingdom. Al Rajhi is also the largest Islamic lender in the world, with total Islamic financing assets of $97 billion as of year-end 2018.

The Kingdom’s second-largest bank, National Commercial Bank (NCB), is also a strong Islamic institution, despite the fact that not all of its assets are Sharia-compliant, says Fitch. NCB is almost entirely focused on Islamic financing and is currently pursuing a merger with the conventional institution Riyad Bank.