GCC bank profits: heading for a fall?

An almost uniform run of exceptional profit results from the GCC banking sector ought to sound alarm to any shareholder. The obvious question to ask is 'where are these profits coming from, can they be sustained?'

This week the National Bank of Abu Dhabi delivered the highest nine-month result in the history of the UAE banking sector. Profits were up by 153% on the same nine months of 2004 at $548 million. Yet chief executive Michael H. Tomalin sounded a warning note in his accompanying statement:

'These results are substantially above trend line and are not sustainable in the medium term, being flattered by strong local equity markets.'

Indeed the 17% decline in profits between the second and third quarter from $229 million to $189 million may be more than a summer blip. For in the third quarter the UAE stock market saw a 30% correction in July which has since rebounded.

A look at the nine-month figures also reveals that 54% of income was from non-interest sources, presumably related mainly to the UAE stock market. The position at NBAD is pretty typical for the UAE banking sector; they have all chosen to ride the stock market boom.

Non-interest profits soar

Of course, shareholders would be very unhappy if they had not done so. The problem now is that stock market valuations for banks have been driven to very high levels across the GCC on the back of profits that are acknowledged to be unsustainable.

Given that banks comprise more than 50% of GCC stock markets, we seemingly have an accident waiting to happen. For the banks have been profiting from the stock market which has been rising due to the banks' profits. Such a self-fuelling market valuation is indeed also unsustainable.

However, away from their stock market earnings the banks have also been doing well at their core business, and have benefited from the huge growth of regional liquidity thanks to surging oil revenues. There is therefore a big cushion in the system against any systemic strain, such as bad debts from a falling stock market.

Diversification or consolidation?

What the banks need to do is to diversify into other income sources away from dependence on the local stock market. The aggressive foray by the Abu Dhabi Commercial Bank into mortgage lending is one recent example of diversification that comes to mind.

Otherwise, the usual course of events in a profit-squeeze is a rush to cut costs by consolidation of the sector. With new WTO rules in place this could mean cross border mergers and acquisitions by the more aggressive banks in the GCC, and the international players buying up local banks.

For the boards of Gulf banks presently basking in the glory of their record profits the old childhood adage of 'Pride comes before a fall' is something they might care to remember.