Outlook darkens for the Middle East banks

This has not been a good year for Middle East banks, although they are currently still counting the profits from the good times of the oil boom. And higher interest rates are not the main cause but are just another reason to be pessimistic about the future outlook.

For the most immediate reason for lower profits in the second quarter was the collapse of Arabian stock markets this year. One after another the region's bourses have crashed as a spate of investor irrational exuberance came to an abrupt end.

Bank profits have suffered because they were making large fees from initial public offerings and lending frighteningly big amounts to fund oversubscriptions. There will also be bad debts from loans used to buy shares that have now fallen in value. For the UAE banking sector analysts reckon this factor will mean a 20-30 per cent fall in annual profits this year.

Commercial lending boom

The quid pro quo for the banks is that commercial lending remains on a high, and indeed is to some extent required to make up for the shortfall in IPO proceeds. However, there is also a feeling in banking circles that the business cycle may be nearing the top of the recent boom phase.

Stock markets are generally forward indicators of the business outlook, and on this reckoning the sudden collapse in local investor confidence is a precursor to a setback in the real economy. But this would have to mean a decline in the oil price, while at the time of writing oil prices are close to an all-time high and more likely to spike higher if the present violence in Lebanon and Iraq spirals.

Moreover, the massive surplus oil revenues of recent years have largely gone unspent in the GCC and remain available to fund budget deficits if required. So the Gulf governments could carry on spending to complete their current huge infrastructure programs whatever the oil price.

Final crunch

The real crunch would then only come later when the infrastructure projects are finished and have to deliver a return-on-investment. However, the immediate outlook is still an environment that will be considerably tougher for the Middle East banks that that experienced in recent years.

Those banks which have over expanded and made bad lending decisions will find themselves in trouble. Hasty mergers and consolidation of the sector is the probably outcome, with a greater and greater presence for the international banks that will look to take immediate advantage of any local weakness and continue their strategy of global expansion.