Buoyed by excellent profits and increased lending opportunities in 1997, banks in the Gulf are preparing for a spate of changes that are likely to dramatically affect the sector during the next few years.

Opportunities are growing for the well managed institutions to take a larger regional

Just as US and UK corporations are re-discovering the attractiveness of bond markets in what many expect to be an era of deflation and low interest rates caused by spillover from the Asian crisis, both state-owned and private entities in the Gulf are finding it timely to borrow. Governments which are feeling the pinch on spending are also recognising, at last, the need to proceed seriously with measures that can attract private and foreign investment into their private sector, particularly for projects such as electricity and power, aviation, transport and telecommunications that are becoming overstretched by rapidly increasing consumer demand, or which need modernisation and upgrading.

BIG BOND ISSUES

As a result, commercial and investment banks in the region, along with the big international houses, are moving to play a greater role in some of the major upcoming schemes. One early beneficiary was the huge petrochemicals plant, Equate, set up by two Kuwaiti companies and Union Carbide of the US. Equate is now said to be seeking a re-financing package that could secure an interest rate as low as 80 basis points (bp) over the London Interbank Offer Rate (Libor), a figure which compares extremely favourably with the 187.5 bp and 162.5 bp over Libor it had to pay in 1995.

Last year, the Saudi Petrochemical Company (Sadaf) achieved a successful re-financing for $700 million in project finance at a rate of 85 bp, compared to the original 234 bp it had to pay in 1995. Last autumn, bankers were quoted as saying that further borrowing could be charged at just 50 bp, so favourable is the financial and economic climate for such projects.

Bankers in the Gulf were also taken by the surprisingly successful $1.2 billion bond issue for Qatar's $2.4 billion project to export liquefied natural gas (LNG). Confidence in the region's political stability, pools of liquidity waiting to be invested and Qatar's own excellent economic prospects over the medium-term were cited as primary reasons for the attractiveness of the issue for Rasgas shown by the international markets.

Another big LNG project in Oman which is expected to cost $2 billion, for which the government is seeking a bond of $500 million, is also expected to find favour abroad, proving that the recent measures taken by some governments in the Gulf to implement economic reforms, open their company books to international disclosure and to put together a team of highly qualified managers is beginning to pay dividends.

PRIVATISATION

In the next few years, other mega-projects will be seeking similar finance. The Saudi Arabian Basic Industries Corporation (Sabic), together with the Kingdom's power and water sector, is reported to need up to $35 billion for new projects in the next five years, particularly if power shortages are to be avoided and the rapidly increasing demand for electricity is to be met adequately.

Saudi Arabia's planned privatisation of its huge telecommunications network is also going ahead, despite many delays. It is expected to be followed by the sell-off of the state holdings in Saudi Arabian Airlines (SAA) and by measures to allow private sector investment in ports, airports and shipping.

Elsewhere, Oman is finalising plans for the development of private infrastructure projects covering ports, water, wastewater and sewerage disposal, while Qatar's list is expected to include airlines, fertiliser and petrochemical plants, steel, power, water and telecoms.

Abu Dhabi and the smaller emirates of the UAE are also expected to revise legislation to allow similar moves, although the progress will be slow. In contrast, Kuwait's privatisation programme is well advanced, and the country's banks have been heavily involved, drawing in capital from the other Gulf states as well as Kuwait. In the next two to three years, more funds will be needed as the programme expands to include oil and gas installations, retail and office developments and utilities.

However, while the big global players such as Goldman Sachs of the US -- which raised the huge bond issue for Equate -- J.P. Morgan or Merrill Lynch are expected to dominate the growing bond markets in the Gulf just as they are tending to do around the world, regional banks in the Gulf have the advantage of lower prices and a greater knowledge of their clients.

Although the mega-projects may continue to elude most of them, analysts in London as well as in the Gulf say there is ample scope for the leading financial institutions to increase their activities in the privatisation and infrastructural projects as well as in project finance and corporate finance in general. This is particularly the case as more of the industries and services due to be privatised seek to list their shares on Gulf stock markets as well as to raise funds from regional capital markets. The National Bank of Kuwait's success in playing the lead role in putting together the loan package for Equate is but one example, they note.

INVESTMENT BANKING

In theory, some of the top banks in the Gulf have the capital and asset base to be big players in corporate financing schemes. The top five Arab houses listed in September by the respected London monthly, Euromoney -- the Arab Banking Corporation (ABC) of Bahrain, Saudi Arabia's National Commercial Bank (NCB) and Riyad Bank, Jordan's Arab Bank Group and Banque Misr of Egypt -- have funds they can bring to bear on the scale that is required.

But corporate finance requires much more: in addition to keen pricing, highly qualified management with the expertise to put together sophisticated packages and to provide a range of products, services and research is needed. Not all of the top banks have this, nor do some have the will to enter what is a highly competitive field. ABC, which had a market capitalisation of $1,175 million at the end of August, and which has a large network of subsidiaries in Europe, North America and the Far East, is a likely candidate, though it is struggling with the need to redefine its activities and seek new directions.

Investcorp, by all accounts the leading investment bank in the region, has scored huge successes in bringing private companies in Europe and the US to the market, but so far it has shown less interest in business closer to home. All that may now change.

Meanwhile, offshore banks such as Bahrain International Bank (BIB) and Bahrain Middle East Bank (BMEB) are moving more rapidly to spot, and develop, the new opportunities, particularly in restructuring Gulf corporates and in preparing companies in the region for entry into the expanding stock markets.

In Dubai, the Emirates Bank Group has announced plans to establish a new international offshore unit, the Emirates Merchant Bank, which will specialise in corporate finance, fund management and private banking. The move represents "a major initiative to develop the group into a leading regional financial services conglomerate by providing the full range of investment banking services," commented Anis Abdullah al Jallaf, Managing Director and Chief Executive.

For the smaller domestic commercial banks in the Gulf, the expanding retail sector will provide another source of profitable earnings in the coming few years. This is especially the case in Qatar, which the International Monetary Fund is predicting will be the world's leading growth economy this year, thanks largely to its vast reserves of natural gas which are now being exported to Europe and Asia.

"Personal banking facilities are in demand. The retail side is presently the growth area as thousands of people of all nationalities come into the country," Andy Stevens, assistant general manager at the Commercial Bank of Qatar told the London-based monthly, The Banker, in October.

"We need more strong banks to take up the opportunities being provided by the rapid expansion of the economy, rather than leaving this exclusively to international banks," adds John Finigan, General Manager and Chief Executive Officer of Qatar National Bank (QNB), which had assets of $4.5 billion at the end of 1996. Credit cards, automated teller machines, investment and savings plans are part of the new offerings, along with loans and accounts.

Islamic institutions, such as the Qatar Islamic International Bank (QIIB) and the Qatar Islamic Bank (QIB) are also quickening the pace in the retail sector, by providing interest-free loans to consumers for everything from simple overdrafts to finance for cars and furniture. As the demand for religiously sanctioned deposits and savings grows, they are expected to provide stiff competition to the more conventional banks in the region.

In Kuwait, loans to individuals already comprise 43 per cent of outstanding credit to the private sector, the National Bank of Kuwait reported last autumn. "Personal facilities resumed a strong pace in the second and third quarters of 1997, rising to more than KD 100 million in each quarter, for an annualised rate [of increase] of 30 per cent," it added.

This helped send bank profits up last year, with the Commercial Bank of Kuwait (CBK), for example, showing a 38 per cent rise in the first half of 1997. Al-Ahli, which has 14 per cent of the domestic credit market, reported an increase of 34 per cent during the same period, with even higher growth -- 45 per cent -- in loans and advances.

In the UAE, expectations that long delayed plans to set up a local stock exchange will finally go ahead this year are fuelling activity in the commercial banking sector. "Bank results during the first nine months of 1997 have been excellent," The Banker quoted the central bank as saying in December.

Abu Dhabi Commercial Bank (ADCB), Emirates Bank International (EMI), Mashreq Bank, the National Bank of Abu Dhabi and the National Bank of Dubai, which together account for the majority of the country's deposit base and assets, are expected to be the main beneficiaries of the increased demand for credit by both individuals and companies. However, the central bank has already been forced to issue warnings to the banks to ensure that adequate collateral is sought and limits placed on lending for the purchase of shares. This, the supervisors hope, should also reduce the chances of over-inflated share prices.

In Bahrain, the country's largest commercial bank is seeking to expand its retail services as part of a larger programme aimed at improving and diversifying its range of products and at introducing state-of-the-art technology. Last year it scored a first in the country by introducing an Islamic investment outlet, the Al-Watani Fund for Islamic Investment.

More are now planned as a result of the positive response. Half year net profits to the end of June last year were up by 19 per cent, but only at the cost of a reduction in general provisions.

Despite the undoubted successes of 1996 and 1997, however, the banking sector in the region as a whole faces the growing need to confront the problem of size and market share. As reforms aimed at integrating the region into the global economy begin to bite, both regional and domestic players need to increase their resources, whether these be financial, managerial or technical.

The process of consolidation will be slow, but has begun already in both Saudi Arabia and in Oman. United Saudi Commercial Bank (USCB) and Saudi Cairo Bank (SCB) paved the way by announcing a merger in September that will create the third largest bank in the Kingdom. The fact that the famed international investor, Prince al-Waleed bin Talal, was a shareholder in both institutions was a key factor in overcoming what, elsewhere, has been entrenched attitudes opposing such rationalisation.

In Oman, the Commercial Bank of Oman (CBO) has announced plans to join with the Bank of Oman, Bahrain and Kuwait (BOBK) to create what will become the most strongly capitalised bank in the Sultanate if it is approved by the country's central bank.

With some 65 branches when combined, the merger will give the new institution the second largest network in the country, ranking just behind the Oman International Bank (OIB).

Throughout the region, the challenges, as well as the opportunities, need attention if the Gulf is to play its potential role in developing its home markets. The prospect of further turmoil on the international scene, particularly in Asia, should concentrate minds this year even more than usual.