The Next Banking Crisis Will Not Be in the Middle East

A budding financial crisis perpetually loiters around the modern global economy. Crises in banking sectors — a subset (and often a harbinger) of a broader financial crisis — have shocked developing and advanced countries alike for decades with increasing frequency. In their notable book, This Time is Different: Eight Centuries of Financial Folly, authors Carmen Reinhart and Kenneth Rogoff survey the causes and consequences of banking crises across the globe but spend little time going over banking crises in Middle East and North African (MENA) countries. This is not because of a lack of interest; there simply have been very few such crises in the region. In a comprehensive global list of banking crises dating in some cases to the early 1800s, MENA countries are largely absent, and when they do appear the crises are almost never systemic.

Banks in the Middle East and North Africa weathered the effects of the global financial crisis as well as could be expected[i] and in the main have strengthened in the intervening years. These banks played no role in the subprime crisis that began in 2007 and had almost no exposure to its root causes. In fact, the financial instruments such as mortgage-backed securities and credit default swaps — the instruments that played a starring role in the global financial crisis — are rare in MENA financial systems.

Bank profits suffered during the financial crisis because of a global decline in trade, investment, and economic growth, not because of being over-leveraged, lacking sufficient capital, or balance sheets bloated with poorly regulated or understood securities. GCC countries were more affected by the global crisis than countries elsewhere in the region because of their open financial systems and more over-extended banks, but they rebounded quickly in 2010, largely because of government support. The economic slowdown in the region’s other countries was moderated largely due to their less-extensive overseas reach.

MENA banks, and in particular those in the Gulf Cooperation Council GCC), hold high levels of capital, generally comfortably above minimum capital requirements and standards set under the Basel II agreements, and virtually all of non-crisis MENA countries are already internalizing the capital requirements set forth in the Basel III Accord — regulations set by the Basel Committee on Bank Supervision, which provides recommendations on banking regulations in regards to capital risk, market risk and operational risk. [ii] According to a 2014 IMF study, this prudent approach enabled the banks in the GCC to weather the global financial crisis, with the banking system remaining “a bastion of financial stability amidst a global financial system that was in turmoil.”[iii][iv] Bank capital acts as self-insurance, providing a buffer against insolvency, and MENA banks are generally well capitalized.

The Road to Banking Stability

The incentive structure in the U.S. and Europe that pushed some banks and financing companies into dodgy lending, overexposure, and dangerously high leverage ratios is mostly absent in MENA banks. With few exceptions, most banks in MENA whether in the GCC or not have historically engaged in conservative lending and maintain a stable base of depositors. These banks have generally focused on large, established clients and the public sector, and they have been reluctant to expand lending in riskier business lines, such as small and medium enterprise or mortgage finance.

This conservative trend also extends to investments, where banks rarely invest in or trade exotic derivatives. Of course, this hesitance to trade in instruments like mortgage-backed securities or interest-rate swaps is also because these instruments are not readily available in MENA countries. Could MENA banks in the coming years develop more sophisticated business lines and in the process expose themselves to greater risk? They could, especially in places like Dubai where the appetite for pushing the envelope is more developed. Before diving into these lines of business, however, banking executives would have to ask themselves the following questions: do we have the expertise and infrastructure in place, do we have a competitive advantage to justify entering into riskier business lines that are already sufficiently saturated by international banks, and would the local regulatory environment support such moves? The answer to all three of these questions is a qualified “no.”

One short-hand (albeit imperfect) approximation of risky lending is the degree to borrowers repay their loans in a timely manner, which is calculated by examining the percentage of a bank’s “non-performing loan (NPL)” as a percentage of its total loan portfolio. A bank loan is considered non-performing when more than 90 days pass without the borrower paying the agreed installments or interest — “bad debt” in other words. Assessing aggregate NPLs in a region with such divergent banking and economic systems is not optimal, but on the whole NPLs are strikingly low on average when seen against a backdrop of market and political turmoil.

In its 2018 regional economic report, the IMF notes that bank profitability has fallen in some countries because of tighter margins, but “NPLs do not appear to be a significant concern in many countries.”[v] In a recent report on the financial soundness of its banks, the Central Bank of Egypt said that the NPL ratio amounted to 3.4 percent of the total loans in the top 10 banks operating in the Egyptian market at the end of 2017; the ratio was just 2.9 percent among the top five banks.[vi] Questions of reporting accuracy aside, these numbers show better than many ratios in advanced EU countries.[vii]

A note of caution, however, is always appropriate, especially for countries like Egypt: The ratio of NPLs to total loans can be understated in an environment in which banks tend to roll over loans that otherwise would become nonperforming or disclosure is not up to snuff. That said, the overarching theme in most non-crisis MENA countries is that NPL ratios are healthy. The same goes for the region’s more economically stable countries. According to Moody’s Investors Service, the NPL ratio in Kuwait registers just some 2 percent,[viii] on par with German and Dutch banking sectors.

Of course, this paucity of relatively riskier financing to the private sector comes at a cost to long-term economic development and diversification. Conservative lending can protect a banking sector from exposure to risky assets, but a concentration on “safe” borrowers like governments and large state-owned enterprises and wealthy familial connections retards the growth of private companies and of course comes at the expense of stronger profits.

The story of modern MENA banking systems is also one of often explicit government support and protection. Take banks in the GCC. The governments of most GCC states have significant (often controlling) interests in most of the major banks and established ties with the extended royal families. Dubai-based financial adviser Acreditus, as reported by The Financial Times, says arms of the GCC states — including sovereign wealth funds, state pensions, and social funds — have a shareholding in more than 80 per cent of the GCC’s top 50 banks.[ix]

Through the Abu Dhabi Investment Council and Mubadala Development Company — two Emirati sovereign wealth funds — the UAE government owns 37 percent of First Abu Dhabi Bank, one of the region’s largest banks following the merger of National Bank of Abu Dhabi and First Gulf Bank in 2017. To drive home the government’s and royal family’s iron ties to the banking sector, the bank’s Chairman is Sheikh Tahnoon bin Zayed Al Nahyan, the UAE’s National Security Advisor and royal family member. First Abu Dhabi Bank’s shareholder information lists UAE entities and individuals as holding 52 percent of its shares, and although the publicly available information does not detail who these shareholders are, there is every reason to suggest that other members of the Emirati royal family hold interests in the bank.

The Investment Corporation of Dubai, a sovereign wealth fund owned by the government of Dubai, controls a 56-percent controlling stake in Emirates NBD, the UAE’s second largest bank. Sheikh Ahmed bin Said Al Maktoum of Dubai’s ruling family has been the bank’s chairman since 2011. 

The list goes on. The Crown Prince of Dubai, Sheikh Hamdan bin Mohammed bin Rashed Al Maktoum, owns 26 percent of Noor Bank (formerly Noor Islamic Bank), and the Investment Corporation of Dubai holds an additional 23 percent. The Abu Dhabi royal family owns 67 percent of First Gulf Bank, the country’s fourth largest bank. According to Karen Young, the author of The Political Economy of Energy, Finance, and Security in the United Arab Emirates: Between the Majlis and Market, family ownership appears to be a positive influence on credit ratings.

Emirati banks might stand out in terms of the explicit symbiotic relationship with the government and connected families but they are not alone. The Qatar Investment Authority — Qatar’s sovereign wealth fund — owns 50 percent of Qatar National Bank, and a large number of royal family members sit on the bank’s board of directors. The Omani government through state-owned pension funds and the influential Royal Court Affairs control more than 40 percent of Bank Muscat, Oman’s largest bank.

As for Saudi Arabian banks, despite years of liberalizing the sector, the government directly or indirectly owns significant shares in the kingdom’s banks, often with substantial controlling interest. The Public Investment Fund (PIF, the kingdom’s enormous sovereign wealth fund) holds 44 percent of the shares of National Commercial Bank, the kingdom’s largest bank, with the General Organization for Social Insurance and the Public Pension Agency holding an additional combined 20 percent. The PIF owns more than 20 percent in Riyad Bank with the Public Pension Agency holding an additional 9 percent.

Unlike the governments in the Gulf, the region’s other governments, such as Jordan, Lebanon, and Morocco have much smaller footprints in their banking sectors. Government ownership of banks in Morocco has fallen to just 10 percent as the state gradually privatized its economy.[x] Arab Bank, Jordan’s largest bank and one of the largest banks in the Middle East, is majority privately owned, although the state-run Social Security Corporation still holds 16 percent of the bank’s shares. Jordanian banks have continued to demonstrate healthy liquidity and adequate capital ratios.[xi]

Unlike in Europe and the U.S. where state ownership of banks is a thing of the past if every really a thing, banks in the GCC especially — whether state owned or influenced — have a more symbiotic relationship with their governments. This relationship has given the banks all but a guarantee of a state bailout if insolvency looms. The shortcomings of too much government in finance are well known, but in the aftermath of the worst global financial crisis since the 1930s the presence of a steady government hand with ample capital puts a stamp of stability on otherwise unsteady economic trends. In short, the reputation of these governments are on the line — not to mention the wallets of princes especially in places like the UAE — and consequently a bank failure would be countenanced.

Jordan has experienced only one important bank failure in its history — Petra Bank. Jordan’s then third-largest bank, it collapsed during Jordan’s currency crisis of 1989, but its failure almost certainly was prompted more from malfeasance rather than regulatory failures or massive balance sheet mismatches. Ahmed Chalabi, the infamous Iraqi businessman, founded the bank in 1977 and was charged with embezzlement and hastily fled Jordan.[xii]

When To Worry?

As any good forecaster of economic or financial crises will tell you, the next crisis will seemingly come out of nowhere, and the origins of the new crisis will bear little resemblance to the previous one. The catalyst for the global financial crisis that began in 2007 was nothing like the catalysts for the Thai banking crisis in 1997, the savings and loan crisis in the U.S. of the 1980s,[xiii] or the Panic of 1907.[xiv] Rules of prudent lending and investments, limits on exposure and concentration, a stable macroeconomic environment, and solid transparency and disclosure rules all build foundations for a sound banking sector, but even in the best of circumstances when forecasters have ample data and can lean on seasoned analysis, crises can catch fire quickly.

The global financial crisis that began in 2007 laid bare the limitations of financial sector reporting and traditional analysis. Even with the most experienced regulators and seemingly sophisticated risk modeling, the capital markets in the United States and much of Western Europe sunk during the crisis. Large off-balance sheet liabilities or rapid declines in asset values can turn today’s stable bank into tomorrow’s multibillion-dollar bailout. A number of banking sectors in the MENA region are exposed to the notoriously volatile construction and real estate markets (Bahrain, Dubai, etc); some to excessive government debt (Lebanon); others to economic insecurity (Egypt, Iraq). 

The health of any country’s banking sector is nearly synonymous with economic stability, and the oversized role of the region’s banks make their viability especially crucial. MENA banks might not deeply touch the lives of many citizens in the region’s poorer countries because of the lack of financial inclusion, but the banks’ role in financing government expenditures and lending to large companies and entities is enormous. Banks hold this position of economic influence in large part because alternative methods of financing — such as bond and equity finance or venture capitalists — are still developing.

The closest a banking sector in the region has come to a full-blown financial crisis in the last few decades has been that of Dubai in 2009. Excessive spending and leverage on the part of Dubai World, the state-run colossus that had helped spearhead Dubai’s real-estate development during the 2000s, had led that company to hold $59 in liabilities, more than two-thirds of Dubai’s entire debt stock.[xv] It turns out that even without widespread use of mortgage-backed securities such as used in the U.S., big bad bets can turn sour. It took a $10 billion bailout from neighboring Abu Dhabi to prevent default and the promise of negative ripple effects. [xvi]

History is no forecast. The right mix of ingredients — whether fraud, currency mismatches on the balance sheet, overexposure to a declining market, regional economic shocks, over leverage or insufficient capital — can push any relatively healthy bank or banking sector to illiquidity or insolvency. The same is true for banks in MENA countries. Nonetheless, as this analysis aims to demonstrate, the current state of the region’s banking sectors — notwithstanding of course those in crisis countries (Iraq, Libya, Syria, and Yemen) — suggests little cause for alarm. This does not necessarily mean that banks in the region are consistently profitable or models of good corporate governance. But it does mean that on the whole MENA banks do not show signs of a looming crisis. Perhaps one good bit a news in a region that needs it.

[i] Rocha, Roberto, Zsofia Arvai and Subika Farzai, Financial Access and Stability: A Road Map for Middle East and North Africa, World Bank, 2011. 

[ii] https://www.strategyand.pwc.com/reports/silver-lining-middle-east-banks

[iii] https://www.imf.org/external/np/pp/eng/2014/102514.pdf

[iv] https://gulfnews.com/business/sectors/banking/basel-iii-higher-local-capital-requirements-to-increase-banks-costs-1.1992347

[v] “Regional Economic Outlook Update: Middle East, North Africa, Afghanistan, and Pakistan,” International Monetary Fund, May 2018.

[vi] https://www.zawya.com/story/Nonperforming_loans_in_Egypt_fell_to_49_of_loans_at_end2017-SNG_112331852/

[vii] https://www.bloomberg.com/news/articles/2018-02-14/get-a-grip-on-europe-s-bad-loan-problem-with-these-five-charts

[viii]  https://www.thenational.ae/business/kuwait-banking-system-stable-as-economy-grows-moody-s-says-1.713005

[ix] https://www.ft.com/content/ac0789fc-87e1-11e7-8bb1-5ba57d47eff7

[x] http://documents.worldbank.org/curated/en/802191484661795353/Morocco-Financial-Sector-Assessment

[xi] Al-Amarneh, Asma’a, “Corporate Governance, Ownership Structure and Bank Performance in Jordan,” International Journal of Economics and Finance, Vol 6, No 6 (2014).

[xii] https://www.theguardian.com/world/2003/apr/17/iraq.davidleigh

[xiii] https://www.federalreservehistory.org/essays/savings_and_loan_crisis

[xiv] https://www.frbatlanta.org/-/media/documents/filelegacydocs/ern390tallman.pdf

[xv] https://www.reuters.com/article/us-dubai-economy/dubai-seeks-debt-delay-some-units-cut-to-junk-idUSTRE5AO4Z120091125

[xvi] https://www.economist.com/finance-and-economics/2009/02/26/the-outstretched-palm

The author is an employee of the United States Government, which is funding his fellowship at the Wilson Center. All statements of fact, opinion, or analysis in this work are those of the author and do not reflect an official position or views of the Government or of the Wilson Center.