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Does the World Still Need Banks?

Economic and business environments are conspiring to prompt some uncomfortable questions for financial institutions. One such question is – does the world still need banks? Rising competitiveness in the financial sector, persistently low interest rates, technological innovation, and a rapidly changing banking sector are just some of the key developments in the UAE of late where the financial sector plays a very significant role in the economy.

Whether looking at the UAE or beyond, banking – both retail and commercial – is becoming more competitive, driven in part by the combination of a tough operating environment and a saturated financial sector.

The UAE economy is set to improve this year with non-oil GDP growth estimated at 2.4% for 2020 after slowing to just 1.3% in 2018 (the weakest growth since 2011). This past weakness has come despite the greater public investment in infrastructure and projects ahead of Expo 2020. Crucially, lower activity in the wholesale and retail trade sector throughout 2018 and much of 2019 has also led to a slowdown in wage growth, consumption, borrowing, and population growth across the Emirates.

In the UAE specifically, nearly 50 domestic, regional and foreign lenders compete to do business with a population of about 9.4 million people and hundreds of companies. Against a backdrop of lower growth driven by flat oil prices, a number of these lenders are pursuing mergers in a bid to leverage economies of scale. This includes Abu Dhabi Commercial Bank, which merged with Union National Bank (UNB) and Al Hilal Bank in 2019, enabling the combined lender to become the third largest bank in the UAE.

That merger was not the first in the financial sector and is unlikely to be the last, particularly if the operating environment remains challenging, borrowing (retail or commercial) remains subdued, interest rates remain low, or regulatory costs become increasingly burdensome.

Despite recently thwarted attempts to normalise monetary policy in the US and Europe, nearly a decade of record-low interest rates has helped to create a supportive environment for borrowers and reduce debt-servicing costs while also thinning margins for banks. This appears likely to continue in the near term as the global economic outlook weakens and the world’s largest central banks – the US Federal Reserve, the Bank of England, and the European Central Bank – once again look towards rate cutting and monetary easing as essential tools to combat economic stagnation.

In the UAE, where monetary policy is almost inextricably linked with that of the US on the back of the Dirham being pegged to the US dollar, the resulting opportunities for borrowers – and pressures on banks – will likely be much the same.

Capital Raising in the UAE is Changing

Yet significant competition, low interest rates, and structurally lower growth all reinforce not only a sense that the economy is changing, particularly in maturing EM countries like the UAE, but that banking is too – along with the needs of borrowers. One example of this is that the debt capital market has increasingly become a source of funding for governments and corporates in the region.

Looser monetary policy is encouraging institutional investors and asset managers to take more risks in their hunt for yield and enter new markets, regions, and asset classes. This has started benefitting borrowers in the UAE and the wider GCC and enabled them to seek out new pools of capital.

Further inclusion of GCC credits in widely tracked EM bond and equity indices over the past year is likely to help drive an influx of foreign capital into the region. In the UAE, new regulations are aimed at increasing foreign ownership of businesses and long-term residency for expatriate workers. New rules that strengthen the ability of non-GCC companies to own real estate in the UAE also bolster the long-term prospects for additional long-term capital entering the region.

At the same time, as I have written elsewhere, the region is becoming increasingly embedded in global capital markets.

The GCC bond and sukuk universe has, over the past fifteen years, grown from virtually nothing into a near USD400bn asset class, roughly doubling in size since 2015 when a crash in the oil price prompted regional sovereigns to orient themselves outwards towards new pools of investors to help finance ambitious domestic development initiatives. GCC bonds and sukuk now account for approximately 16% of outstanding emerging market hard-currency fixed-income assets, with exposure to a broad group of investors in a number of geographies.

All of this has taken place while central banks in the GCC and elsewhere have been introducing increasingly stringent banking capital rules designed to reduce the kinds of macro-prudential risks that gained international notoriety after the global financial crisis of 2008. Those rules entail, among other things, changes to how – and to whom – banks deploy their capital. While they help to ensure that banks remain strong and well-regulated in the face of market and economic volatility, they can provide a drag for clients often in the form of mountains of documentation and higher regulatory costs.

And so is Banking

Against a backdrop of increasing domestic economic diversification, and a deepening of the UAE region’s integration into global markets, a structural shift in the demand for and sourcing of capital is slowly taking place. This move is prompting commercial banks to transform from capital allocators or deposit shepherds into service providers.

This is only likely to accelerate as the domestic long-term investor base deepens; as the region’s capital market diversifies and becomes more vibrant; and as fintech – which has galvanized the retail banking world and redrawn the relationships between consumers and financial institutions – and non-traditional lenders make their way into the commercial banking sector.

The kind of fintech-driven transformation seen in retail banking – where ease of use, mobility and accessibility, agility, and the adoption of trust-enhancing solutions are leading factors when it comes to winning over customers – may not be seen in commercial or transaction banking anytime soon. Commercial banking services are more difficult to commoditise, and tend to be more specialised and tailored to strategic business objectives and capital deployment than those catering to retail consumers. And banks, due to their size and heavily regulated nature, can be slower-moving than some of their non-bank peers.

Nevertheless, shifts in consumer services are clearly influencing the kinds of services that CFOs and Treasurers are looking for when it comes to supporting their funding strategies.

As the Central Bank of the UAE deliberates and seeks feedback on a first draft of rules regulating loan-based crowdfunding platforms, a growing number of technologically enhanced and operationally agile alternative lenders or capital allocators are challenging incumbent banks to evolve the services that they offer.

In the UAE, partnerships between traditional financial service providers and fintech providers are being fostered in a bid to ensure that the end-users of financial services – CFOs and Treasurers – are empowered to move more quickly and be less incumbered by regulation while at the same time allowing authorities to leverage digitisation and trust-enhancing technologies like Blockchain to continuously manage the systemic risks presented to the financial system. As part of the Ghadan 21 accelerator programme, a three-year initiative launched by the Abu Dhabi Government to stimulate economic development, Abu Dhabi Global Market (ADGM) in October launched a first of its kind fintech digital lab to help bridge the gap between legacy technology platforms and innovative new service providers by increasing the interoperability between the data and information systems managed by fintech providers, financial institutions, government entities, and other stakeholders. Initiatives like these will likely help to foster deeper, more seamless integration among financial stakeholders.

Bank-Client Relationship to Become Service- and Data-Centric

What does all of this mean for the future of the bank-client relationship? In our view, it will lead to new, deeper relationships with clients, centred on services and the sharing of expertise to achieve broader corporate objectives.

Commercial lending has traditionally been a leading revenue business driver for financial institutions, at times accounting for more than half of some institutions’ overall loan portfolio. Lending has in turn created a platform for banks to provide a range of other services, including cash management or transaction banking support, for example. Given the depth of local banking liquidity and the expertise available to UAE businesses, this is unlikely to change drastically in the near term.

But with new challenger organizations in the banking industry gaining power and influence through the implementation of technology, in a decade’s time the banking industry will very likely look nothing like it does today. The brick and mortar nature of traditional branches will likely give way to a collection of banking ecosystems and apps, while the customer-centric approach that many banks have started adopting will look very different and be more aligned to the expected customer experience of ‘pick and choose’ banking services.

At the same time, it would be foolish to dismiss the value that banks currently provide. Stringent rules and regulations imposed by central banks offer protections for corporate and retail clients that simply aren’t available to other types of service providers.

As traditional lending begins to give way to more disintermediated forms of capital raising, the need for banks to invest in evolving core capabilities and strengths has become more apparent. Those core capabilities are centred on supporting a client’s ability to manage capital in a way that maximises growth and resilience, catering beyond the near-term needs of capital raising to help foster a more dynamic financial management strategy less cluttered by mountains of documentation and regulatory filings.

So, what can the world expect of banks in the future? Clients are likely to give more importance to multiple providers of banking services and not just traditional banks. Banking activities will also likely be broken down into bespoke and technology-driven niche services that can be drawn upon from an open application ecosystem, at any time, on a real-time basis. Data analytics will play a critical role in shaping this new banking model. Recent research has shown that over 80% of CFOs and Treasurers are now focusing heavily on data-centric models, artificial intelligence and machine learning in an effort to drive more value from the multi-dimensional set of variables affecting their companies.

For ADCB, this means leveraging our commercial and transaction banking expertise and in-depth knowledge of local businesses and diverse sectors, alongside the power of data and emergent technology ecosystems, to support our clients in achieving their strategic and commercial objectives. Fortunately, banks like ADCB have already done a lot of good work in terms of digitally transforming their business to meet this future head-on.

In 1994, the famed former chief of Microsoft and renowned philanthropist, Bill Gates, famously quipped that while banking is necessary, banks are not. It was a clairvoyant reminder not just that the ethos which made Silicon Valley firms famous for challenging every aspect of industry would inevitably stretch well beyond California and the Information Technology sector but that evolution is key to avoiding obsolescence.

This much can be gleaned from the technology sector itself, and quite appropriately, in the differences between the old Microsoft and the rise of Amazon. One is a technology company and the other is a technology services company. This subtle difference is important.

In the financial sector, among others, the same is becoming clear, and commercial and transaction banking is on a similar path as organisations seek a new set of expert and financial services to help them remain dynamic and competitive in an ever-evolving, increasingly diversified commercial landscape. Like most disruption-driven transformations, banks, like the organisations we serve, may one day vaguely resemble the institutions they are today. But with the right investment, banks can also move away from relying heavily on interest-based lending or deposit management and become more agile, value-adding and service-oriented organisations, while ensuring that they remain stable, reliable and well-regulated institutions. This is something to be seized, particularly in a region that so clearly and wholeheartedly embraces innovation.

Economics and Markets Middle East Global

Ludovic currently serves as Group Head of Wholesale Banking at Abu Dhabi Commercial Bank (ADCB), a leading UAE-based lender. He previously served as Head of Investment Banking, and Head of Financing Solutions. Before joining ADCB, Ludovic held senior roles at Citigroup and Credit Agricole CIB.

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