Multinational financial institutions have been active in the states of the Gulf Cooperation Council (GCC)—Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates (UAE)—since before the 1950s, but until recently few have identified the region as a growth opportunity. Its economic prospects paled beside those of other emerging markets such as China and India. Even today, the GCC’s population is only 35 million, and its share of global banking assets is less than 1 percent.

But now, high oil prices are fueling rapid economic growth in the region. More and more, foreign financial institutions are looking for ways to exploit the sizable investment opportunities the boom has created. Wealthy people in the GCC, who have relied on offshore banking to manage their assets, are investing more money within the region. GCC businesses riding the economic wave are demanding a wider range of financial services. In 2005 these factors helped to increase banking assets by 7 percent in Oman and by 20 percent in Qatar. And in Saudi Arabia, the region’s largest market, total mutual funds under management swelled from $10.2 billion in 2000 to $36.5 billion in 2005.

While regulations and unwritten barriers prevent foreign financial institutions from exploiting some opportunities, these firms do have a host of others, from wealth management to corporate and consumer finance. In an increasingly crowded financial market, they must focus on areas where scale and experience give them a competitive advantage—for example, by harnessing their global networks to develop innovative responses to local needs. To implement most strategies, institutions new to the region will also likely need a local partner that can offer regional expertise, a distribution network, and immediate access to banking clients.

The barriers to expansion

The current influx of multinational banks marks the third wave that has entered the region. The first came in the earlier part of the 20th century, before oil became the dominant economic factor. During this period, European banks such as the British Bank of the Middle East (later acquired by HSBC) and the Netherlands Trading Society (later ABN Amro) established a presence in the UAE and Saudi Arabia, respectively. A second wave of foreign banks followed in the 1970s, to finance an oil-driven economic growth spurt. Some, such as Barclays and Lloyds TSB in the UAE, obtained commercial-banking licenses and focused on corporate-banking activities at this time. In the past 20 years, the consumer-banking markets have become attractive, but foreign banks have struggled to expand their retail operations because of entrenched regulatory barriers. These included tacit limits on the number of branches that foreign banks could open, to protect local institutions.

Market entrants still face these barriers, as well as a reluctance by GCC governments to grant commercial-banking licenses. In particular, regulators in Saudi Arabia and the UAE prefer to award commercial licenses to banks from other countries on a reciprocal basis. However, these arrangements typically limit the number of branches to one. Such regulatory practices make it difficult for foreign firms that do have licenses to rely on services related to the taking of retail deposits.

Acquiring a bank in the GCC is also difficult. Despite a decline in 2006, current prices are high, as the torrent of oil revenues coming into the region competes for investment opportunities. Price-to-earnings and market-to-book ratios for local institutions have reached levels that are often twice those of financial institutions in developed markets. Even if an international player was prepared to pay a high price for a local institution, most targets are not for sale. Wealthy merchant families or local governments are the majority shareholders of most GCC financial institutions, and few have reason to put them on the market. In some cases, emotional bonds tying the majority shareholders to their assets also prevent sales.

Despite these obstacles, some multinational banks, such as Citibank, HSBC, and Standard Chartered Bank, have entered the region early and been rewarded for their persistence. From 2001 to 2004, for example, the UAE operations of Citibank and Standard Chartered recorded annual growth in profits of more than 20 percent and 30 percent, respectively—outperforming those banks’ global operations in measures such as return on assets. Together, ABN Amro, Citibank, HSBC, and Standard Chartered hold more than 50 percent of the UAE’s credit card market.

Signs that the GCC’s financial sector is opening up further should encourage firms that are new to the region or considering moves there. Dubai and Qatar recently established international financial zones where foreign banks can offer services in corporate finance, investment banking, asset management, and private banking. Foreign firms in these zones provide jobs and training to local workers, prompting governments to reconsider the value that multinational corporations might bring to the region. Since early 2005, Dubai has authorized more than 250 players, including Deutsche Bank, Goldman Sachs, and J. P. Morgan Chase, to open offices in its International Financial Centre (DIFC). Saudi Arabia’s newly established Capital Market Authority is issuing investment-banking and asset-management licenses to domestic and international firms more quickly. Kuwait recently issued commercial-banking licenses to three international banks.

As foreign institutions flock to the GCC’s relatively underdeveloped financial-services sector, they face increasingly stiff competition. Domestic firms have begun improving their services and capabilities to meet the specific preferences of the GCC market, including a heightened interest in Islamic financial products and GCC-related mutual funds, as well as an aversion to complex financial instruments. Domestic banks with extensive retail operations have access to a large and growing customer base, giving them a leg up on foreign firms, especially those new to the region. To compete effectively, multinational corporations must play to their own strengths: experience and scale.

Choosing where to play

To capture opportunities in the GCC, a bank must first identify and eliminate the least promising possibilities. Given the regulatory barriers and the entrenched position of the local competitors, nuts-and-bolts retail banking, including the taking of deposits, continues to be a no-go zone for foreign banks that do not already have commercial-banking licenses.

What’s more, opportunities in brokerage services are limited, despite recent high trading volumes and explosive growth on the region’s stock markets. The reason: local players dominate an already saturated market. Dubai is home to 58 brokerages, almost 1 for each of the 60 companies listed on the stock market. In Saudi Arabia, local players operate more than 200 trading lounges—public areas where investors can buy and sell shares as they sip coffee. In these lounges, local firms have shifted toward providing more customized, value-added services, such as designated areas with extra screens for heavy traders. Nonetheless, targeted plays in corporate and investment banking (including asset management), consumer lending, and wealth management offer multinational banks significant growth prospects (Exhibit 1).

Corporate and investment banking

Although corporate- and investment-banking services have been a mainstay for foreign financial institutions in the region,¹ debt issues in the larger GCC states remain small compared with those of developed capital markets. Outstanding corporate-bond volumes (including those issued by financial institutions) across the GCC averaged about 3.5 percent of the region’s GDP in 2005, but the volumes ranged from 0.7 percent of GDP in Saudi Arabia and 7.1 percent in the UAE to 20 percent in Bahrain, the smallest GCC state. The corresponding figures for the United States, Japan, and Germany are 146 percent, 45 percent, and 101 percent, respectively.

To be sure, the market is accelerating. The volume of bond issues in the GCC rose to $12 billion in 2005, from $1.5 billion in 2002, as domestic companies took advantage of the upsurge in local markets to expand and diversify. For example, Emaar Properties, which is listed in Dubai, recently appointed Citigroup as the lead manager of its $1 billion syndicated-debt issue to finance its international and UAE-based real-estate projects as well as its diversification into health care and education.

Meanwhile, project and syndicated-finance volumes increased by close to 60 percent a year from 2002 to 2005. Foreign firms, which accounted for eight of the top ten deals from 2001 to 2005, already dominate project finance. But more intense competition is taking a toll on margins: upfront fees for bond issues, for example, have dropped by an average of 20 percent a year since 2002.

Future opportunities will come from the more than $1 trillion in various projects planned in the region over the next decade. Most involve the distribution of water and the generation of electricity, investments in the exploration and construction of gas and oil facilities and related industries, and construction or expansion of production facilities in energy-intensive industries; real-estate projects in Qatar, Saudi Arabia, and the UAE are scheduled as well. These projects will require not only mainstream corporate lending but also expertise that local banks may lack, such as derivatives to hedge oil prices. By contrast, leading international banks, such as Deutsche Bank, offer specialized structured trade and export finance to GCC companies to complement local banks’ conventional lending products.

Financial expertise and international scale will also benefit foreign firms seeking a share of the GCC’s market for M&A advisory services. In private equity alone, the amount of capital committed to buyouts exceeds 1 percent of the region’s GDP, compared with 0.59 percent in the United States and 0.16 percent in Europe. Private equity houses in the GCC need the support of multinational investment banks that can help them in both conducting business locally and making acquisitions abroad—much as Dubai International Capital appointed HSBC as an adviser on its purchase of the British aerospace firm Doncasters, in 2006. Other global investment banks, such as Goldman Sachs and Morgan Stanley, recently opened offices in the region to support outward investment flows.

Consumer finance

The growing wealth of GCC citizens is most apparent in their appetite for loans. Consumer finance is the fastest-growing segment of the GCC’s lending markets, with loans to individuals reaching more than $100 billion in 2005 and accounting for upward of 37 percent of total lending, compared with just 23 percent in 1999. Retail lending is especially strong in Saudi Arabia (Exhibit 2). Although we expect the growth rate to slow by 2010, continued demand for loans to finance purchases of new homes, automobiles, and investments in local stock markets will generate a 50 percent rise in total lending revenues (loan margins multiplied by volumes).

Domestic banks are aggressively pursuing this demand, in part by upgrading their sales capabilities (for example, adding call centers and direct sales forces). However, these players lack the risk-management skills that would allow them to lend more aggressively, especially for unsecured loans—for instance, because the region lacks sophisticated credit bureaus to help local institutions evaluate prospective borrowers. Although banks have begun upgrading their risk-management capabilities under the Basel II accords, which set international standards for improving the supervision of capital, they are still not on par with foreign institutions.

As a result, domestic banks prefer to offer loans secured by the borrower’s salary. Many customers who would qualify for loans in more developed nations, however, cannot get credit in the GCC. In fact, despite the strong growth in consumer lending within the region, these products (including mortgages) equal only 17 percent of GDP in Saudi Arabia, the region’s largest market, compared with an average of 74 percent of GDP for France, Germany, Italy, the United Kingdom, and the United States.

Foreign financial institutions could fill this gap in consumer lending by using their stronger risk-management capabilities to venture into segments beyond the comfort zone of local players. Citibank, for instance, successfully introduced unsecured loans with significantly higher margins by using information about its strong credit card customer base to predict the behavior and appetite for risk of customers in the Gulf.

Much of the upcoming action in retail lending will center on the GCC’s underserved but burgeoning mortgage market. In the UAE, the region’s most active market for such products, retail loans accounted for just under 4 percent of GDP in 2005, compared with an average of 45 percent in most developed markets. Perhaps unexpectedly, structuring mortgages to comply with Sharia,² or Islamic law, which prohibits the taking of interest, is not the major obstacle³ (see “Rethinking regulation for Islamic banking”). A much larger barrier is the way property transfers may be interpreted. Sharia could impede a bank’s ability to repossess a home if a borrower were to default on a mortgage, for example, since repossession could be seen as harming the occupant, who might be left homeless. Without any clear recourse, banks have been reluctant to issue mortgages, so most home purchases in the GCC states are cash deals. Innovative lenders have found ways to protect their interests, however. Property developers in Dubai, for example, have built special zones where home buyers and property developers agree to allow banks to take over properties in the event of default. Several international financial institutions, including Barclays and HSBC, have used such agreements to venture into mortgage financing in Dubai.

Partnerships with small domestic banks or property developers are particularly attractive, since they offer foreign firms access to an existing customer base

International banks new to the market must also obtain a consumer finance license to build a mortgage business. Since new licenses are difficult to secure, would-be entrants could consider acquiring an existing consumer finance firm or partnering with a local business, property developer, or leading merchant bank to apply for a license. Partnerships with small domestic banks or property developers are particularly attractive, since they offer foreign firms rapid access to an existing customer base in return for providing the local partner with the foreign firm’s risk-management skills, marketing capabilities, and brand name.

A consumer finance license, however, comes with its own challenges, which vary from one GCC state to another. Foreign firms are limited to lending and cannot take deposits, and the capital requirements are high: in the UAE, for instance, 15 percent of assets for conventional consumer finance companies and 33 percent for their Islamic counterparts. New banks seeking to offer mortgages will have to weigh these costs against the potential gains.

Wealth management

The great accumulation of wealth in the region among the affluent class makes the management of these assets another rapidly growing segment of financial services. The total liquid assets of high-net-worth individuals (those with more than $1 million in financial assets) have been estimated at more than $780 billion—almost equal to that segment’s assets in China and India combined. The liquid assets of this cash-rich class will continue to grow at 10 percent annually for the next three years.

In the past, the GCC’s high-net-worth customers have preferred to invest up to 80 percent of their financial assets abroad. Booming local stock and real-estate markets, however, are pulling these investors toward domestic opportunities, which now account for 25 to 30 percent, on average, of their investment portfolios. These clients increasingly require the services of banks that have a strong presence in the region, are familiar with its domestic markets, and can react quickly to new opportunities. Since the most affluent customers—those with financial assets surpassing $10 million—are typically well known to foreign and domestic private banks in the region, competition to serve the segment is intense. Banks that can offer this investment-savvy group a distinctive offering either in products or in services will come out ahead.

Foreign banks could also target the growing number of people on the lower rungs of the affluence ladder. But there’s a lot of competition for this segment too: people who have $1 million to $10 million in assets under management already account for up to 80 percent of the domestic banks’ high-net-worth customer base.

To reach these customers, foreign banks could obtain private-bank licenses in one of the GCC’s newly formed financial centers and operate independently. Another way forward involves partnering with local players. For local firms seeking to expand through partnerships, a foreign institution can offer sophisticated risk-management techniques, a comprehensive range of products (for example, Islamic investment funds focusing on assets in non-GCC markets), far-flung distribution networks, and a strong reputation. Partnerships offer the foreign firms quicker entry into this growing market by providing a local distribution channel and assistance in navigating the regulatory waters. In addition, by gaining access to the local partner’s customer base, foreign firms are likely to find a significant number of new high-net-worth individuals seeking to place some of their assets in offshore accounts. In 2001, for example, the National Bank of Dubai allied with the Swiss private bank Pictet to offer wealth-management services. Pictet provided NBD with investment advisory and portfolio-management services, while NBD provided access to a growing market.

Partnerships also enable foreign asset-management firms to fill gaps in the local banks’ mutual-fund product lines, such as hedge funds and structured products. The current demand for domestic funds is unprecedented, as increasing numbers of GCC investors hunt for investment vehicles (such as real-estate equity funds that target growth in the value of GCC property) to capture local opportunities. On the institutional side, cash-rich state-run investment authorities are seeking outlets for their surplus revenues and are increasingly looking to work with asset managers that have offices in the region.

As a result, mutual-fund volumes in Saudi Arabia, for example, rose at a compound annual rate of almost 28 percent a year from 2000 to 2005. Domestic equity funds represented the bulk of the growth (Exhibit 3). Despite a recent downturn in local markets, asset-management revenues across GCC markets should continue to grow by 15 percent a year over the next five years. Islamic products are particularly popular: more than 70 percent of the funds under management in Saudi Arabia are Sharia compliant. Asset managers might also focus on offering specialized products, such as private equity funds, to high-net-worth individuals and families and to institutional investors.

Thanks to high oil prices, the states of the GCC are witnessing a huge inflow of cash, which is opening up promising opportunities for financial institutions. While regulations close some of these opportunities to foreign banks, multinationals can still leverage their scale and expertise to occupy many unexploited but profitable niches in this financial landscape.