FEBRUARY 2018 | ISSUE 203
THE RISE OF GCC BONDS A healthy pipeline for 2018 despite precarious oil prices and geopolitical instability
BALANCE OF POWER The hard work begins in Saudi Arabia
THE MENA POTENTIAL
Venture capital activity rising to the eyes of the west
FIRST LADY Rania Nashar, CEO, Samba Financial Group
Dubai Technology and Media Free Zone Authority
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THE JOURNEY TO SIMPLICITY 50 years ago, we started with a single thread of hope. Even though there were knots and tangles along the way, we persisted until we overcame the complexities to offer simpler banking solutions today. ABK... moving forward over 50 years.
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15/02/2018 13:34 14/06/2017 18/07/2017 09:49 17/10/201711:20 17:16
his year started off with a significant level of optimism. On the back of increased oil prices and improving economic conditions, industry players and market analysts all expected business to pick up pace. However, almost two months into the year these sentiments have begun to slowly dissipate with some suggesting that the landscape is somewhat muted. Industry players are perhaps treading more cautiously in this bullish market, adopting a wait and see approach as the year progresses. Granted, 2016 and 2017 were some of the most difficult years since the 2008 Financial Crisis and many have indicated that it was a period of correction and adjustment to current global financial conditions. Most market constituents were excited for 2018 and beyond, having projected it to be the year that things would start to get better—as was also reflected at DAVOS. Nonetheless since then, we’ve seen global stock markets experience a period of volatility, so much so that it was almost contrary to the usual January effect predictions. And this was due to the political concerns in the US as well as concerns about rising inflation, interest rates and bond yields. Banks across the GCC have posted improved profits, lower costs and large reduction in cost of risks positively impacting their profitability. Despite this positive indication, some have suggested that international financial conditions are currently unstable due to the bubble created by excessive liquidity, which could possibly lead to another
financial crisis. Additionally, the changing economic environment in Middle East is also affecting business activities within the region. Recent conversations mostly revolved around the biggest pivot of them all—technology. The industry is without a doubt aware of the range of technologies that can be leveraged on—blockchain, artificial intelligence, biometrics, distributed ledgers—all sorts of buzzwords come to mind. However, apart from just understanding how these technologies work, more importantly, financial institutions need to be able to recognise the impact of these technologies and how it changes the structure of the market. More foresight into how banking and finance will look like with these added capabilities is perhaps where one should start in assessing the best way to leverage it. In this issue we bring to you exclusive commentaries on technology, equity and debt capital market activity as well as corporate governance issues in the region. Our cover story follows the rise of a female Saudi leader in the country’s banking sector, on the back of the Kingdom’s efforts in transforming itself into a progressive and forward-looking nation. The Saudi theme continues with another two pieces on the Kingdom’s economy and its VAT implementation. As usual, I wish you a productive read.
Nabilah Annuar EDITOR, BANKER MIDDLE EAST
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FEBRUARY 2018 | ISSUE 203
22 Saudi banking’s first lady COUNTRY FOCUS—SAUDI ARABIA
28 Balance of power INVESTMENTS
36 Building ties, strengthening relationships, creating opportunities
40 On stethoscopes, telescopes and governance of Arab banks
48 The MENA potential
US Fed under Jerome Powell: navigating in choppy waters
12 Improving sentiments 15 The rise of GCC bonds LEGAL PERSPECTIVE
18 VAT—where do we go from here 4 page 3-4 contents.indd 4
54 Financial services disrupted: open banking and AI
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58 Artificial intelligence: Finding opportunities amid the rise of the machines
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THE RISE OF GCC BONDS
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A healthy pipeline for 2018 despite precarious oil prices and geopolitical instability
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BALANCE OF POWER The hard work begins in Saudi Arabia
THE MENA POTENTIAL
Venture capital activity rising to the eyes of the west
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US FED UNDER JEROME POWELL: NAVIGATING IN CHOPPY WATERS Some have questioned the potential impact of Powell’s appointment to global markets and closer to home, the MENA region. Banker Middle East explores this
erome H. Powell on 5 February 2018 took the oath of office as Chairman of the Board of Governors of the Federal Reserve System, succeeding Janet L. Yellen. Powell’s term as Chairman is four years; his term as a member of the Board ends 31 January 2028. President Donald Trump announced his intention to nominate Powell to be the Chairman of the Board of Governors on 2 November 2017, and the Senate confirmed him on 23 January 2018, following a hearing by the Senate Committee on Banking, Housing and Urban Affairs on 28 November 2017. Prior to his appointment as Chairman, Powell served as a member of the Board of Governors. Chairman Jerome H. Powell in his remarks at the ceremonial swearing-in asserted, “While the challenges we face
are always evolving, the Fed’s approach will remain the same. Today, the global economy is recovering strongly for the first time in a decade. We are in the process of gradually normalising both interest rate policy and our balance sheet with a view to extending the recovery and sustaining the pursuit of our objectives. We will also preserve the essential gains in financial regulation while seeking to ensure that our policies are as efficient as possible. We will remain alert to any developing risks to financial stability.” Powell vows to continue the policy of his predecessor Yellen. However, due to inflation surprises, the industry could expect in the future a more pronounced reaction than previously foreseen. Due to the exchange of the four policyvoting presidents of Fed District banks in the Federal Open Market Committee
(FOMC), this new body might become more willing to advocate rate hikes than the committee under Yellen. “Long-standing Federal Reserve (Fed) Governor Jerome Powell, who succeeds retiring Janet Yellen, has been sworn in as the new chair of the Fed. Many observers will be asking whether this new leadership might affect or change the Fed’s policy stance going forward, in particular, in the light of the higher wage growth that surprised financial markets in January. At first glance, no major changes are to be expected nor do they appear imminent. Powell has vowed to continue Yellen’s policy. After all, Yellen followed a cautiously consequent and, so far, successful policy stance during her four-year tenure, which set the Fed on a track of interest rate normalisation since December 2015 and balance sheet shortening as of October 2017,” said Janwillem Acket, Chief Economist at Julius Baer. He continued, “However, should not only wages but subsequently also inflation surprise on the higher side, especially over several months in a row, we should expect a more pronounced reaction from the Fed than so far foreseen. The last update of the Summary of Economic Projections of the individual Federal Open Market Committee (FOMC) members, the so-called ‘dots’, suggests three hikes by 25 basis points of the policy target rate in 2018. Given what the Fed stated at its meeting recently, and with rising uncertainty about higher inflation perspectives, a rate hike at the upcoming meeting in March looks like a done deal. Nevertheless, in the case of surprising rises in inflation, the Fed could go for four instead of three rate hikes or we might even see a 50 basis-point hike. This could have significant market impact, as it would be the first time this has occurred during the current interest rate normalisation cycle.” Sean Evers, Managing Partner at Gulf Intelligence suggests, “The impact of the new Fed Chairman on the GCC could
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Vice Chairman for Supervision Randal K. Quarles swears in Chairman Powell, as wife Elissa Leonard holds the Bible. PHOTO CREDIT: Flickr/Federalreserve
be a bit of a double-edged sword—on the one hand he is expected to raise interest rates and end a decade of cheap money which will make it more difficult and more expensive to fund massive expansion projects, but on the other hand these policies would strengthen the purchasing power of the dollar which has been on a slide for the last year.” In addition, the renewed composition of the FOMC could have an impact on the future behaviour of the Fed, i.e. policy implementation. So far, pundits have suggested that the FOMC might have a more ‘hawkish’ stance on interest rate hikes in 2018 than last year. According to Acket, this has to do with the fact that four policy-voting presidents of Fed District banks in the FOMC are to be exchanged: the Chicago Fed’s Evans, Dallas’ Kaplan, Minneapolis’ Kashkari and
Philadelphia’s Harker have been replaced by the Atlanta Fed’s Bostic, Cleveland’s Mester, Richmond’s Interim President Mullinix (to be replaced as of June by Barkin) and San Francisco’s Williams. Two apparently ‘dovish’ voting members of the FOMC in 2017, Evans and Kashkari, were replaced by the ‘hawkish’ Mester and Mullinix, joined by the lately rate-hike-friendly so-called ‘centrist’ Williams. With Yellen retired, the current board of governors is understaffed by four, as there should be seven. Fed Chair Powell, Brainard as well as Quarles are currently the only three governors in office (out of the 12-member FOMC). Furthermore, the FOMC’s vice chair, New York Fed President Dudley will retire by mid-2018. Sharing similar insights, Diego Würgler, Head Investment Advisory
Middle East at Julius Baer added, “The fact that four policy-voting presidents of Fed District banks in the FOMC are to be exchanged bears the risk that the future Fed-Board might be keener at rising interest rates in order to fight inflation pressure. This would be negative for emerging markets broadly, including the Middle East, as higher USD interest rates may translate into a stronger USD which subsequently could lead to money outflows from the region. That said, much more important for the region is the global recovery as well as the development of crude oil price.” “It remains to be seen how important this constellation might become in the light of future inflation surprises. In any case, the new, decimated FOMC still has ample clout to sail the choppier waters of the financial markets,” Acket surmised.
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UAE Central Bank begins groundwork on country’s National Payment Systems Strategy The Central Bank of the UAE has launched an initiative to develop a National Payment Systems Strategy for the country. In line with the UAE vision 2021, the initiative enables the country to transition into a cashless society, reducing the cost of domestic and cross-border payments, promoting innovation and positioning the country as a global leader in payment systems. “This will result in benefiting from higher quality services at a competitive cost, in addition to reduced transaction fees, greater levels of efficiency, improved collection cycles, and more innovative payment channels,” said HE Mubarak Rashed Al Mansoori, Governor of the Central Bank of the UAE. Through this initiative, the Central Bank will own and lead the delivery of the National Payment Systems Strategy where several objectives will be achieved including: ensuring the payment systems are interoperable and well-regulated, in addition to fostering an enabling environment to support the transformation of the UAE to a cashless society in the long run. The Central Bank will also consult and collaborate with the relevant stakeholders from the federal and local governments, other regulatory entities, financial and non-financial institutions, telecommunications companies, industry and other entities in achieving these objectives.
FAB receives green light to conduct investment banking business in Saudi Arabia First Abu Dhabi Bank (FAB) has secured a licence from the Capital Market Authority of Saudi Arabia to establish an investment banking subsidiary in the Kingdom. The wholly-owned subsidiary, FAB Investment KSA, will provide arranging and advisory services throughout the Kingdom to both KSA corporate clients and institutions looking to access international markets. “This development will strengthen FAB’s ability to tap into one of the largest economies and capital markets in the MENA region. I would like to highlight that establishing this subsidiary will further cement the strong relationship which exists between the UAE and Saudi Arabia in the financial sector,” commented Abdulhamid Saeed, Group CEO of FAB, on this landmark development.
Saudi Arabia announces $293 million infrastructure project across Kingdom Saudi Arabia has announced plans to spend $293 million on major infrastructure projects across the kingdom. According to industry reports, the development project includes the implementation of 16,000 sanitary drainage connections to homes. Cementing this commitment, the Minister of Environment, Water and Agriculture has signed an agreement with the National Water Company (NWC) to begin work with an estimated completion within two years. Saudi Arabia is expected to see its infrastructure construction market reach $37.5 billion by 2021.
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Kuwait’s fiscal strengths mask long-term challenges
Central Bank of Yemen receives $2 billion in support A consortium of countries: Saudi Arabia, UAE, United States and the United Kingdom, has pledged to continue supporting the Central Bank of Yemen and stabilise the exchange rate of the Yemeni riyal and the Yemeni economy in general. According to industry reports, Mohammed Al Jaber, the Saudi Ambassador to Yemen said that his country is leading the support operations of the Central Bank of Yemen through several elements, the most important of which was supporting the bank with an extra $2 billion, which were added to another $1 billion deposited earlier. Al Jaber explaines that the UAE has committed to provide technical training and assistance to the Central Bank of Yemen, and the US and British sides have shown their commitment to provide technical advice to the central bank.
Kuwait’s recent budget outturns and the government’s draft budget proposal point to the country’s continuing fiscal and external strengths, which are reflected in its ‘AA’/Stable sovereign rating. Nevertheless, the slow pace of fiscal reform and economic diversification increases long-term risks to Kuwait’s public finances. Fitch Ratings has raised its estimate for Kuwait’s fiscal surplus in FY18, ending 31 March 2018, to 1.9 per cent of GDP, from 0.2 per cent previously. Recent data published by the Ministry of Finance indicates that Kuwait’s budget was close to balance in the first nine months of FY18, with revenues at 84 per cent of original budget allocations, but spending considerably lower, at 63 per cent. Rising oil prices are a key driver of the outturns. The FY18 budget assumed an oil price of $45/bbl, but the price of the Kuwait export blend has already averaged $51.7/bbl in the fiscal year to date. The projected surplus highlights the fact that, at around $50/bbl, Kuwait has the lowest fiscal breakeven Brent price in the GCC. With estimated sovereign net foreign assets at around 500 per cent of GDP, it also has the largest fiscal and external buffers. Fitch’s fiscal forecast still implies a financing need of nearly $19 billion in FY18, as the government cannot spend most of the KIA investment income and is required by law to transfer 10 per cent of its revenues (or around four per cent of GDP) to the KIA’s Reserve Fund for Future Generations.The FY19 budget proposes a broadly unchanged total spending allocation of KWD 20 billion (from KWD 19.9 billion in FY18), with a rising allocation for investment and energy subsidies but restrained spending elsewhere. However, despite likely under-execution on capital spending, overspending is a risk as rising oil prices push up subsidy costs further, and limiting public sector hiring and wage growth may be politically difficult. The subsidy system remains largely unreformed. Petroleum prices were raised in October 2016 but remain the lowest in the GCC, and the immediate fiscal benefit has been consumed by rising oil prices. Phased utility price hikes came into force in last year, but prices remain low and have not directly affected most Kuwaiti households.
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Key takeaways from Davos 2018 Industry reports have indicated upbeat sentiments at Davos this year. The main themes of the forum revolved around major transitions to issues such as the implications of AI, blockchain, Big Tech power, quantitative tightening, rise of impact investing and the populist revolt against globalisation. Nevertheless, a World Economic Forum poll of 1,300 executives captured the bullishness, with 57 per cent convinced the economy will improve over the next 12 months—the most upbeat reading since the survey began seven years ago. Huw van Steenis, Former WEF Agenda Council on Banking in a commentary pointed out that there are five main concerns for the banking and finance sector: 1) the likely end of easy money due to the tightening of financial conditions by central banks and the lack of meaningful inflation; 2) the constant battle between technology and finance; 3) the underestimated potential impact of artificial intelligence; 4) the significance of doing business with a social purpose; and 5) the populist threat to global trade. “No cycle or bull market lasts for ever. Investors will need to weigh risk and reward carefully. But the message from Davos last weekend was optimistic: the growing breadth of global growth, gradualist central bank policies and improving corporate investment are supportive of a longer cycle,” said Steenis. Adding to Steenis’ observations, Dominic Barton, Managing Director of McKinsey & Company in a separate commentary warned makets to prepare for an even more intense wave of corporate transformation. Barton said that the recent radical restructuring of portfolios is just a prologue. Corporates are on a quest for new engines of growth which can involve shifting a core business to something entirely new—and at the same time moving headquarters to a completely new geography. Additionally, some issues that remain unchanged from 2017’s Davos meeting is the need to reskill workers to keep up with technology advances and ensuring that the gains from growth are more widely shared. There has been calls to radically rethink education systems to meet the life-long learning requirements of the 21st century. In the same breath, Barton highlights that talent should be a top priority for CEOs. There is a critical importance of recruiting, developing, and managing human capital. He stresses that there is a need to focus attention on the critical two per cent that drive disproportionate value (and are not always at the top of the org chart), and to deploy talent as thoughtfully as is done with capital. Getting this right will be crucial to building enduring institutions that can survive and thrive in turbulent times.
Central Bank of Egypt to begin easing cycle with a 50bps reduction The Central Bank of Egypt is expected to begin its easing policy, with a 50-basis point (bps) reduction in both the overnight deposit rate and overnight lending rate to 18.25 per cent and 19.25 per cent, respectively. Bloomberg Economics has reported the change in its monetary policy stance signals beginning of an easing cycle. Ziad Daoud, Chief Middle East Economist at Bloomberg Economics explained that the Central Bank of Egypt will likely ease policy at its next meeting for four reasons: inflation has fallen sharply, reaching 17.1 per cent on a year-on-year basis in January; the decline in inflation gives the central bank space to ease policy while keeping real interest rates positive; capital flows into Egypt are unlikely to be impacted by the move as markets already expect a 100bps rate cut over the next three months; and the Central Bank of Egypt has communicated its plans to start easing monetary policy 'soon'.
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AI to contribute $320 billion to Middle East GDP by 2030
GCC insurance market outlook negative due to continuing headwinds
Artificial intelligence (AI) will contribute $320 billion to the Middle East economy by 2030, the equivalent to 11 per cent of GDP, according to PwC Middle East. In a recent report that illustrates the scale of economic impacts associated with AI, PwC highlights that there are greater, untapped opportunities that could increase the impact of AI on the region’s economy. The impact could be even larger if governments continue to push the boundaries of innovation and implementation of AI across businesses and sectors between now and 2030. The most significant relative gains in the region are expected in the UAE where AI is expected to contribute almost 14 per cent of GDP in 2030. This is followed by KSA (12.4 per cent), the GCC4, Bahrain, Kuwait, Oman and Qatar (8.2 per cent), and then Egypt (7.7 per cent). At the sectoral level, the most significant gains in absolute terms are expected in the construction and manufacturing sector. The sector is expected to account for almost a third of the entire benefits to the region, equivalent to almost $100 billion in 2030. Relative to their size, the retail and wholesale trade sector and the public sector (including health and education) stand to experience the most significant contribution from AI.
A.M. Best in a recent report has projected a negative outlook on the insurance markets in the GCC. Insurers in the GCC (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates) have historically enjoyed significant capital buffers and benefited from extensive reinsurance support. However, continuing headwinds could lead to potential volatility in the operating performance and capitalisation of market participants. Persistent low oil prices (and the resultant pressure on public spending), the introduction of value-added tax (VAT), political tensions and trade embargos and the unrelenting level of price competition are some of the challenges that GCC insurers currently face. They have historically relied on government spending for premium growth–particularly for infrastructure projects. As hydrocarbon prices are trading below fiscal break-even levels, governments have been reconsidering their economic policies, and have demonstrated increasing spending restraint. Over the medium term, A.M. Best expects pressure to increase on earnings from margins being squeezed (from underwriting operations due to pricing competition), as well as continued low and volatile returns from investments. Moreover, the dependence on reinsurance commission for many commercial lines and the resultant high concentration toward motor and medical insurance on a net basis remains a concern.
RATINGS REVIEW Entity
Bahrain Egypt Iraq
LT IDR/LT Rtg (FC)
Ras Al Khaimah Saudi Arabia
ST IDR/ST Rtg (FC)
B B B
LT IDR/LT Rtg (LC)
ST IDR/ST Rtg (LC)
KEY Positive Negative Evolving Stable
Saudi Arabia Qatar
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Vijay Valecha, Chief Market Analyst at Century Financial Brokers, provides a comprehensive review of financial markets since the start of 2018
12 page 12-14 The Markets_Century Financial Brokers.indd 12
ne month into 2018, and investors have already started fearing the roller-coaster ride in global markets. They say morning shows the day, and with January starting off at a spectacular note, hopes shot high and investors expected the bull to continue its run. But little did anyone anticipate that a sort of ‘Black Monday’ was around the corner. 5 February witnessed the greatest slide in the history of Dow. Dow Jones Industrial Average, a forerunner amongst all US indices, lost a whopping 1700 points in 24 hours. The frantic February saw the US stock lose $1 trillion in the first week itself. Even though this correction was long overdue, it caught investors unwary as they were busy basking profits in the shiny bull run. The recent correction in equities has thrown markets off guard despite a sound global economy and everyone is contemplating what’s next. Before we divulge into that, let’s sum up what has brought markets to where they stand today. After a strong start to 2018, major indexes pulled back as strong wage figures in the monthly US jobs report added to concerns about a pickup in inflation and subsequent tightening of monetary policy. January 2018 has been terrific in terms of employment in the US, which saw 200,000 jobs being added in the economy and a growth of 2.9 per cent in wages. The unemployment rate now stands at the levels of 4.1 per cent against 10 per cent in 2009. Post 2008 recession, this has been the most meaningful progress in the economy. In a tight job market, there were more jobs available than there were workers to fill them. This forced employers to offer higher pay to attract and keep workers. The uptick in the wages has been a clear indicator of improving economic status which, in turn, has pumped up inflation expectations.
This was reflected in a massive surge in the US Treasury Bond yields. For the first time since 2014, the benchmark 10-year bond yields rose above the 2.7 per cent mark. Markets have now become very certain of not only the impending rate hikes but also expect the Fed to raise rates at a faster pace. The rising interest rates along higher yields lead to higher borrowing costs for the corporates, and thus, lower the relative attractiveness for stocks.
WITH OIL LIKELY TO REMAIN STABLE IN 2018, OUTLOOK FOR MIDDLE-EAST MARKETS ARE BIASSED TO THE UPSIDE, ESPECIALLY WITH POLITICAL UNCERTAINTY EASING. Vijay Valecha
While the limelight was focused on the robust US economy, growth in the European Union reached 2.5 per cent in 2017, the best since 2007, which saw a growth of 3.4 per cent. The European economy is at the cusp of a broad cyclical expansion, after years of economic stagnation and rolling crises, boosted by regaining confidence and monetary stimulus from the Draghi-led European Central Bank. The German bund mirrored this optimism as the five-year bund yield breached 0.01 per cent breaking above the zero per cent levels, for the first time since 2015. The 10-year German bund yield climbed close to 0.7 per cent. The Asian markets displayed the same sentiment. China has held on to the baton of leadership in many segments of the economy. Now, the word on the street is that China is passing along its inflation to the rest of the world. Its Producer Price Index (PPI), which is a measure of inflation, turned positive for the first time in five years.
PHOTO CREDIT: Shutterstock/3000ad
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The PPI rose to 6.3 per cent for the full year of 2017, the highest in nine years. The GDP also grew for the first time since 2010 to 6.9 per cent. The attractive economic data buoyed on the Chinese government’s campaign to reduce excess capacity in industries such as coal, steel and aluminium and improve international trade. The Chinese bond yields have been growing since late last year and can be regarded as the leading indicator of growth globally. The Chinese 10-year RMB bonds trade at 3.9 per cent, which remain unperturbed amidst havoc elsewhere. Another major factor that can be considered for the sudden US debts sell-off was the surge in oil prices, which rose to three-year highs in January. This oil price surge led markets to markets expecting higher headline inflation. Rising inflation and a crash in the bond market can be considered as the greatest tail risk for markets in general. Tighter monetary policies can crimp economic growth in the long term. This has underpinned much of the climb in stock prices over the past year. Despite the recent dip across Wall Street, the Dow Jones Industrial Average rose three per cent in 2018 already. Strong corporate earnings and improving investors’ sentiments lend a bright picture
Vijay Valecha Chief Market Analyst, Century Financial Brokers
OECD INVENTORIES DROPPED
between January 2017 and December 2017
for the stock market. With both the US and Euro zone growing in tandem and with Asian economies on a roll, 2018 is expected to deliver continued growth and economic stability for the first time in a decade. FOREX MARKET With Trump's tax plan and US Fed’s intention to raise interest rates at least three times, the dollar could be a favourite in the trading community. Also, one should not forget that Fed is reducing the balance sheet size by $30 billion a month. This is going to be the first time in multiple years that Fed policies are going to contribute to rising bond yields. Counter intuitively, this could be termed as ‘Quantitative Tightening’. Well, if purchasing bonds is ‘Quantitative Easing’, reducing purchases is certainly the opposite. To put things into perspective, it seems that the US Dollar has some strong tailwinds behind its back in 2018.
OIL: BRIGHT OUTLOOK Major forecasts indicate that the positive sentiments in global economy will spill over to energy markets also. Oil demand could grow faster as the global economic growth is broad based and surprises to the upside. This could push the oil markets to deficit as demand for OPEC crude is expected to rise to 33.42 million barrels per day while OPEC compliance of more than 100 per cent means OPEC production growth will be stagnant. Rising US oil production might not be sufficient to tip the balance. OECD oil inventories fell 4.6 per cent between January and December 2017 due to the rise in global oil demand and strict OPEC compliance with production cuts. OECD oil inventories which touched a record high of 3093 million barrels in July 2016 has since then fell by six per cent. US Energy Information Administration (EIA) forecasts suggest that oil inventories could further decline 1.4 per cent and average 2952 million barrels in 2018. Overall it, looks like this could be a good year for crude oil. MIDDLE EAST With oil likely to remain stable in 2018, outlook for Middle East markets are biassed to the upside, especially with political uncertainty easing. Saudi Arabia’s crackdown on corruption had resulted in some prominent business men and even royals being detained in RitzCarlton, Riyadh. However, the majority of the cases have resulted in settlement and it is rumoured that the Kingdom’s government had netted a bonanza of almost $106 billion. This should ease the fiscal burden of the desert Kingdom immediately while the proposed IPO of Aramco in 2018, might help it garner enough funds for funding transformational initiatives. Outlook for UAE also is bullish as a slew of infrastructure projects have been announced ahead of the EXPO 2020 Dubai. The recent introduction of VAT should increase the fiscal strength of UAE government. Other GCC markets remain supported in light of rise in oil prices this year.
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THE RISE OF GCC BONDS On the back of strong foreign investor demand, the appetite for GCC debt is expected to continue in 2018 despite precarious oil prices and geopolitical instability
he year 2017 witnessed a series of landmark events: record year of issuance despite elevated geopolitical instability and rating downgrades; Dana Gas’s Sukuk restructuring, with minimal impact on the broader Sukuk markets; and heightening fears that higher oil prices may weaken the momentum of reform initiatives. According to a joint whitepaper produced by Fisch Asset Management and ENBD Asset Management, these milestones had a major impact on regional debt markets and will likely shape them going forward. Last year was the first time GCC federal governments (except for the State of Qatar) all tapped the international debt capital market. With issuances over $70 billion, 70 per cent of the region’s issuances came from sovereigns as they were necessitated by the persistent need to fund twin deficits because of lower oil prices. The bond offerings were comfortably met by non-GCC investors, who absorbed over 75 per cent of the amount issued in the primary market. The whitepaper suggested that the strong international demand for GCC sovereign and quasi-sovereign papers was underpinned by a range of idiosyncratic factors, including benchmark eligibility (Sultanate of Oman), attractive pick-up over strategic neighbours’ bond yields (Kingdom of Bahrain), strong evidence of fiscal consolidation (Kingdom of Saudi Arabia) and a dearth of supply (United Arab Emirates). A key driver for better access to the GCC bond market was hard currency issuance. In Central and Eastern Europe, Middle East and Africa (CEEMEA) region, hard currency issuance has historically been dominated by Russia and Turkey.
PHOTO CREDIT: Shutterstock/PSboom
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By contrast, in 2017 the GCC held the lion’s share: four of the top five sizable deals ($5 billion+) in emerging markets came from GCC sovereigns (two from Saudi Arabia, one from Abu Dhabi and one from Kuwait). “What are the key take-aways of 2017? Firstly, the market’s ability to absorb a significant uptick in bond issuance without a real price disruption speaks strongly for the GCC’s appeal to a broadening investor base—most notably in Asia and the US. While events such as the Qatar dispute can be price disruptive, they also bring investment opportunities. For example, we moved to an overweight position during the summer to take advantage of wider Qatar credit spreads,” said Philipp Good, CEO at Fisch Asset Management. On the Islamic front, the industry feared for the repercussions of the contentious Dana Gas litigation. Contrary to popular expectation, the Dana Gas Sukuk litigation, which emerged in June 2017, did not impact credit spreads across the broader Sukuk markets or impede GCC issuers’ ability to issue Islamic debt. Between June and December 2017, GCC issuers raised $2.25 billion in Shari’ahcompliant debt, which attracted strong order books and was an encouraging confirmation that investors understand risk in the GCC well enough to isolate esoteric events. Oil prices and regional unrest is something that the region has never been able to escape. The unforeseen embargo of Qatar was followed by the equally unexpected and heavily publicised anticorruption measures in Saudi Arabia, both of which caused shockwaves, leading to widening of the credit default swap spreads. Oil on the other hand, which had shown negative price momentum in the first part of the year, reversed the trend to finish 2017 trading at a two-year high. According to the whitepaper, the policy implications of higher energy prices will become an important topic in 2018. Furthermore, from a credit standpoint,
GCC USD ISSUANCE (billion) 80 70 60 50 40 30 20 10 0 2014
Issuance of USD 250m and above
Shaded area indicates sovereign issues
Source: ENBD AM, Bloomberg
GCC NEW ISSUES - 2017 SPREAD PERFORMANCE (basis points)
Oman Government 2027 MAF Global Securities Perpetual CBB International Sukuk 2025 KSA Sukuk Ltd 2027 ICD Sukuk Co Ltd 2027 Warba Bank Sukuk Perpetual BOS Funding Ltd 2022 Equate Sukuk 2024 DIB Sukuk 2022 Alpha Star Holding 2022
Source: ENBD AM, Bloomberg
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BRENT CRUDE PRICE (USD/barrel) 70 65 60 55 50 45 40 35 30 25 Q1 2016
CAPITAL REQUIREMENTS EXCEED BASEL III GUIDANCE 20%
Tier 1 Capital Ratio Latest Total Capital Ratio
Source: Moody's December 2017
Min. CET 1 Ratio
Min. Total Capital Ratio
UAE Min. Ratio
UAE Banks Capital Levels
Saudi Min. Ratio
Saudi Banks Capital Levels
Qatari Min. Ratio
Qatari Banks Capital Levels
Oman Min. Ratio
Oman Banks Capital Levels
Bahrain Min. Ratio
Bahrain Banks Capital Levels
Kuwait Min. Ratio
Kuwait Banks Capital Levels
Min. Tier 1 Ratio
a sustained increase in Brent crude is one of the greatest risks for 2018, as the temporary reprieve that the recovery has provided will likely test the resolve of governments to maintain structural reform initiatives. Usman Ahmed, Head of Investments at Emirates NBD Asset Management added, “Emerging market fixed income ended 2017 on a strong note and the positive sentiment has carried over into 2018. Looking ahead, we expect to see synchronised global growth in conjunction with monetary policy tightening, which would mean that the beta rally of 2017 will not be repeated in 2018. Investors will need to be far more vigilant in picking markets and credits, especially in the GCC, where the combination of attractive yields, structural reforms, choppy oil prices and geopolitical factors could throw a curveball at fixed income investors.” The widely expected stability in Brent crude prices should provide some reprieve to sovereign balance sheets but is unlikely to address the twin deficits, which should sustain in 2018. Consequently, the trend of large sovereign and quasi-sovereign issuance is set to continue, with the GCC likely to continue to play a prominent role in 2018’s new issue market. Net new issuance may increase, which will test current strong market technicals. In 2017, the Qatari sovereign, quasi-sovereign and bank issuers were notable absentees from the market, but with a budget deficit expected to reach over $7 billion, both ENBD and Fisch expect the sovereign to be a strong candidate for a new issue this year. Within its outlook for 2018, the whitepaper indicated that convertible bond issuances were overdue an uptick, but that until rates rise further the straight debt market will continue to dominate. While convertible bonds have been a feature of GCC markets for more than 10 years, with around 20 issues totalling at $23 billion to date, there remains a relative lack of supply to meet investor demand.
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VATâ€”WHERE DO WE GO FROM HERE? Riccardo Ubaldini, Partner for international tax law at BonelliErede deliberates on the implications of VAT on the economies of UAE and Saudi Arabia
18 page 18-20 Legal Perspective.indd 18
he much-discussed new Value Added Tax (VAT) legislation in the United Arab Emirates (UAE) and the Kingdom of Saudi Arabia (KSA), which has been modelled around its European counterpart, went live on 1 January 2018. The new legislation mandates a general five per cent levy applicable (with certain exceptions) on supplies of goods and services made by a taxable entity. VAT’s introduction is being closely watched by both the revenue-collecting authorities and the taxpayers (i.e. those subject to paying and collecting VAT).
While the relevant authorities will be able to raise money by an easy-to-collect levy, VAT-able persons (both established and non-established) will have to face unprecedented challenges when dealing with both the tax and the new compliance associated with the legislation. In principle, VAT is seemingly an easy tax to assess and collect. VAT is imposed at any stage of the value chain by the VAT-able person that charges VAT to its client (so-called ‘output VAT’), who then pays it to the fiscal authorities before deducting the amount of VAT its supplier has charged to him (so-called ‘input VAT’).
Riccardo Ubaldini, Partner for international tax law at BonelliErede
PHOTO CREDIT: Shutterstock/Gunnar Pippel
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As a result, effectively only the value that is ‘added’ by any VAT-able persons along the chain is actually subject to the new levy. By charging VAT to the client and deducting VAT paid to the suppliers, the tax ends up being ultimately only borne by the final consumer (who pays the tax and cannot deduct it). At any intermediate stage of the value chain the tax is, in effect, neutral, as any excess of VAT paid to suppliers over VAT charged to clients is then claimed as a refund from the revenue. (In the reverse situation the VAT-able person pays the excess to the Government, i.e. the excess of output VAT over input VAT.) Such neutrality however, is guaranteed so long as there are no limits to deduct the input VAT. That right of deduction is pivotal for a European Union VAT-style system in order to properly operate, i.e. so it may be limited in specified circumstances only. For example, the VATable person carries on exempt supplies that bears no right of deduction of input VAT charged on supplies obtained to provide the exempt supplies. As such, the introduction of VAT in the UAE and KSA brings about a number of economic implications. Firstly, any entities having to manage and pay VAT will see their costs increased on both a once-off and ongoing basis in order to meet compliance regulations. This will place an additional financial burden on businesses against a backdrop of often rising costs and increasing customer price sensitivity. However, Government coffers will be increased via this additional revenue, which are expected to be ploughed back into spending on national development programmes. (VAT-related revenues from imported goods are expected to represent a large portion of the total revenues raised, given that both national economies are heavily import-related.) Ultimately, the end consumers who are paying VAT and not able to reclaim it will face across-the-board price increases
ANY ENTITIES HAVING TO MANAGE AND PAY VAT WILL SEE THEIR COSTS INCREASED ON BOTH A ONCE-OFF AND ONGOING BASIS IN ORDER TO MEET COMPLIANCE REGULATIONS. THIS WILL PLACE AN ADDITIONAL FINANCIAL BURDEN ON BUSINESSES AGAINST A BACKDROP OF OFTEN RISING COSTS AND INCREASING CUSTOMER PRICE SENSITIVITY. Riccardo Ubaldini, Partner for international tax law at BonelliErede
for the goods and services they consume. In simple terms, their daily cost of living will go up. Both the UAE and KSA are home to large resident populations of expatriates, many of whom are highly cost-conscious. Various studies are already showing evidence of a ‘tightening of belts’ in spending terms among many citizens and expatriate residents especially, which is having economic knock-on effects, particularly in discretionary purchasing (such as eating out and luxury goods). It may also be that some expatriates decide that the heightened cost of living no longer justifies the reasons they had to move to the country in the first place, and relocate elsewhere. This has the potential to remove valuable skills from the job market as well as other economic impacts associated with decreased consumer spending.
Looking at the history of VAT’s introduction in Europe we can consider that compliance costs for those liable to pay them will be diverse. The most obvious financial implications will be the costs incurred with compliance with the new legislation, such as reporting obligations, but there are less obvious costs associated with the new system which will place potential burdens on VATliable businesses. For example, there will be costs associated with likely supply chain restructuring, cash-flow issues (if the refunds of excess input VAT over output VAT is not returned in a timely manner), changes in contractual agreements (linked to provisions which provide that prices must be VAT-inclusive both in B2C pricing but also in B2B), and constant monitoring of contractual counterparties in order to avoid being involuntarily implicated in any fraudulent or other illegal scenarios that may occur in an international setting. Additionally, costs will also be incurred as a result of the need to have the new legal framework studied and interpreted with relation to the individual VAT-liable entity. Among others, these costs will arise from the individual entity’s need to clarify its ‘objective value’ as its taxable base (when supply is made to a VAT-able person with no full right of deduction) determination of the place of supply of goods (especially in complex ‘chain transactions’ when right to dispose over the goods is transferred almost simultaneously to many acquirers), and VAT grouping. In summary, the logistical challenges ahead are numerous, and many stakeholders will be impacted by the new VAT legislation. However, given that that VAT in the Gulf states is modelled along the EU VAT system, European experience should provide useful guidance in order to minimise the impact of the new rules on established, as well non-established, companies doing business with and in KSA and the UAE.
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Rania Nashar, CEO, Samba Financial Group
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Y SAUDI BANKING’S FIRST LADY In an exclusive interview, Banker Middle East speaks to Rania Nashar, Chief Executive Officer of Samba Financial Group and the first female CEO of a listed Saudi Arabian commercial bank
ou were appointed CEO in February 2017, the Tadawul now has a female Chair and Citibank also appointed a female CEO to its new operation in Saudi Arabia— what significance do you apply to these appointments? I believe that these appointments reflect the vision and leadership of the Kingdom, and that the broader objective is to make a positive change in the Saudi society, particularly for Saudi women. It is time for them to take their rightful place, commensurate with their potential, to fulfil their ambitions and aspirations, and to contribute to the Kingdom’s society and business communities. 2017 has been a tough year for the Saudi banking sector—how has Samba coped with the challenges? One of Samba’s major strengths, one that earns it high rankings in the banking industry both in the Kingdom and the region, is its ability to adapt to emerging market conditions and challenges. This nimbleness enables it to maintain its normal high-level of performance and reduce its exposure to risk rates within minimum limits. This is what we consistently seek to achieve through our policies. Are you happy with the way the bank is managing the rising cost of credit and expenses? Certainly. Our cost management mechanism for both credits and expenses is prudent and professional. Our commitment to managing costs has resulted in the positive performance that can be seen in the Group’s final financial statements.
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Samba has made significant investments in its technological infrastructure so that it meets the needs of the future.
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The IMF believes GDP growth in KSA to be close to zero for 2017 and looking to the whole of 2018, credit demand is expected to weaken in KSA, partly on the back of reduced government spending. Do you foresee any issues as a result of this? The recently announced 2018 budget is the largest in the history of the Kingdom. In terms of government spending, particularly on capital projects, it has made a significant difference and it reflects the state’s commitment to expand development projects. Such indicators will have positive implications for boosting confidence in the local economy and for encouraging an optimistic outlook on growth rates. How significant is the MoU between the Capital Markets Authority of Saudi Arabia and the Saudi Arabian General Investment Authority (in October 2017) to build a framework to allow more foreign investment in the Saudi market? This MoU reflects the growing interest of major international and foreign investors in investing in the Saudi market. It is proof of the confidence in the local economy and it will help encourage investors who want a foothold in the Saudi market. What is the bank’s commitment to CSR and within that commitment how do you see the partnership with the Ministry of Housing developing? Social responsibility has always been a top priority for Samba. The bank has sought to institutionalise its activities in light of sustainable development. Our objective is to go beyond the traditional boundaries of community service activities through pioneering development programmes and projects that aim to meet people’s basic needs. An example of this is our initiative to provide 500 fully furnished housing units to needy families. Samba has signed an MoU with the Ministry of Housing, establishing
a real partnership between the public and private sectors to provide decent housing to Kingdom citizens.
SOCIAL RESPONSIBILITY HAS ALWAYS BEEN A TOP PRIORITY FOR SAMBA. THE BANK HAS SOUGHT TO INSTITUTIONALISE ITS ACTIVITIES IN LIGHT OF SUSTAINABLE DEVELOPMENT. OUR OBJECTIVE IS TO GO BEYOND THE TRADITIONAL BOUNDARIES OF COMMUNITY SERVICE ACTIVITIES THROUGH PIONEERING DEVELOPMENT PROGRAMMES AND PROJECTS THAT AIM TO MEET PEOPLE’S BASIC NEEDS. Rania Nashar, CEO, Samba Financial Group
Where do you see the competitive position of Samba Financial Group? Samba is a well-established banking group. Its track record of achievements and expertise make it a leading provider of banking and financial services on both a national and regional level. Our reputation is not the result of luck, but of decades of achievements, initiatives, and superior performance. The proof can be seen in the international banking awards and recognition certificates that we have received for many areas of our operations. What are your key strategies for customer acquisition and retention? Samba is always a winner in this field. Continuous improvements in customer service quality—beyond customer expectations— remains key to our success in gaining customers’ trust and retaining their loyalty. At Samba, we always look forward to strengthening our position as a banking partner to our customers.
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Women comprise about 22 per cent of the workforce in Saudi Arabia. Nashar's appointment as the first female leader of a Saudi commercial bank was a fundamental step in the right direction.
How do you see the business of banking in Saudi Arabia changing over the medium term? The banking sector in the Kingdom has always kept abreast of developments and changes in the communities and growing customer needs. I believe this is why financial institutions are more focused than ever on promoting e-banking services. Their experience in the local market has been remarkably successful and their efforts have enabled customers to meet their banking needs efficiently, safely and responsibly anywhere, anytime. What steps is the bank taking to ensure robust, secure and future-proof IT systems? Samba has paid close attention to its e-banking systems and made significant
ONE OF SAMBAâ€™S MAJOR STRENGTHS, ONE THAT EARNS IT HIGH RANKINGS IN THE BANKING INDUSTRY BOTH IN THE KINGDOM AND THE REGION, IS ITS ABILITY TO ADAPT TO EMERGING MARKET CONDITIONS AND CHALLENGES. Rania Nashar, CEO, Samba Financial Group
investments in its technological infrastructure so that it meets the needs of the future. Samba is now at the forefront of technology and is well equipped to meet the requirements of this era of banking services. The bank is also committed to maintaining technical and security standards. What do you identify as key challenges for Samba now and in the future? I believe that Sambaâ€™s main challenge is to maintain its position and reputation, which are based on its achievements and its contributions to the local and regional banking industry. Samba has the potential, expertise and the technical and human resources to support its efforts to consolidate its position and enhance its gains.
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12 Hawkamah Annual Conference th
April 30, 2018 - Dubai
Navigating Transformation and Disruptions: Overcoming Governance Challenges
Enabled by government support, technological innovations are disrupting traditional business models pushing boards and executives to re-think and transform their approaches to cope with such a dynamic landscape. Hawkamahâ€™s 2018 conference will explore the impact that these transformations and disruptions will have on how companies are governed. How can organizations align their decision making to match the increasing speed of change? How can Boards of Directors drive transformation and foster innovation within their businesses? How can transformation and innovation be encouraged and monitored? Join us. Debate the future. Now.
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POWER Gaoling more than 200 members of its elite was just the beginningâ€”now the hard work begins in Saudi Arabia
PHOTO CREDIT: Shutterstock/Natanael Ginting
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audi Arabia has a difficult job: it has to convince the world that everything will change but nothing will be disrupted. Its young population cheered the detainment of over 200 top officials in an anti-corruption drive, but now the Crown Prince must soothe the nerves of foreign investors and ramp up security for fear of a backlash. The Crown Prince Mohammed bin Salman has vowed to wean the Kingdomâ€™s economy off oil, end lavish subsidies, create a million or so jobs through mass privatisation and tackle the countryâ€™s dire environmental problems. All this comes with a hefty price tag. The Royal Order alone, which introduced a number of additional measures to soften the blow of economic reforms on Saudi households, has been estimated at $13.3 billion by the Government. However, the Bank of America Merrill Lynch (BofAML) calculates the cost at nearer $16.5 billion, equivalent to 2.3 per cent of GDP. The total cost could even climb to $18.7 billion.
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The overspend is likely to pay off. “The introduction of discretionary and potentially sticky payments in the January 2018 Royal Order is likely to support a recovery in economic activity,” said BofAML MENA Economist JeanMichel Saliba. “While the 2018 budget only contained a limited fiscal impulse and mega-projects have little immediate visibility, the handouts are likely to support more decisively economic activity.” BACK TO BUSINESS The biggest shake up to its economy since the discovery of oil in the 1930s was bound to cause a shock. January data from the Saudi Arabia PMI showed the weakest rise in business activity in the survey’s history following the introduction of VAT in January. Respondents commented on softer rises in new business intakes, intense competition for new work and fuel subsidy cuts. “The softness in the January PMI survey was fairly broad-based, with faster employment growth being the main highlight,” Khatija Haque, Head of MENA Research at Emirates NBD, said. “Wage increases, fuel subsidy cuts and the introduction of VAT is evident in the higher input costs and staff costs components of the survey in January. However, firms were the most optimistic about their prospects in the coming 12 months than they have been since May 2017.” Reports from non-oil businesses suggested that the impact on sales was likely to prove transitory, with part of the slowdown simply reflecting a natural payback following strong order flows prior to the policy implementation. More good news was hiding behind the headline. With private sector firms continuing to experience resilient demand, staff hiring picked up to its strongest since August 2016 and business optimism reached an eight-month high. The rate of job creation was the fastest for almost a yearand-a-half, with a number of firms noting that business conditions were expected to improve over the course of 2018.
SAUDI ARABIA’S FISCAL DEFICIT IS EXPECTED TO DECLINE FROM
17.2% of GDP in 2016 to
of GDP in 2017 and to under
of GDP by 2022 Source: Morgan Lewis
Ironically, the price of oil hit a twoyear high in November as the corruption crackdown sparked fears of a shortage. The economy remains scarred by consistently low petrochemical prices; however Saudi Arabia doesn’t bruise easily. FISCALLY HEALTHY The International Monetary Fund (IMF) predicts that non-oil growth will pick up to 1.7 per cent in 2017, but overall real GDP growth is expected to be close to zero as oil GDP declines in line with Saudi Arabia’s commitments under the OPEC+ agreement. Growth is expected to strengthen over the medium-term as structural reforms are implemented.
The fiscal deficit is projected to narrow substantially in the coming years. The IMF expects it to decline from 17.2 per cent of GDP in 2016 to 9.3 per cent of GDP in 2017 and to just under one per cent of GDP by 2022, assuming that the major non-oil revenue reforms and energy price increases outlined in the Fiscal Balance programme are introduced on schedule. “Fiscal consolidation efforts are beginning to bear fruit, progress with reforms to improve the business environment are gaining momentum, and a framework to increase the transparency and accountability of government is largely in place,” the IMF noted in a report. S&P Global Ratings (S&P) said that it expects the Saudi authorities to continue to take steps to consolidate public finances and maintain government liquid assets close to 100 per cent of GDP over the next two years. SCATHED BUT STABLE The banking system is also scathed but stable. Banks—the beating heart of the Saudi financial system—remain liquid and resilient. “Stress tests show that most banks, including all systemically important banks, would be able to continue operating and meeting regulatory capital requirements in the event of additional severe economic shocks, characterised by oil prices falling substantially below current levels,” the IMF said. However, the Kingdom’s banks have not escaped the impact of the government’s spending cuts. Moody’s Investor Services (Moody’s) warned that profitability at five of Saudi Arabia’s largest banks could be hit in 2018 as lower government spending drags on economic growth, in turn dampening credit demand and weakening corporate—and to a lesser extent— consumer borrowers’ ability to repay debt. “As the Saudi Government reins in spending, we expect lending to slow and problem loans to rise,” said Ashraf Madani, Vice President and Senior Analyst at Moody’s. “However, the big-five banks
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will be able to use their pricing power to offset these pressures and keep profit steady over the coming 12 to 18 months.” Rising interest rates will offset the impact on banks’ profitability of higher provisions and lower fees and commissions, Moody’s said, allowing them to reprice floating-rate corporate loans and achieve higher returns on their investment portfolios. Credit growth will be muted, with most banks already reporting flat or negative lending growth. “Non-oil GDP, a key driver of banks’ business activity, will grow by just two per cent, keeping credit growth subdued at around three per cent,” it said, adding that provisioning costs will rise, and fee income will fall as the economy slows. Banks’ funding strategies and SAMA’s liquidity management framework will have to adjust to structural changes in liquidity conditions, according to the IMF. The model in place for over a decade whereby banks relied almost exclusively on domestic deposits for funding and on SAMA for draining chronic excess liquidity came under pressure during 2015–16. Recognising that liquidity conditions may be more balanced going forward, SAMA is re-assessing its liquidity management framework. Reforms should include establishing a framework that supports the pegged exchange rate and helps SAMA align market interest rates with its policy objectives; developing liquidity forecasting models;
THERE IS A RISK THAT DOMESTIC POLITICAL CHALLENGES COULD DISTRACT FROM FISCAL CONSOLIDATION AND DETER INVESTMENTS IN THE NON-OIL ECONOMY. Fitch Ratings
SAUDI ARABIA: FINANCIAL SYSTEM STRUCTURE (End-2016; in percent of total assets)
Investment funds 2%
Specialised credit institutions 19%
Commercial banks 51%
Pensions funds 26%
Source: Saudi Arabian Monetary Authority. Total assets of $1.2 trillion (about 186 per cent of GDP).
focusing money market interventions on regular, short-term liquidity operations, while moving away from non-competitive ways of allocating liquidity; limiting standing facilities to overnight maturity; and requiring collateral for all lending to commercial banks. GAME OF THRONES The fate of Saudi Arabia lies in the hands of Crown Prince Mohammed bin Salman, the first in line to the throne and the real power behind it. Few had heard of the 32-year-old First Deputy Prime Minister outside Saudi Arabia before 2015; now the world’s youngest ever Minister of Defence has the job of shepherding the Kingdom’s economy away from disaster and into the modern age. The popular opinion seems to be that he is the right man for the job. “We believe that concentrating power in the hands of Crown Prince Mohammed bin Salman should bolster economic and social reform efforts,” said Fitch Ratings in a statement.
However, the key man risk has been heightened and a backlash is possible. Indeed, it wasn’t just the elite that the Crown Prince confined to luxury of the Ritz Carlton, but his political rivals. “It is likely to take some time for the implications for the domestic political and policy environment to become clear,” said Fitch. “The detention of senior members of the Saudi elite following the creation of an anti-corruption commission under Mohammed bin Salman seems likely to immediately strengthen his position.” In a statement, the crown prince said that the country’s Economic Affairs Council recognised “the importance of ensuring that investors could operate with confidence in Saudi Arabia”, and that anti-corruption measures were a key part of Vision 2030. The Crown Prince chose his target well—the country scores poorly on World Bank governance indicators; sustained anti-corruption measures can help improve this, but it will take time.
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The National Commercial Bank Realize Tomorrow
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| 9 2000 1000
19/02/2018 11:18 16:18 14/09/2017
Banks—the beating heart of the Saudi financial system—remain liquid and resilient. PHOTO CREDIT: Shutterstock/Natanael Ginting
In the meantime, Fitch believes that domestic political challenges could distract from fiscal consolidation and deter investments in the non-oil economy. “Potential domestic challenges to reforms could emerge from three groups,” the ratings agency said. “The parts of the governing elite that are seeing their influence declining could try to fight back. Efforts to liberalise social policies, including promoting a less conservative version of Islam, could anger social conservatives.” Reforms to reduce public deficits may potentially lead to greater discontent among those most affected, despite significant efforts to cushion the economic impact through a citizen account system of allowances to lowand middle-income families. It remains to be seen if the events of November reduce the risk of such
IT HAS BEEN SAID THAT THE PRICE OF DOING NOTHING IS GREATER THAN THE PRICE OF CHANGE. FOR SAUDI ARABIA, CHANGE DOESN’T COME CHEAP, BUT THE ALTERNATIVE WOULD COST IT EVERYTHING.
challenges or whether they embolden dissent regarding the Crown Prince’s rapid rise and his policy agenda. Nevertheless, spill overs from regional conflicts or a domestic political shock that threatens stability or affects economic policies remain a threat to the Kingdom’s 2030 vision. S&P suggests that the risks emanating from recent shifts in Saudi Arabia’s political power structures and societal norms, alongside various regional stresses, are balanced by the possibility that these structural reforms could empower Saudi citizens and make Saudi Arabia more attractive to investors over the medium term. It has been said that the price of doing nothing is greater than the price of change. For Saudi Arabia, change doesn’t come cheap, but the alternative would cost it everything.
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SAUDI ARABIA in numbers POPULATION
FINANCIAL SOUNDNESS INDICATOR CROSS-COUNTRY COMPARISON AND BANKS' BALANCE SHEET COMPOSITION (end-2016 or latest available; in per cent)
BANKS' ASSET STRUCTURE Foreign assets 14%
Manufacturing loans 9%
Cash and reserves 7%
Source: Worldometers; United Nations estimates (February 2018)
SAMA bills 6%
Commercial loans 16%
Government 6% Other assets bills 5%
Other corporate loans 18%
CROSS-BORDER EXPOSURES OF BANKS (In per cent of total) 40 30 20 10 0
Household loans 19%
B jhi A ad B si B al IB a ad ra NC lRa MB Riy SAB Fran AN ww S linm lbil Jazi a A A Al A SA Al
Source: Worldometers (February 2018)
GDP REAL GROWTH RATE
0.1% 1.7% 4.1%
BANKS' DEPOSIT STRUCTURE Time, public 12% FX 9% Demand, public 4%
Time, private 17%
Saudi Arabiaâ€™s GDP is expected to grow in 2018
16 15 14 13
Interbank 4% Other 3%
ab bia Ar es ra iA ed irat t d i u Un Em Sa
NONPERFORMING LOANS TO GROOS LOANS 6 5 4 3
2 Debt issuance 2%
(2016 est.) (2015 est.)
BANKS' LIABILITY STRUCTURE
GDP PER CAPITA
Source: CIA World Factbook
Demand, private 56%
Source: International Monetary Fund
$55,300 $56,300 $56,600
Source: CIA World Factbook
REGULATORY TIER 1 CAPITAL TO RISK-WEIGHTED ASSETS
b ra s d A te ite mira n U E
Sources: SAMA, National Central Banks, IMF FSI database, Bankscope, and staff estimates.
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BUILDING TIES, STRENGTHENING RELATIONSHIPS, CREATING OPPORTUNITIES Knight Frank presents the prospects for real estate along the Belt and Road Initiative for UAEâ€”the hub of the belt
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or centuries, the legendary Silk Road from the ancient Chinese capital of Xi’An provided a twoway link with bustling trading centres as far away as Rome and Malacca. Despite intermittent stoppages of this vibrant trade route, fast forward to the 21st century, China has become the world’s largest exporter, with goods and services totalling $2.2 trillion in 2016. BRI The Belt and Road Initiative (BRI) was launched by China in 2013, with an aim to revive the great Silk Road as well as provide a new platform for multilateral cooperation to create new trade routes, economic links and business networks. Six economic corridors have been identified from China to Central and South Asia, the Middle East and Europe (the Silk Road Economic Belt) and, along a maritime route, from Southeast Asia, Oceania to the Middle East, Africa, and Europe (the 21st Century Maritime Silk Road). Spanning 69 countries and encompassing around 60 per cent of the world’s population and 40 per cent of global GDP, the blueprint is also a collection of interlinking trade deals and infrastructure projects, set to be mutually beneficial to BRI countries and China. As one of BRI’s goals is to further stimulate Chinese economic growth, expanding demand overseas will be crucial as the project will open new markets for Chinese goods and services, shoring up the country’s economy against any potential slowdown in domestic demand as well as the potential rise of protectionism in other countries.
PHOTO CREDIT: Shutterstock/esfera
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A significant number of participating BRI countries are undergoing rapid modernisation and urbanisation leading to soaring demand for roads, railways, ports, airports, pipelines, and technology infrastructure. In addition to infrastructure investment, the increased connectivity of some of the less developed markets will lead to increased commercial opportunities, helping integrate these nations with the wider, global economy. Funding for this vast initiative is coming through number of routes, including multilateral sources such as the Chinaled Asia Infrastructure Investment Bank (AIIB), the Silk Road Fund, in addition to allocations from the large stateowned banks. Ratings agency, Fitch, has estimated there to be $900 billion of infrastructure project finance pledged to the initiative. CHINA AND THE MIDDLE EAST Middle Eastern countries, particularly the Gulf Cooperation Council (GCC) countries, over recent decades have had strong trade links to China, particularly as one of the main providers of commodities and
BELT AND ROAD IN NUMBERS
of the world's population
of the worlds GDP
$900 billion of investments projected Source: Knight Frank
natural resources to China, along with its critical access to Africa and Europe. The GCC member nations are eager to transform their economies to reduce over-dependency on oil and gas. This provides fresh prospects for Chinese investors, especially in the real estate, high-tech and energy sectors. Over this period the UAE has become the favoured destination of Chinese capital. However, China and the United Arab Emirates’ (UAE) partnership is not a new story, with Beijing and Abu Dhabi first establishing a formal diplomatic partnership in 1984. In recent years, China and the UAE have continued to strengthen their bilateral relations, these efforts have resulted in China becoming one of the UAE’s major
trading partners. With further integration planned, we expect the relationship to flourish further in the future. Over 4,200 firms have set up base in the UAE, a gateway to access not only the Gulf countries but also Africa. A focal point for Chinese investment has been the UAE’s most populous emirate— Dubai. The signing of a MoU at Dubai Week in China is a case in point with countries looking to enhance trade and investment cooperation. General trade levels between Dubai and China now surpass those that Dubai has with India, USA, Saudi Arabia and Switzerland. The Dubai International Financial Centre (DIFC) has played a central role in this success story; the offering of
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RISE OF CHINESE INVOLVEMENT
increase in Chinese tourists in Dubai in Q1 2017
most active real estate investors in H1 2017
Chinese firms have set up base in the UAE 7 Source: Knight Frank
REAL ESTATE PROSPECTS (Dubai)
REAL ESTATE PROSPECTS (Abu Dhabi) Dragon Mart in Dubai, UAE, is the largest trading centre of Chinese products outside of China. It is 1.2 km long and includes more than 3000 shops. PHOTO CREDIT: Shutterstock/Patrik Dietrich
independent regulators and judicial systems has already attracted many of China leading financial firms, especially with an agreement signed with the Shanghai High People’s Court to foster further closer cooperation and reinforce commercial links for more secure trade. Increased trade has also paved the way for an increase in tourism and real estate investment. The number of Chinese tourists increased by 60 per cent in the year to Q1 2017, ranking them as the fourth largest nationality to visit Dubai, up from eighth in the same period a year earlier. In the first six months of 2017, Chinese investors registered as the fourth most active real estate investors in Dubai, up from sixth in the same period a year earlier.
Source: Knight Frank
China’s Cosco Shipping Ports will invest $400 million in building a container terminal in Abu Dhabi as the emirate aims to expand trade with the world’s second largest economy. Dragon City in Dubai, developed by Nakheel, has more than 3,000 shops managed by 1,700 Chinese traders and receives 65,000 visitors daily. Dragon Mart in Dubai is the largest trading centre of Chinese products outside of China. The ties between China and the UAE are expected to grow further in the coming years as Dubai strengthens its position as a global hub for trade, travel and investment ahead of the Dubai Expo 2020, creating more opportunities for Chinese businesses to use Dubai as
a platform for growth and expansion. These factors provide a strong platform for the BRI to succeed. Lower oil prices, higher interest rates and a strong dollar have underpinned the slowdown in GDP growth over the last two years. As the economy adjusts to the new norm in oil prices and diversifies to cut its reliance on crude oil revenues (2030 Dubai Industrial Strategy), the UAE’s GDP growth is expected to gain momentum in 2017 (+2.7 per cent) and 2018 (+3.3 per cent) in the run up to Expo 2020. We have started to see market sentiment in real estate stabilise in the first half of 2017 and start to turn positive at the back end of 2017.
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ON STETHOSCOPES, TELESCOPES AND GOVERNANCE OF ARAB BANKS Alissa Amico, Managing Director at GOVERN discusses the corporate governance regulations and culture of financial institutions in the Arab world
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n the wake of the financial crisis that started unravelling a decade ago, banks were perceived as the major culprits of corporate misconduct. A decade later, they have been subjected to volumes of regulations ranging from the Dodd-Frank Act, to the Volker Rule, to MIFID and the Basel Committee requirements. There is, seemingly, no end in sight of the regulatory wave that has focused on bank governance generally, and conflicts of interest in particular. That regulators mean business was demonstrated by hefty fines handed to major banks for practises ranging from trading irregularities to distribution of toxic financial products to manipulation of interbank rates. REGULATORY ZEAL The message behind these regulations and enforcement actions—delivered not by a white dove, but rather by a watchful eagle—signalled to bank executives and boards that the velvet gloves have come off. The main focus of this effort was on corporate governance failings in developed markets, where governments in the United States, United Kingdom, Greece and Spain have emerged as white knights in shining armour, injecting swaths of capital in failing banks such as Lloyds, Goldman Sachs and the Royal Bank of Scotland, to the dismay of the general public. Regulators and banks in emerging markets, on the other hand, have begrudgingly inherited the consequences of this newfound regulatory zeal, while the health check of most emerging market-domiciled banks has not revealed the same compensation excesses or conflicts of interest targeted by the new global regulations. Indeed, when
the supervisory wave hit the shores of emerging markets, protests by both growth market regulators and banks regarding their relevance were palpable. While emerging market regulators and banks pointed out the irrelevance of these regulations to their national circumstances, they begrudgingly complied in order to avoid compromising their integration in the global financial architecture. This is certainly how this story has played out in emerging markets such as the Middle East, where banks have always been rather strictly supervised, and where due to the concentrated ownership structure of banks, similar abuses and excesses did not occur. BANK REGULATION IN THE ARAB REGION Over the past decade, all countries in the Arab region have developed specific corporate governance codes or guidelines for banks, reflecting the new Basel Committee and OECD recommendations, which were revised in 2015. In most jurisdictions in the region, governance codes have been reviewed and have gradually been imposed as mandatory regulations. Jordan, Bahrain and Qatar continue operate on a 'comply-or-explain' basis, reflecting the Central Banks’ desire to provide scope for governance scalability. A decade later, Arab Central Banks’ interest in evolving governance regulatory frameworks remains unabated: Morocco revised standards in 2014, Qatar in 2015, Kuwait and Jordan in 2016, Saudi Arabia and the UAE are doing so this year. Although with some exceptions, these standards are largely in line with global practices. However, their adoption by the banking community is questionable.
PHOTO CREDIT: Shutterstock/Peshkova
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A KEY QUESTION IS WHETHER BOARDS OF ARAB BANKS STAND READY TO FACE THE SIMULTANEOUS MULTIPLICATION OF RISKS, INCLUDING GLOBAL COMPLIANCE, DOMESTIC LENDING AND GLOBAL INDUSTRY DISRUPTION. Alissa Amico, Managing Director, GOVERN
Even more questionable is the suitability of these standards—which at the time of their development reflected global bank governance failings—to organisations in emerging markets—as well as the Arab world. Indeed, in the Middle East— considering the critical role of banks in national economies—bank governance has been a priority for regulators well before the financial crisis knocked on the door. Historically, the sector has been the largest contributor to the financial services industry and today, it continues to account for more than 54 per cent of the industry in the region, while equity and bond markets contribute to only 33 per cent and 13 per cent respectively. In Jordan and Kuwait, the banking sector accounts for a whopping 80 per cent of the financial sector and in Bahrain and Lebanon, bank assets exceed the GDP by several multiples. Banking regulators are not the only supervisors interested in good governance of banks. For most countries in the region, banks are the most important sector represented in public equity markets. According to our recent research, of the 100 largest listed companies in the region, 42 are banks, far higher than any other sector. Banks are therefore key to attracting capital to the region’s equity markets and indeed,
bank shares tend to be the among the most actively traded in the region where liquidity is scarce. For instance, in Qatar, five of the largest 10 listed companies that account for 70 per cent of market turnover, are banks. Driven by revisions of banking governance standards and principles for listed companies over the past decade, Arab banks and their regulators have formally aligned with international governance standards, making their boards more independent and reinforcing risk management. However, considering that the regulations emanating from the global standard-setters were not targeted at specific risks in the Middle East, these were adopted more for the form than for their substance. In private, board chairs concede that independent directors serve a decorative role and do not dare to
BANKS ARE KEY TO ATTRACTING CAPITAL TO THE REGION’S EQUITY MARKETS AND INDEED, BANK SHARES TEND TO BE THE AMONG THE MOST ACTIVELY TRADED IN THE REGION WHERE LIQUIDITY IS SCARCE. Alissa Amico
challenge the majority shareholder, who is often also the chair or the CEO. In recent years, the tables have turned: the symbolic application of international governance practises by Arab banks sector will no longer suffice. Their governance is now of critical importance not only as a signal of the acceptance of the global rules of the game, but also to protect banks from a range of international and domestic risks. National and international developments over the past three years have highlighted the need for a home-grown regulatory overhaul of bank governance in the Middle East to address specific domestic economic threats and opportunities that require robust risk management and oversight. The fact that Arab banks had survived the financial crisis with minimal battle scars offers little consolation at this juncture. They were neither allowed to structure potentially toxic financial products nor had an issue with excessive remuneration of executives, given that the separation of management and ownership in the region is symbolic. Perhaps more importantly, while the concentrated ownership of some banks by families and other state protected banks during the crisis also carry specific governance risks, it also need to be examined going forward.
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Banking assets of top 10 banks
per cent GDP
BROAD CHALLENGES Domestically, banks in the Middle East are operating in an uncertain environment as economies of both oil-exporting and importing countries have been negatively affected by the decline in the price of natural resources and political instability in some countries of the region. This has accentuated the existing risks, notably raising questions around structure of loan books, where credit concentration both to specific borrowers and sectors remains relatively high. For instance, the five largest borrowers are equivalent to 35 per cent of the total capital of Omani banks. Arab banks remain mostly domestically concentrated which further contributes to their risk profile. In Saudi Arabia, net foreign assets account for just over 10 per cent of banks’ total assets and in Qatar, domestic credit comprises 88 per cent of the total outstanding credit, according to the latest available data. While their loan book is concentrated, it is also dominated by short-term lending such personal and real estate loans, which represent, on average, 40 per cent of the total banking assets in a number of Arab countries. Internationally, Arab banks have been under pressure due to concerns around money laundering and illicit financing,
ASSETS OF TOP 10 BANKS AS PERCENT OF GDP (billion USD)
In Lebanese family-owned banks for example, boards, management and the shareholders are often one and the same, impeding the necessary separation between the CEO and Chair roles. State-owned banks, whose market share ranges from 20 to 40 per cent in individual Arab countries, have their stability and governance concerns primarily linked to challenges of maintaining an arm’s length relationship to other state-owned enterprises. In Egypt, this has, in the 1990s, resulted in high non-performing loans and difficulties in restructuring banks prior to their privatisation.
Top 10 banking assets as % GDP
Source: GOVERN calculations, 2017.
REGION’S 100 LARGEST LISTED COMPANIES BY SECTOR (as % of total market capitalization)
Transport & Logistics 3%
Telecoms 15% Retail 0.71%
Oil & Gas 0.35%
Metals & Mining 3% Food 3%
Non-Banking Financial Services 2%
Source: GOVERN calculations, 2017.
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forcing Central Banks to actively engage with international organisations and standard setters in Washington, Brussels and London for a more nuanced and betterinformed regulatory approaches. The pressure on central banks to dispel these perceptions have increased considering the potential negative repercussions on the integration of Arab banks in the global financial architecture if doubts around their integrity linger. For instance, the classification by the European Commission of the UAE, Bahrain and Tunisia in December 2017 as tax heavens has put further pressure on the national regulators to demonstrate that the sector is transparent and adequately overseen. At the same time, the de-risking by global banks has put enormous pressure on correspondent banking relationships with Arab banks, with CBR withdrawals affecting 39 per cent of MENA banks, affecting both commercial clients and even NGOs operating in the Middle East.
THE BANK GOVERNANCE CULTURE, ESPECIALLY AT THE LEVEL OF BOARDS, NEEDS TO BE RE-THOUGHT CONSIDERING THE DYNAMICS IN THE SECTOR REGIONALLY AND INTERNATIONALLY. Alissa Amico, Managing Director, GOVERN
While it is debatable as to what extent these concerns and measures are wellfounded, examples of legal battles such as the Arab Bank case (which will be decided in the US Supreme Court this year), further fuel concerns around the linkages of Arab banks to illicit activities. Emerging examples such as the recent Turkish Halkbank case, where earlier this month one of its senior employees was convicted of assisting to evade sanctions against Iran, highlight the risk of a spillover of political tensions on the banks.
Together, these national and international developments imply that the traffic light at the current juncture where Arab banks find themselves has turned from green to yellow. Last monthâ€™s bank country risk assessment by Standard and Poorâ€™s classified a number of countries in the region as high risk, including Morocco, Tunisia and Egypt. While Arab banks remain highly capitalised, strict prudential regulation and conservative approaches to lending and product distribution will not suffice in the Aldous Huxley-like 'brave new world' of banking. The bank governance culture, especially at the level of boards, needs to be re-thought considering the dynamics in the sector regionally and internationally. This re-thinking is occurring while the sector is sitting on shifting sands both domestically and internationally. Domestically, the banking sector is starting to witness significant structural changes with the consolidation of banks in the Gulf
BANK CORPORATE GOVERNANCE STANDARDS Jurisdiction
Corporate Governance Code
Corporate Governance Code (for banks and listed companies)
Corporate Governance Code for Banks
Corporate Governance code for banks, additional guidelines for Islamic banks
Rules and systems of governance in Kuwaiti banks Regulations of legitimate governance oversight in Islamic Kuwaiti Banks
Multiple decrees of the Central Bank
Central Bank Directive on Corporate Governance of Credit Organisations National Corporate Governance Commission recommendations
Corporate Governance Guidelines for Banking and Financial Institutions Recommendations for Islamic banks
Corporate Governance Guidelines by the QCB
Principles of Corporate Governance for Banks
Guidelines for Banks and Credit Institutions
Corporate Governance Guidelines for UAE bank directors (draft currently under revision) Required Administrative Structure in UAE Banks
Source: GOVERN Research, 2017.
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(e.g. NBAD and the FGB merger in 2017 in the UAE). This might, in the long-term, lead to the emergence of clear national champions operating cross-border and hence needing to reckon with governance standards in multiple jurisdictions. Globally, the banking sector is poised for significant disruption. Tech titans have the potential to unsettle the sector in a way WhatsApp and Skype have with the highly protected telecommunications sector in the region. Regulators and policymakers will no longer be in a position to shield local banks from the winds of change as they previously have from foreign competition because the status quo has increasingly become about fintech and innovation as opposed to size and scale. The days that Arab banks can continue dealing with clients through tellers and faxes seem numbered. FUTURE OUTLOOK To remain integrated in the financial system, their boards will be required to demonstrate commitment to integrity and transparency principles, where bare-bones governance disclosure will not assuage foreign and supranational regulators. To a large extent, the responsibility for this lies with the Central Banks which will need to coordinate with peer regulators and facilitate cross-border transparency. At the level of individual banks, a re-thinking of transparency, especially for banks with foreign shareholders or dual listings, will likewise be important. At the same time, bank boards will be put under pressure not only to improve transparency, but perhaps more importantly, to adjust to the forthcoming threat to their brick and mortar business model. Just as Careem has brought ‘creative disruption’—as Schumpeter would have it—to the transportation industry, fintech will render the traditional business models of Arab banks largely obsolete in the longterm. Already in other emerging markets such as China, the mobile payment sector has reached $5.5 trillion.
REGULATORS AND POLICYMAKERS WILL NO LONGER BE IN A POSITION TO SHIELD LOCAL BANKS FROM THE WINDS OF CHANGE AS THEY PREVIOUSLY HAVE FROM FOREIGN COMPETITION BECAUSE THE BUSINESS OF BANKING HAS INCREASINGLY BECOME ABOUT FINTECH AND INNOVATION AS OPPOSED TO SIZE AND SCALE. Alissa Amico, Managing Director, GOVERN
THE ROLE OF BOARDS A key question is whether boards of Arab banks stand ready to face the simultaneous multiplication of risks, including global compliance, domestic lending and global industry disruption. Due to the concentrated ownership that previously shielded banks from the financial crisis, boards of most Arab banks continue to be composed of family and state nominated representatives, and as a result of the low turnover of board members, lack the diversity and fresh blood that can help them navigate the risks, but also the opportunities, offered by fintech innovation. While boards and C-suits of banks are cognisant of the domestic economic context and political risks, they are less prepared for the technological forces set to disrupt the industry. Many bank boards have not conducted an evaluation and generally speaking, do not possess critical skills such as information technology due to the lack of refreshment of boards linked to their stable ownership structure. Board evaluations and measures to foster diversity in the management and board ranks are certainly welcome. It is a new dawn not only for bank boards but also for the banks regulators in the region. The transposition of international regulations (which in some ways are ill-suited to the reality of Middle Eastern economies) that has occurred over the past decade is no longer a sine qua non condition to protect the
reputational capital of Arab banks. Local regulations and their implementation will be needed to address the ownership structures and specific economic risks in the region. The practises of the bygone era where banks were exempted from governance standards that were applicable to other listed companies will need to be reconsidered as well as regulations for listed companies and banks streamlined. Regulators will also need to critically re-assess the supervisory approaches such that governance is explicitly considered as part of the prudential supervisory framework as opposed to a separate pillar of oversight. In doing so, they will need to integrate the concerns that arise in the case of family and state-controlled banks, while aiming to ensure that all banks—irrespective of their ownership—compete on a levelplaying field. In the coming years, bank regulators in the Middle East will need a stethoscope to diagnose the ability of institutions to withstand the macro-economic and political risks, by identifying and focusing on systemically important banks, while at the same time assuring the viability of smaller banks. They also need a telescope to foresee and integrate in their regulatory frameworks looming industry risks to ensure that boards and C-suites are positioned to withstand broader shifts in the industry that may render the traditional banking industry obsolete in the coming years.
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THE MENA POTENTIAL Philip Dowsett, Funds Partner at Morgan Lewis, sheds light on Dubai’s pedestal and MENA rising to the eyes of the west
n terms of the international stage, for a while it’s been all eyes on Dubai and its prevalence in relation to its standing as jurisdiction of choice for operating in or out of the Middle East. By virtue of this prevalence, Dubai has arguably and by default, found itself as the Middle East and North Africa (MENA) region’s jurisdiction of choice for the startup and venture capital (VC) industry. MARKET SHARES AND INITIATIVES Now, notwithstanding this somewhat serendipitous facet of Dubai’s growth and stature as a hub of business in MENA, over the last few years Dubai has promulgated many efforts to cement this status and ensure it remains the VC centre of the Middle East. According to a recent report, the UAE leads the MENA region as home to 42 per cent of its start-ups, followed by Egypt at 12 per cent, Lebanon at nine per cent and Jordan at eight per cent. However, a number of other MENA countries are launching similar initiatives to try and capture a portion of this fledging market and attempting to knock Dubai of its mantle. For example, in the last year, Saudi Arabia has launched ambitious plans in the country’s 2030 Vision plan to depart from the notion of being an oil-dependent economy, and encouraging female participation in the workforce, as well as its recent $3.5 billion investment into a leading US tech company.
ON THE BACK OF THE SOUQ ACQUISITION AND CAREEM, THE PAPER-UNICORN, MORE EYES FROM THE INTERNATIONAL STAGE ARE ON THE MENA VC INDUSTRY. Philip Dowsett, Funds Partner, Morgan Lewis PHOTO CREDIT: Shutterstock/grmarc
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Oman has also initiated ambitious plans, with various investments arms of the country launching the Sultanate’s first equity-based venture capital firm, Innovation Development Oman Holding, that has an initial capital of $129 million. Additionally, the Oman Investment Fund launched its own $200 million Oman Technology Fund. Qatar has equally initiated its efforts with The Qatar Development Bank having launched a $365 million SME Equity Fund to provide capital to innovative startups and entrepreneurs, as a part of the country’s overall economic diversification. ON A GLOBAL STAGE Taking a step back, the VC industry in itself is an established industry and market in the West. VC investment in the United States last year totalled around $58.6 billion and Europe had $16 billion, while MENA only stands at around $800 million. The MENA region is therefore playing a challenging game of catch-up. This is however carried out against the backdrop the MENA VC industry which is still in its infancy. It has arguably become an industry in itself over the last decade and its progress and achievements within that period are nonetheless notable. The rise of VC in the Middle East has primarily been led by a select band of protagonists that have each, and in certain cases, all, been involved in financing rounds for the most high-profile start-ups in the MENA region. This roster includes Wamda Capital, STC Ventures/Iris Capital, Middle East Venture Partners (MEVP), and Beco—which now has numerous other investors vying for a piece of this VC action in the MENA. It’s fair to say however, that this interest has, and in the large part remains to be, from MENA-based investors. The lure of investing in MENA start-ups has not quite yet gained the mainstream interest from across the various ponds. That said, there has recently been an increased interest from foreign investors
42% in UAE
12% in Egypt
in Jordan Source: Morgan Lewis
into MENA-based start-ups, including Series A and B investments in Fetchr which attracted considerable interest from Silicon Valley VC firms (recently closing a $41 million Series B round). A Series A investment by Russian VC, Addventure, was also made in Service Market (formerly known as movesouq). On top of that a majority European-based investment was made in Sprii (formerly MiniExchange). And of course, the recent high profile buy-out of Souq by Amazon. CHALLENGES Given the potential that the nature of many tech-based start-ups means that locality and operational bases are flexible compared to traditional asset-based business, and the attractive tax-free opportunity that basing an operation in a MENA country may afford, one may question why the MENA region has not attracted more start-ups.
This is potentially multi-fold: 1. Operations in MENA are not without their hurdles. Although of course operating across statelines in the US and across Europe comes with managing different laws and regulation, there are numerous synergies and similarities. However, in MENA operating across the region often involves grappling with laws and regulations that are generally more simplistic in their nature and often which have not modernised to address technology business, resulting in ambiguities and uncertainty around operations. This is often coupled with complex issues relating to foreign ownership (which differs in each country), as well as varying demographics. 2. The ownership issue. A number of Gulf Cooperation Council (GCC) countries require local ownership, and this can be a struggle for foreign investors to get to grips with. On the positive side, several countries have free zones affording 100 per cent foreign ownership which circumvents this concern, but, depending on the nature of the business, sometimes an onshore presence in the same country is required which then requires local ownership (and structuring appropriately to protect the assets). 3. We need a Unicorn (or two). In the same way proof of concept is often vital in a start-up, MENA needs headline grabbing deals and exits to legitimise its standing. And with the Souq exit and the recent $100 million investment by STC in Careem creating a paper Unicorn, this is getting there. 4. The cost issue. Setting up in the GCC can be notably more expensive than doing so in Europe and the United States. However, there more cost-efficient options such as establishing in Egypt, Jordan or Lebanon where it is cheaper to set-up and have start-up culture.
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PROFILES IN LEADERSHIP An important new series from CPI Financial, the Middle East’s leading financial and business publishing house. In challenging times, clear and dynamic leadership is the key to business success. CPI Financial’s new series Profiles in Leadership will identify and define those qualities necessary to succeed, profiling successful individuals and their businesses.
CPI Financial TV CPI Financial TV is proud to launch a new online Leadership series. We are conducting a series of in-depth, on-camera, face-to-face interviews with the key players in the Middle East banking and financial services sector.
Dubai Islamic Bank The longest-established modern Islamic bank is one of the leading financial institutions and our interview with its Group CEO launched our Leadership series on 10 September 2017. You may watch the full interview online or alternatively view key segments of the interview individually.
Who’s next? Our Leadership series launches with Dr. Adnan Chilwan of Dubai Islamic Bank. Look out for more great interviews in the coming weeks. We already have Patrice Couvegnes, CEO of Banque Saudi Fransi, and HE Abdul Aziz Al Ghurair, CEO of Mashreq, lined up with even more to come…
Unparalleled insight Understand how the region’s top bankers view the challenges and opportunities their institutions face… and the plans they intend to implement.
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Dr. Adnan Chilwan Group CEO Dubai Islamic Bank
HE Abdul Aziz Al Ghurair CEO Mashreq
Michel Accad Group CEO Al Ahli Bank of Kuwait
To learn more, contact: OMER HUSSAIN +971 4 391 5419 email@example.com
CPI Financial FZ LLC • PO Box 502491 Al Shatha Tower, Office 1209 Dubai Media City, Dubai, U.A.E. Tel: +971 (0) 4 391 4681 • Fax: +971 (0) 4 390 9576 • www.cpifinancial.net
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Although, it is not uncommon for these start-ups to look to relocate their HQs to Dubai when finances start to permit. 5. Geopolitics and negative press. Unfortunately, one thing holding back investment in MENA (on many fronts), is negative headlines. These have—in the past—had the tendency to overshadow the many successes, growth, and increased stability throughout much of the MENA region. MENA is not Silicon Valley. One of the further challenges as a start-up in the MENA region is the lack of transparency over financing terms and investment criteria, as well as the difficulty in obtaining information on potential suitors for investment, as compared to a considerably greater flow of information in the western world. Part of this is due to the limited number of deals which means that benchmarking terms are more difficult. There is also no real access to the same reports or insight into financing terms that can be at the hands of startups in the US and Europe.
The MENA Private Equity Association has sought to redress this and provide more visibility on structures, terms and investors, and despite movement, information and comparatives are still difficult to obtain. Consequently, VC investors are potentially in a stronger negotiating position in the MENA region than outside of MENA, and the luxury of term-sheet shopping as a start-up in MENA is generally rare, and arguably the investors hold most of the cards and know how to play them. POTENTIAL On the positive side, notwithstanding the infancy of VC in the MENA, many of the principals working for the leading VC firms in the region are sophisticated and seasoned. Plus, as the VC industry in the MENA region matures, these individuals and firms have endeavoured to adopt best international practises and proper documentation to ensure that— even if by size—MENA is catching up and that it can compete from a sophistication perspective.
Ultimately, despite its infancy, the VC industry in MENA is quickly becoming an industry in its own right and is a key focus for many of the jurisdictions looking to move away from the legacy dependency on oil and create alternative means of wealth and income. Concerted efforts have been made by a number of the MENA governments to foster entrepreneurial spirit and accommodate start-ups—from the launch of incubators and accelerators, to accommodating 100 per cent foreign ownership structures and tax-free regimes. With proven increasing interest from non-MENA VC firms into the region’s start-ups and on the back of the Souq acquisition and Careem, the paperUnicorn, more eyes from the international stage are on the MENA VC industry. Based on the last few years and the determined, albeit ambitious, plans of various governments, the MENA region is seemingly positioning itself well capturing its own share of the global VC market. It will be increasingly interesting to see if anyone can topple, or at least start to unbalance, Dubai off its current pedestal as the home of MENA VC.
There has recently been an increased interest from foreign investors into MENA-based start-ups. PHOTO CREDIT: Shutterstock/dotshock
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FINANCIAL SERVICES DISRUPTED:
OPEN BANKING AND AI
By Wissam Khoury, Managing Director, MEA, Finastra
PHOTO CREDIT: Shutterstock/Sarah Holmlund
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he banking industry is undergoing a major transformation. Banks and financial institutions are continuously exploring new ways to leverage technology to reduce the cost of operations, improve customer experience and speed time to market. Among these challenges, two technology developments stand out in terms of their potential for disruptive innovation. 1. Open bankingâ€”empowering the customer Data sharing between banks and authorised third party applications (such as personal finance managers or payment aggregators) has been tried with some success in parts of Europe and the US. The real push has been driven by two recent regulatory developments: the EU Payment Services Directive (PSD2) and the UK Competition and Markets Authority (CMA) initiative on open banking.
IN THE OPEN BANKING SYSTEM, THERE ARE STILL LINGERING QUESTIONS AROUND CUSTODY OF DATA AND ITS PROTECTION. Wissam Khoury
However, when it comes to the Middle East, things are a little different. Fintechs have undeniably disrupted the traditional banking model. The regulatory burden is escalating and the regional correspondent banking relationships are witnessing a dynamic shift. Amidst all this the industry is also expected to make a transition to open bankingâ€” which raises issues of its own. Concerns around data sharing and cybersecurity are prevelant and must be taken seriously, but the industry must also find solutions to enable it to put this discomfort aside and realise the benefits on offer.
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The PSD2 mandate and the UK open banking initiative are going to create a level playing field for incumbent large banks and new entrants alike. Both these initiatives, which are expected to be implemented in 2018, will unleash fierce competition for market share and see the launch of many innovative services using secure open APIs which banks will have to provide. This will enable european banks to continue vying for a bigger share in the global banking and financial services industry. The open banking model encourages sharing data through open APIs and works towards developing an open banking standard. This data exchange between banks and third-party application service providers will enable consumers to: • Get a 360-degree view of all their banking accounts and cards; • Manage finances using a single sign-on app; • Find trustworthy and objective information on products and services of different providers in one place for comparison; • Initiate payments from various accounts using a single app. • Quite a few fintech companies are witnessing renewed attention from industry stalwarts on public facing APIs, partner focused APIs, and internal APIs. Banking and nonbanking entities need to gear their processes towards an open banking paradigm as it gains momentum. 2. Artificial Intelligence (AI)—endless opportunities Banks and financial institutions sit on a treasure trove of data. Many have analytical tools in place to extract value from this data, but it is here that AI can bring real value. Machine learning, cognitive computing and natural language processing capabilities
Wissam Khoury, Managing Director, MEA, Finastra
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and tested across several organisations globally. The financial sector can also use them to reduce human managed processing and automate customer engagement, freeing up bank employees for more value-added tasks.
FOR MIDDLE EASTERN BANKS, THE DOWNSIZING OF CORRESPONDENT BANKING RELATIONSHIPS IS ANOTHER STRATEGIC CHALLENGE THAT NEEDS TO BE ADDRESSED. LACK OF DATA TRANSPARENCY MAY CAUSE A FEW INTERNATIONAL BANKS TO EXIT REGIONAL RELATIONSHIPS WHICH COULD THREATEN BUSINESS. Wissam Khoury
can maximise the insight banks can extract from this wide availability of data. The first, and arguably the most critical, aspect that AI can cater to is fraud identification. Fraud impacts both the bottom line and the reputation of the bank. Although banks, of course, have detection solutions implemented, they are not foolproof yet. AI can help identify fraud for intervention, using a combination of: • rules and reputation lists, where a human encoded logic is used; • supervised machine learning, where the machine is fed historical data of fraudulent behaviour to flag suspicious activity today; • unsupervised machine learning, where hierarchical clustering or principal component analysis are used. AI can also help to catch human error, for example to prevent fat finger trades. Another major aspect where AI can make a real difference is the customer
experience. An AI solution can help delve deeper into both structured and unstructured data to bring out meaningful insights. This can uncover hidden patterns, subtle buying preferences and triggers for dissonance of customers. Once you know your customers better, you can personalise your engagement with them. You can be proactive rather than reactive. These insights and customer knowledge will further help the industry create more intelligent and customised products and services for customers. In fact, a few Middle Eastern banking groups are already piloting an AI driven virtual assistant with a limited set of customers. There are also a few banks that are currently using beta versions of chatbots to improve customer service and loyalty. Perhaps this is where the most significant opportunity lies—in AI’s ability to automate the frontline. Chatbots are already being implemented
STRATEGIC CHALLENGES One of the biggest concerns when it comes to technology in the financial sector is the protection of data. Integrating new technology into the architecture has its upsides. However, it cannot be done at the expense of data security. In the open banking system, there are still lingering questions around custody of data and its protection. There are audit trails and regulatory requirements that need to be taken into consideration. Sharing of sensitive data also requires a certain type of infrastructure laced with security protocols, technical connections and governance rules in place. For Middle Eastern banks, the downsizing of correspondent banking relationships is another strategic challenge that needs to be addressed. Lack of data transparency may cause a few international banks to exit regional relationships which could threaten business. Another limitation that the industry faces today is the knowledge available. It is important now to look for AI experts— who can take up leadership positions for AI in organisations? The industry must encourage the right skillsets and may need to consider training employees to handle new technology. EMBRACING THE FUTURE Although there are a few challenges that can be envisaged around AI and open banking right now, the cost of not embracing these innovative technologies is going to be exceptionally high in the near future. Banks must combine technology with human intuition at this point. Once they achieve it, they will be better positioned to meet the demands of today’s digital customers.
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FINDING OPPORTUNITIES AMID THE RISE OF THE MACHINES Mikhail Zverev, Head of Global Equities at Standard Life Investments discusses the pros and cons of this emerging technology
dentifying the winners and losers of the rise of AI requires an understanding of the underlying technologyâ€”fast processors and vast datasets. Hardware winners include both innovators and mass producers of semiconductors. Facebook, Amazon and Google have vast amounts of data on their users, but so do other businesses such as healthinsurers. As artificial intelligence (AI) moves from the realms of fantasy to reality, it brings both opportunities and threats for investors in 2018. The possibilities of AI were underscored in 2015 when Google DeepMindâ€™s AlphaGo programme triumphed over the reigning world champion in Go, a Chinese board game of profound complexity.
Mikhail Zverev Head of Global Equities, Standard Life Investments
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In 2017, DeepMind announced that a new programme, AlphaGo Zero, had beaten the original AlphaGo 100 times to nil. Information technology now allows the gathering, storage and analysis of the vast data sets needed to mimic the computational powers of the human brain. This not only brings hope, but also fears that manual work will be replaced by robots and decision-making by algorithms. Apple’s newest iPhone provides a commercial example. In 2012, Google algorithms learned to find videos of cats on YouTube. Google’s researchers created a neural network of 16,000 computer processors with one billion connections that achieved 75 per cent accuracy. The machine was never told what a cat was during the training. Jeff Dean, the Google Fellow who led the study, told the New York Times, “It basically invented the concept of a cat.” Progress since has been spectacular. Now AI-based face recognition acts as the password to unlock the iPhone X. TECHNOLOGY BRINGS OPPORTUNITY An understanding of the underlying technology guides us to where 2018’s investment opportunities may occur. Many industries offer great data sets. If AI can help identify patterns and make better, faster decisions, it will driver higher sales, cut costs and even save lives. These developments have opened the door to new opportunities for innovative companies. One example is NVIDIA, a US semiconductor company. Its original business was graphics processors that accelerated 3D graphics, driving the boom in video games. But the chips that power 3D graphics are also able to perform the tasks that drive machine learning. NVIDIA chips have become key components of machine-learning systems. As a result, sales increased, and the company’s share price has risen more than eight-fold in the past three years.
WE ARE STILL IN THE EARLY DAYS OF AI GROWTH. IF AI CAN ALLOW BUSINESSES TO IDENTIFY VALUABLE DATA PATTERNS AND IMPROVE DECISION-MAKING, THERE IS MORE INCENTIVE TO CAPTURE AND STORE DATA. Mikhail Zverev Head of Global Equities, Standard Life Investments
We are still in the early days of AI growth. If AI can allow businesses to identify valuable data patterns and improve decision-making, there is more incentive to capture and store data. Tesco, the UK retailer, talks about every part of its retail infrastructure—from carts to tills to shelves—being able to generate and store data. This information can both help control costs and target higher sales through a deeper understanding of individual customers. But the rise of AI is also good news for the semiconductor industry. Demand for memory chips produced by companies such as Samsung Electronics is already robust and growing. These trends will help sustain this growth. BIG DATA = VALUABLE ASSET Companies that own great data sets will benefit from their ’asset’ too. Facebook, Amazon and Google have vast amounts of data on their users and are actively investing in AI. In 2018, we expect investors’ attention to shift to opportunities in more specialist niches, such as healthcare, which can be just as promising. American health insurer United Health has one of the largest data sets in the industry. It monitors the health data of tens
of millions of patients, from drug prescriptions to hospital visits. It is working on detecting early changes in its customers’ health using AI. The company’s management team talks excitedly about being able to predict diabetes long before it develops and to intervene early to help its customers manage or prevent the disease. WHO IS AT THREAT? AI is also a threat to some existing business models. Algorithms are already effective at answering simple IT questions, providing customer helpdesk support. AI can even review basic legal documents. Today, these tasks are performed by IT services and businessprocess-outsourcing companies. The survivors will be those companies that adapt by automating these activities and shifting their offering towards more valueadded services. The speed of AI progress has been spectacular. The full impact on industries and societies lies ahead. Already, it has created a lot of value and presents real and material opportunities. The investment winners of 2018 will be those companies that not only have the right data but also understand how to use it.
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I N THE PURSUIT OF E XCELLENCE
I NDUSTRY A WARDS 2018
SAVE THE DATE 3rd MAY 2018
The Ritz Carlton, DIFC, Dubai, UAE 7pm cocktail reception followed by dinner and the awards ceremony
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THE LONG VIEW
THERE NEEDS TO BE A DIFFERENT APPROACH TO RISK FOR HUMAN CAPITAL—ONE THAT THE BANKING INDUSTRY NEEDS TO EMBRACE SWIFTLY.
Tony Long CEO, CPI Financial
EMBRACING THE EXTRAORDINARY Tony Long, CEO of CPI Financial highlights the importance of acquiring the right talent in a fast-paced world
reating the right company culture is one the most challenging aspects of successful leadership. Unfortunately, all too often the reality simply doesn’t live up to the vision and implementation consists of some superficial values and other attempts at aligning the business with a new set of behaviours that most people simply have not bought into (and have little or no intention of conforming to). Clearly, a company’s culture is largely a product of the people that have been hired and the temptation is usually to hire to a perception of ‘our kind of person’. But what happens when the kind of people you need do not fit the corporate mould?
The technology changes that are ripping through the banking industry at the moment present arguably one of the most difficult aspects of managing the necessary change to transform organisations into ones that are fit and able to take on the challenges that the new digital ecosystems present. Banker Middle East was media partner at the recent Magnifintech Seven conference in Dubai in January and one of the opening speakers was Matteo Rizzi, co-founder of Fintech Stage. Matteo is a self-confessed misfit. A super-nice, super-smart guy, but a misfit. Needless to say, at a fintech conference the speakers all wore jeans and t-shirts and the audience mainly wore suits and ties,
but they were all there to listen and learn and Matteo’s advice could not have been clearer—“If you keep hiring the same people, you’re going to end up in the same place.” Now this might sound like stating the patently obvious, but historically for banks hiring people who do not fit is virtually unheard of. The entire search and selection process is geared precisely to finding people who fit perfectly. This is understandable in an industry where mistakes are expensive in both financial and reputational terms, but the people who can really make a difference to the organisation in a world where change is measured in weeks and new platforms can be obsolete before they are even finished beta testing, are not the kind that conform to banking stereotypes. There needs to be a different approach to risk for human capital— one that the banking industry needs to embrace swiftly if it is going to stand any chance of transforming into the kind of businesses that are able to compete with the tsunami of change that is heading its way. Matteo continued, “You need to be able to dare; to hire people you know are not going to fit, because by the fact of not fitting they are going to be able to change your organisation.” Misfits are usually considered mistakes in the perfect algorithm-based hiring processes that most banksemploy. But misfits are the ones who tell it like it is and get things done. Talent does what it can, genius does what it must. And given that maintaining the status quo is no longer an option, there needs to be a re-evaluation of what kind of culture needs to exist within the banking world in order for the incumbents to survive and thrive. The message from the conference was equally clear—fail fast, learn and move on. As Elvis puts it, “A little less conversation, a little more action please.”
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Published on Feb 25, 2018
Published on Feb 25, 2018
An exclusive interview with Rania Nashar, chief executive of Samba Financial Group and the first female CEO of a listed Saudi Arabian commer...