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How will the GCC banks cope if the future is bleak?

Middle East: Sunday, July 15 - 2007 @ 14:44

If you are a cautious banker you need to weigh up both optimistic and negative scenarios and make sure that you survive under all circumstances.

It is not hard to envisage such a negative outlook. After a long period of upward movement in oil prices a correction is to be expected and indeed oil prices peaked last summer and have been lower since then.

This means that average oil prices for 2007 will be lower than in 2006, and that with production also down that total GCC oil revenues may well be lower this year for the first time this century.

Perhaps this is not just a correction in the oil price but a new downward price trend. This is one interpretation of the very sharp stock market crashes seen in the GCC last year – markets have priced in a lower oil price.

It would clearly need a major trigger to cause a further decline in the oil price. But step forward the possibility of a major correction in global bond and stock markets, now running past their usual cyclical correction point. Would such a global sell-off also not instantly result in a fall in commodity prices as speculators would dump all markets in a flight to cash?

Real estate bubble

This has been a pattern seen in the past, but it could be different this time. The impact of a further fall in oil prices on the GCC economies would be sharp because of the bubbles that have formed in local real estate, although admittedly the stock markets have already priced in an oil price shock and their reaction would be less dramatic than if the equity bubble had not already burst.

In this scenario the GCC banks would be left running for cover. Those banks with loan portfolios most exposed to real estate would clearly be in the greatest peril, and the usual pattern under such a scenario would be for some hasty marriages of convenience to shore up damaged balance sheets.

It could be that at this point the global banking giants would make a few regional acquisitions. Again that is the pattern that has often been seen in emerging market banking crises of recent years, and a largely economically beneficial consequence of what looked like a disaster at the time.

Financial free zones

On the other hand, both local financial institutions and the global banks have been expanding rapidly in the GCC in recent years, increasing local competition.

The new licenses in Saudi Arabia, new financial free zones in Qatar and Dubai, and even now Ras Al Khaimah are a part of this process. And in a downturn there would therefore be a much larger shake-out among the participants than would have been the case without such a growth in banking capacity.

Hence if the pessimistic outlook for business in the GCC is proven correct then the regional banking sector will consolidate, lose some players and become more integrated into the global financial system. In the process it will become more competitive and be even more profitable in a recovery scenario.

And with the long term demand for oil and gas likely to support higher prices, even under a pessimistic scenario a recovery will always be in sight, and the banks with the deepest pockets will be able to wait for it.

In part two, The Optimists View of GCC Banking, we look at the flip side of the argument, exploring the results of a positive outlook.

See also:
Parallels with the 1970s are striking
Falling US dollar and surging stocks, like in 1987!
The fundamental and cyclical position of the GCC business cycle

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Sunday, July 15- 2007 @ 14:44 UAE local time (GMT+4) Replication or redistribution in whole or in part is expressly prohibited without the prior written consent of Mediaquest FZ LLC.

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