Tuesday, 28 May 2024

Sands of Change

5 min read

By Research

Even with the Middle East’s lifeblood, crude oil, stuck in prolonged doldrums, bankers remain optimistic about the future of the trade finance and supply chain business in the region

Core to the optimism is the favorable growth in trade, especially with Asia, which according to Monetary Authority of Singapore, expanded five-fold in the past decade. The situation is made more favourable by the retreat of the global banks from the region as they continue to refocus on their home markets and to cut exposures to money laundering risks that have set them back billions in fines. Sparked by this combination, sands of change swept the region’s transaction banking as glaring gaps were left in the wake of global players’ retreat and intense local competition forces banks to break out of their geographical comfort zones.

Competition, credit reliance and dated technology are inhibiting future growth
The opportunity left by the global banks did not go unnoticed and many domestic/regional banks grew their transaction banking business aggressively in the recent years to grab a piece of the lucrative pie. As a result, the intense competition led to an erosion of lending margins as the traditional credit trade business borders on a price war. Moreover, the dependence on large corporations has handed the bargaining power over to the borrowers, further compressing the margins.

While banks are aware of this, the transition away from this credit dependence remains slow and due to their relatively dated technology infrastructure, efficiency and products capabilities remain below global standards. This greatly held them back in terms of providing more sophisticated services, serving the needs of large global supply chains as well as their global expansion.

At the same time, global banks that remain, like HSBC, have consolidated and grown stronger. Increasingly, new entrants, the Chinese banks, are also flexing their deep balance sheet as they ride on China’s “One Belt, One Road” initiative and the new Silk Road policies into the region. Together, they have largely cornered the market for large international corporations and the increasing number of Chinese firms operating in the region.

Opportunities abound
Nevertheless, the growing trade flows through the region remains large enough to support more successful transaction banking businesses as long as these regional/domestic banks know where to position themselves and what areas to specialise in.

Tapping on the often overlooked but gainful clientele, the SMEs, some insightful banks managed to stand out among their peers. Although the SMEs accounts for more than 70% of the region’s economy, they have been traditionally underfinanced due to complications in assessing their credit quality. The recent heightened AML and KYC concerns have made funding even tougher to obtain. In fact, a World Bank study highlighted that the average share of SME loans among total bank loans is just 7.6% in the Middle East and Africa region and at an astonishingly low of 2% in members of the Gulf Cooperation Council.

On the flip side, this represents a tremendous opportunity for local banks to capitalise on their intimate understanding of the local markets. Coupled with increasing government financial and administrative support, the banks can and should be driving a revolution in SME financing. Moreover, many of these clients remain highly reliant on paper based processes, negating the need to invest in advance technology solutions. Far sighted first movers like Noor Bank and Mashreq Bank have benefited from this growing segment. Noor Bank for one has set up a special SME division, Noor Trade that is a special advisory system where financial experts make a close study of a customer’s expansion needs, the industry they operate in, external factors and organic growth potential before handing out the loans. While no specific figures has been released, Noor’s NPL for SMEs remains “comfortable” while overall NPL ratio dropped to 5.1% in H1 2015 from 6.7% a year ago.

For supply chain finance, it is imperative that the banks must understand their clients’ end to end supply chain flow and make certain at which nodes they can play a part in and from there figure out how to be core to their clients. Subramanian Krishnmurthy from National Bank of Fujairah noted: “To be core to their clients, banks must understand their clients so as to do more than fitting them into prefixed set of product categories.” He added: “Banks in the region must work within their capacity as no banks can cover the entire supply chain due to the extreme workload and the tedious, cumbersome paper-based work streams involved.”

This focus allows smaller banks in the regions to better compete against the larger global banks and at the same time, serve the needs of their customers. Additionally, this can kick-start the region economy by giving a financial boost to the traditionally underserved SMEs, potentially sparking off a positive cycle of reinvestments.

Make no mistakes
Nevertheless, banks in the region are under no illusion that transaction banking is not about technology and that they can outcompete with the large global banks in terms of technology capabilities. Therefore, smaller banks have to liberate themselves from the big banks’ brute force mentality towards IT investments.

Banks with limited resource must be open to partnering new entrants such as Fintech and other external vendors to boost their capabilities. Banks can also consider collaborating with its peers to work towards standardisation in order to achieve efficiency and speed to market. To be sure, some banks have already taken a platform approach and are actively seeking to complement their internal IT capabilities with external solutions. This aggregation of costs, both internally and externally, post potential leapfrogging in IT investment efficiency.

Bounded by limited resources, IT investments must be disciplined and focused. Banks must be willing to drop support of certain legacy processes and protocols and focus on increasing systems around their target clients. To build a solid foundation for future expansion, infrastructure investments should be geared towards digitisation and straight through processing in order to improve their products platform and efficiency. This should allow them to effectively target the clients that are do not fit the one size fits all platforms of bigger institutions that while highly scalable and efficient, lacks flexibility.

Risk and compliance framework
Intense competition has forced banks to rethink their overseas expansion plans. Currently, most of the banks’ strategies centre on serving the needs of the region’s businesses overseas instead of fighting for foreign market share. Without a strong clientele abroad coupled with the recent liquidity drain back at home, banks must take a calculated approach on determining if they should enter the new markets via partnerships or via expensive local presence.

To increase their international standing and also due to international pressures, the banks need to do more to combat financial crimes and set in place a strong risk and compliance framework. As banks compete in the crowded home market, some might be pressured into onboarding high-risk clients or facilitating fraudulent trade. Without these in place, global banks and foreign corporates will remain cautious when dealing with these banks.

While there is room for optimism, banks must be aware of the tightening environment and start planning their future strategy. Ultimately, future growth largely depends on whether they can wean away from their current credit reliance, break away from their geographical silos and lastly, form constructive partnership to bring the region’s transaction banking industry to the next level.

Keywords: Middle East, MAS, Credit, SME, AML, Noor Bank, Mashreq Bank, National Bank Of Fujairah, IT, Technology, Standardisation, Digitisation, Risk And Compliance, Regional Trade
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