Frost & Sullivan Whitepaper On Financial Benchmarking of the Financial Services Sector in the Middle East Prepared for:
Table of Contents 1 Objective and Scope...3 2 Definition...3 3 Introduction to Financial Services Industry in the Middle East...3 4 Middle East Financial Services Industry Trends 2020...4 5 Middle East Banking Sector...4 6 Middle East Diversified Financial Sector...5 7 Middle East Insurance Sector...6 8 Middle East Real Estate Sector...7 9 Conclusion...8 10 Appendix...8-21 i
Objective and Scope The objective of this whitepaper is to benchmark the Financial Services industry in the Middle East against its international peers. For this purpose, Frost and Sullivan has compared certain financial parameters over the last five years (2008 to 2012 Year to Date) with six regions North America, Europe, Asia Pacific, Latin America and Caribbean, North Africa, and Sub-Saharan Africa. All countries in the regions mentioned above are included in the scope of this whitepaper. All Year to Date (YTD) figures are as of October 15th 2012. Definition The Financial Services Industry is classified into four sectors given below: 1. Banking Sector includes Commercial Banks, Diversified Banks, National Banks and Regional Banks. 2. Diversified Financial Sector includes Capital Markets, Consumer Finance, Asset Management and Investment Banking. 3. Insurance Sector includes all kinds of insurance such as Life and health, Property and Casualty, Multi-line Insurance, Reinsurance and Insurance Brokers. 4. Real Estate Sector includes both Real Estate management and development companies and Real Estate Investment Trusts (REITs ) Introduction The Middle East has one of the fastest growing financial markets despite economic and political instability. The industry is in the middle of a huge structural shift brought about by changing demographics, increasing regulatory requirements and changing consumer preferences and demands. The Middle East financial sector has been resilient despite the global financial crisis and assets have grown at a 3 year Compound Annual Growth Rate (CAGR) of 7.9 percent in contrast to the global growth of 5.9 per cent CAGR for 3 years. Exhibit 1: Financial Services industry: Assets Growth Rate, Middle East vs Global, 2008-2012 YTD 3
The industry remains fundamentally strong backed by conservative investment practices and proactive measures taken by governing bodies to ensure liquidity and retain confidence in consumers. In addition, the region also has less integration with global markets and little exposure to sovereign debt crisis. Middle East Financial Services Industry Trends 2020 According to Frost & Sullivan the trends in this industry are: Changing demographics, consumer preferences and increasing awareness will drive the need for more sophisticated products and delivery methods. Greater investment in technology and infrastructure would be needed to meet the demands of tech savvy Generation Y consumers and achieve deeper penetration levels. Greater integration with global financial markets would be needed to expand beyond local regions and create a global presence. Leveraging the Islamic banking potential by using differentiation and strategic positioning to fuel the dampened conventional model. As organisations become global, regulations governing financial markets would be standardised. These regulations would become stricter and demand greater level of compliance to ensure consumer protection and transparency. Intensifying competition as more global organisations create their footprint in the Middle East. In fragmented sectors such as insurance, introduction of standard products would intensify competition as there would be less scope for differentiation. Banking Sector The downside risk in Middle Eastern Banks is limited as compared to their international peers. Due to conservative risk practices adopted by Middle Eastern banks, foreign assets are primarily in the form of deposits with almost 85 per cent denominated in US dollars and the remainder in currencies of stronger European nations such as Germany and France. Middle Eastern Banks can be characterised by high profit margins, high capital adequacy ratios, strong government backing and low international credit exposure, access to cheap cost of funds, stronger liquidity position and low-debt domestic products. Parameter 1 Profitability The Middle East has recorded the highest net profit in the banking sector globally since 2008. Middle Eastern Banks generated a net profit between 38 and 42 per cent in 2008-2012 YTD. The Banking sector in the Middle East stands second in terms of return on assets after Latin America and Caribbean and recorded 1.5 percent in 2011 and 2012 YTD. Return on equity has been stable between 12 and 13 per cent since 2008 reinforcing the resilience of this sector during the 2008 global crisis. 4
Parameter 2 Asset Quality Middle Eastern Banks had one of the lowest non-performing asset ratios (non-performing assets to total assets) in the range of 2-2.5 per cent historically between 2008 and 2011. A non-performing asset ratio below 3 per cent is considered good and is an indication of strong asset quality. However, the ratio stood at 5.5 per cent for 2012 YTD, the highest when compared to all other regions and is an indicator of weakening asset quality. According to Frost & Sullivan, this may be due to problematic assets resurfacing in the Middle East banking system and would lead to decline in profitability due to increased impairment charges. This may also lead to increased cost of funding debtors as banks would look at compensating losses due to decline in asset quality. Parameter 3 Capital Strength (Solvency) Total capital ratio for the Middle East is recorded at 16 per cent for 2012 YTD and stands second globally after banks in Sub-Saharan Africa. This ratio reinforces strong fundamentals of the banking sector and places it in a comfortable position to meet the new Basel III requirements. Parameter 4 Liquidity Loans to deposit ratio for Middle Eastern Banks is the lowest globally: has been in the range of 33 to 40 per cent over the last five years. It stands at 40 per cent for 2012 YTD. This ratio indicates a strong liquidity position but is also an indicator of the huge lending potential of the sector. Middle Eastern banks need to increase lending opportunities while maintaining the level of non-performing assets at the 2011 level (below 3 per cent) to ensure sustained profitability in this sector. *Please refer Appendix Exhibits 2 7 for more information on the Banking Sector. Diversified Financials Sector The Middle East has huge government spending and this holds true for the Diversified Financials sector. According to a recent study by Invesco, a leading investment bank, Sovereign wealth funds account for 88 per cent of investable assets and 79 per cent of new assets in the asset management industry in the region. However, political instability and aftermath of the Arab spring has had negative effects on this sector. There is a huge untapped opportunity in private wealth management in the region. According to statistics provided by The Middle East Institute, the affluent or high net worth individuals have roughly about $800 billion in wealth most of which is concentrated in the Gulf Cooperation Council (GCC). Overall, the diversified financial sector in the Middle East is characterised by low profitability, low return on equity, low return on assets and capital, average liquidity, strong solvency and moderate leverage when benchmarked against its international peers. 5
Parameter 1 Profitability Net profit margin for the sector stands at 1.2 per cent for YTD 2012 down from 1.7 per cent in 2011. The sector has shown a decline in profits since 2009 when it was 4.1 per cent. Also, the Middle Eastern diversified financial sector ranks the lowest in terms of net profit margin when compared to other regions globally. Return on Assets stands at 1.6 per cent, which can be rated as average in comparison to its global peers. The Middle East diversified financial sector is one of the lowest in terms of return on equity after the Asia Pacific and stood at 2.6 per cent for 2012 YTD down from 3.6 per cent in 2011. On the other hand, return on capital was recorded at 2.2 per cent for 2012 YTD up from 1.3 per cent for 2011. However, this sector would be below average in terms of return on capital when benchmarked internationally. Parameter 2 Solvency The total liabilities to assets ratio for the Middle East diversified financial sector is 61.9 per cent for 2012 YTD and 67.7 per cent for 2011. This ratio is the lowest after Latin America and the Caribbean and is a reinforcement of the conservative risk management practices adopted by the Middle East. Debt-equity ratio also remains below average and is a good sign of leverage at a nominal level when compared to developed economies such as North America and Europe that are leveraged beyond 100 per cent. Hence, the Middle East diversified financial sector can be rated as strong in terms of solvency when benchmarked against its international peers. Parameter 3 Liquidity The sector has an average liquidity with a current ratio in the range of 1.1 to 1.3, but one that is lower than the global average. *Please refer Appendix Exhibits 8 14 for more information on the Diversified Financial Sector. Insurance Sector The Middle East Insurance sector was affected by the 2008 crisis but the sector showed resilience later and is expected to be a great factor in the development of the financial services industry. The sector has significantly low penetration providing huge upward growth potential and diversification opportunities for the region. Insurance Sector in the Middle East is characterised by low profitability, low return on equity, negative return on assets, and low return on capital, high liquidity, strong solvency and low leverage in comparison to its global counterparts. 6
Parameter 1 Profitability The Middle East insurance sector registered a net profit margin of 3.1 percent in 2012 YTD and 4.4 percent in 2011.The sector has one of the lowest profit margins globally just after Latin America and the Caribbean. The sector has declining and negative return on assets and a declining return on equity. Return on capital seems to be improving but is ranked the lowest globally. The low profitability of this sector can be attributed to the fragmented nature, price competition in the market and lack of awareness among consumers in this region. Also, their investment portfolio comprises mostly of equity and real estate and is subject to high risk and volatility unlike other international insurers where the investment portfolios are 95 per cent investment grade bonds. Parameter 2 Solvency The total liability to assets ratio for the Middle East insurance sector is 80.3 per cent for 2012 YTD and 82.6 per cent for 2011. The sector ranks second in terms of this ratio after Latin America and Caribbean suggesting strong solvency. The Debt-equity ratio is witnessing a downward trend and stood at 21.9 per cent for 2012 YTD. This is one of the highest in the Middle East and North Africa but can be considered low when compared to its global counterparts (developed countries). Parameter 3 Liquidity Liquidity is a key factor in the insurance sector due to the nature of claims or liabilities faced by the sector. The Middle East insurance sector has a high current ratio and is ranked the top most in terms of liquidity. Despite low profitability measures, Frost and Sullivan expects a positive outlook for this sector due to many qualitative factors such as changing demographics, increasing awareness, high savings rate in the region, increasing gross domestic product (GDP), regulations on compulsory insurance and increasing expatriate population. *Please refer Appendix Exhibits 15 21 for more information on the Insurance Sector. Real Estate Sector Real Estate has been one of the volatile sectors in the Middle East. The sector has a huge growth potential attributable to huge infrastructure projects being undertaken in the region. Real Estate Sector in the Middle East is characterised by low profitability, low return on equity, low return on assets, low return on capital, average liquidity, below average solvency and high leverage in comparison to its global counterparts. 7
Parameter 1 Profitability The net profit margin stood at 14.4 per cent in 2012 YTD and 14.3 per cent in 2011. Return on Assets stood at 3.3 per cent while return on equity was registered at 5 per cent in 2012 YTD. Return on capital was recorded at 4.2 per cent for the same period. The sector is ranked the lowest in terms of all of the above measures of profitability after Europe. Parameter 2 - Solvency The liability to assets ratio for this sector was registered at 62.2 per cent for 2012 YTD, a minor change when compared to 62.7 per cent in 2011. The sector can be rated as average when benchmarked against its peers. The sector is highly leveraged and has a debt-equity ratio of 115.4 per cent in 2012 YTD down from 119.2 per cent in 2011. The leverage in this sector resembles those in developed economies such as North America and Europe and is much higher than in other regions such as Asia Pacific, Latin America, and Africa. Parameter 3 - Liquidity Current ratio for this sector was recorded at 1.3 and 1.4 times in 2012 YTD and 2011, respectively. This is the highest after Asia Pacific and suggests an above average liquidity position. *Please refer Appendix Exhibits 22 28 for more information on the Insurance Sector. Conclusion Middle East has a low profitability in all sectors of the financial services industry except for the banking sector, which has the highest profitability measures globally. However, despite low profitability, the industry has a huge growth potential and strong qualitative growth drivers such as scope for penetration, high government support, changing demographics, increased investment in technology and infrastructure, increasing aware consumers and stricter regulations and increased interaction and integration with global peers. Frost & Sullivan suggests a positive outlook for the Financial Services industry in the next five years. 8
Appendix Exhibit 2: Middle East Banks are the Most Profitable Banks Globally. Exhibit 3: Middle East stands Third in terms of Return on Equity after Latin America, North Africa and Sub-Saharan Africa. 9
Exhibit 4: Middle East stands Second in terms of Return on Assets after Latin America. Exhibit 5: Middle East Banks have the lowest Loans to deposit ratio indicating huge lending potential and strong liquidity position. 10
Exhibit 6: Non-performing assets ratio more than doubled for the current year 2012 in comparison to 2011 indicating a cause of concern for Middle East banking sector. Exhibit 7: Middle East Banks have one of the highest capital ratios after Sub-Saharan Africa and are well placed to meet stringent Basel III requirements. 11
Exhibit 8: Middle East diversified financial sector has the lowest Net profit margin globally. Exhibit 9: Middle East stands Third in terms of Return on Assets after Latin America and North Africa region. 12
Exhibit 10: Middle East diversified financials ranks one of the lowest in terms of Return on Equity measure Exhibit 11: Middle East Diversified financials has the lowest Return on Capital by region globally. 13
Exhibit 12: Middle East Diversified Financials sector scores an average on short term liquidity measures when compared to international peers. Exhibit 13: Middle East diversified Financials sector has one of the lowest liabilities to assets ratio after Latin America, an indication of strong solvency and conservative risk practices adopted in the region. 14
Exhibit 14: Middle East Diversified Financial sector is more leveraged than Latin America but less leveraged than any other of its international peers. Exhibit 15: Middle East Insurance sector has the lowest net profit margin after Latin America and Caribbean. 15
Exhibit 16: Return on Assets for Middle East Insurance sector has been declining since 2008. Exhibit 17: Middle East Insurance sector ranks one of the lowest in terms of Return on Equity Measure 16
Exhibit 18: Middle East Insurance has the lowest Return on Capital by region globally. Exhibit 19: Middle East Insurance sector ranks first in terms short term liquidity measures when compared to international peers. 17
Exhibit 20: Middle East Insurance sector has almost the same liabilities to assets ratio as its global counterparts (except Latin America). Exhibit 21: Middle East Insurance Sector is shifting towards less leverage since 2010. 18
Exhibit 22: Middle East Real estate sector has the third lowest Net profit margin in 2012YTD. Exhibit 23: Return on Assets for Middle East Real Estate sector is the lowest globally after Europe region. 19
Exhibit 24: Middle East Insurance sector ranks one of the lowest in terms of Return on Equity measure Exhibit 25: Middle East Real Estate sector doubled its return on capital in 2012 YTD in comparison to 2010. 20
Exhibit 26: Middle East Real Estate sector scores an average on short term liquidity measures when compared to international peers. Exhibit 27: Middle East Real Estate sector has average liabilities to assets ratio. 21
Exhibit 28: Middle East Real Estate sector is highly leveraged after North America and Europe. **Note: Secondary research sources include Capital IQ (raw data source), World Bank Outlook, and IMF Regional Outlook. All analysis done by Frost & Sullivan; 2012 YTD figures are as of October 15 2012. 22
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