Middle East Banks Join Global Digitalization Trend
The Middle East banking industry has been witnessing knock-on effects of the pandemic, volatile oil prices, and intensifying multi-dimensional disruptions. However, it has been able to withstand these pressures and bounce back strongly. It continues to make tangible strategic progress to drive growth and has joined the global trend of digital transformation, digitalization, and innovation. We believe newer innovations, regulations, and technology will continue to alter the banking landscape in the coming years.
With well-capitalized balance sheets, regional banks are aggressively investing in digitalization to defend and grow their market shares. In fact, some of the regional banks have already become global examples of successful digital transformation. A few innovative banks in the Middle East have proven their mettle in the digital banking business and have delivered outstanding results. Eight Middle Eastern banks (four of them from the UAE) were featured in the world’s most innovative Top 100 Digital Bank Ranking list. These banks were recognized for their highly innovative digital platforms, truly differentiated customer value propositions, scalability, and cost efficiency.
All leading banks in the UAE, including ENBD (Liv.), Mashreq (Neo), and CBD (CBD), are already active in the digital market since 2017. While digital banks in other parts of the world are often fintech intermediary startups, digital banking entities in the Middle East, the UAE in particular, are set up largely by established banks and consortia. As a result, digital banks in the region get significant advantages in terms of achieving scale and growth, and saving costs.
In this article, we will review the ongoing digital transformation journey, analyze the regional digital ecosystem, and highlight structural issues and challenges associated with the digitalization strategies of banks in the Middle East.
Source: www.theasianbanker.com, Company Filing, Evalueserve Analysis
Digitalization Driving Growth in Banking Industry
Tech-savvy consumers and fast-developing technology hubs are fueling a massive digital transition in the Middle East banking industry. The region, which is otherwise majorly driven by crude oil, can add billions of dollars to economic growth by accelerating digitalization as there is a strong correlation among banking growth, GDP per capita, and digital strength.
By 2025, the Middle East is expected to have about 160 million users of digital services, which could account for up to 3.8% annually of its GDP1. With this, the banking revenue in the Middle East could reach to more than USD359 billion by 2025, at a CAGR of about 8% per year from 2020.
Retail banking will be a major beneficiary of the rapid shifts in consumer preference towards digital banking solutions. Furthermore, there seems to be a growing demand for frontline services and new digital platforms, which could surge retail banking revenue to USD135 billion by 2025, at a CAGR of ~9%.
Corporate banking accounts for ~55% of the assets and ~44% of the revenue of the Middle East banking industry. Over the years, regional corporate lenders have undergone a digital transformation and made bold and aggressive moves to meet the complex needs of corporate banking clients. As a result, corporate banking revenue is expected to significantly jump to USD169 billion by 2025, at a CAGR of ~7%.
Islamic banking plays an important role in the overall banking system in the Middle East and accounts for a sizeable portion of the banking assets in the region. In Saudi Arabia, the largest economy in the region, Islamic bank assets are ~73% of the country’s total banking assets, compared with an average of ~25% in other Gulf jurisdictions3. However, most Islamic banks in the region are behind their conventional banking counterparts in terms of the depth of digital banking products and services offered.
Source: Company Filing, Evalueserve Analysis, 1&2 Global Banking Annual Review 2021, Mckinsey Projections For MENA region, 3Saudi Arabia Islamic Finance Report 2021
Evolving Digital Banking Landscape in Middle East
Accelerating digitalization has become a strategic priority for all Middle East banks, which embarked on their digital journeys about five years ago and have already made significant investments in digitalization. Their investment has proved invaluable as banking customer behavior has changed rapidly. Over the past few years, there has been a continuous rise in the number of digital transactions, digital subscriber base, and digitally active customers. Contactless payments now constitute a majority of all POS transactions in the Gulf.
A strong digitalization push by regional banks to empower client relationships and promote bespoke approaches to product development has stimulated demand for digital banking solutions. Digitalization efforts are influencing several strategic areas of banking including client relationships, distribution channels, and cost structures. Banks in the Middle East are focusing on co-creating and building innovative business models to offer pioneering solutions, allowing them to innovate and improve the digital banking experience for customers. They are aggressively targeting API Sandbox, as part of their digital transformation strategy. The open banking sandbox environment will likely be a turning point as it will immensely simplify and drive innovation in banks. Such platforms will bring tremendous economic value to banks and fintech.
With ENBD’s Open Banking sandbox, developers can avail around five million simulated data related to one million client accounts based on the Banking Industry Architecture Network model. The data is reorganized to depict the bank’s retail and corporate banking data. This is fully compliant with open banking regulations. Several banks are embracing open banking by enhancing their API and API security capabilities. They are using AI and advanced data analytics to provide a quick, secure, and extraordinary customer experience.
This indicates that the shift towards digital banking in the Middle East will continue to grow rapidly. To
remain at the forefront of innovation, leading banks are continuously enhancing their digital and technological capabilities.
Source: Company Filing, Evalueserve Analysis
Fintech Ecosystem is at Nascent Stage in Middle East
A well-developed fintech ecosystem is crucial to the development of a vibrant digital banking environment in the Middle East. However, the fintech ecosystem in the region is still at a nascent stage and most innovative digital banks are startups. As a result, corporate banks in the Middle East are yet to leverage the full potential of digital banking to cater to their clients.
Compared with their retail counterparts, corporate banking customers have relatively fewer digital banking solutions to choose from in the Middle East. Although many banks have successfully developed a full range of retail digital capabilities, only a few have successfully digitized their entire corporate banking value chain (commercial lending, trade finance, leasing and factoring, cash management, and capital markets). Regional corporate banks primarily offer digital solutions in transaction banking and digitalization is concentrated around cash management and FX products. Digitalization in corporate banking can only be seen in back-office operations (servicing, operation, etc.), while front-office services (lead generation, sales) continue to operate traditionally without much innovation. Corporate banks in the Middle East need to be as proactive as their retail counterparts in pursuing digital transformation strategies.
Digitalization has brought a plethora of opportunities for the banking industry in the Middle East. As such, competition in this industry has intensified. The market is consolidating, leading to the creation of highly competitive wholesale banks. The growing competition will have a direct impact on the customer base of large corporates and government-owned enterprises, while consolidation will drastically reduce the lending and cross-selling margins. Since the outbreak of COVID-19, things have changed in the trade finance segment (traditionally have been a steady income source for banks) as alternative funding sources are being directed towards the corporate supply chain.
To remain competitive and profitable, banks must adopt strategies that effectively cater to all customer segments including SMEs. Digitalization will help banks to have a more holistic understanding of their clients and lower their cost-to-serve with new engagement models. Better process optimization can lower customer acquisition costs through economies of scale and lead to a healthier ROI.
Source: 1 UAE Fintech Report 2021, 2 GSMA Report -The Mobile Economy MENA in 2022, 3 Worldbank, 4&5World Payment Report 2021, Capgemini, Evalueserve Analysis,
Digitalization Gaining Momentum Among Islamic Banks
The Islamic banking industry in the Middle East is growing rapidly and delivering strong operational performance across business lines. All regional Islamic banks have been able to deliver strong and robust growth while maintaining steady balance sheet growth, liquidity, and capital ratios. Islamic banks have a different operating business model compared with conventional banks. They operate as per the Shari’ah law, which prohibits receipt and payment of ‘riba’ ( interest), ‘gharar’ (excessive uncertainty), and ‘maysir’ (gambling) or short sales. All regional central banks have a central Shari’ah board for unified supervision and guidance. Islamic banks have their own Shari’ah boards as well.
Islamic banks are trying to elevate customer convenience through digital platforms and are transitioning towards becoming data-driven organizations by leveraging advanced analytics and AI. These banks are continuously redefining and transforming processes to ensure a faster and more seamless customer experience. Kuwait-based Boubyan, through its five-year strategy Boubyan 2023, aims to enhance the digital proposition of its cash management offering for corporate and SME customers. It has already introduced cardless withdrawals, which lets customers use ATMs through an SMS on a mobile app.
Nevertheless, the digital drive for Islamic banks is fraught with challenges. The most pressing factors relate
to budgeting constraints, a lack of open banking initiatives, legacy infrastructure, and a lack of requisite human capital.
Source: Company Filing, Evalueserve Analysis
Example of Growth in Digital Banking in Middle East
As compared to their regional counterparts, UAE banks have been more prompt to embark on their digital transformation journey. Innovative banks such as ENBD (Liv.) and Mashreq (Neo) have rewired themselves for digital innovation and pioneered the digital banking revolution not only in the UAE but also in the Middle East. ENBD’s Liv. is one of the fastest-growing banks in the UAE in terms of customer acquisition.
The other banks are working on their digitalization models to drive efficiencies while investing heavily in their digital infrastructure to enable cloud migration, open banking platforms, digital branches, and other digital innovations. It is true that not every digital bank has been successful but those that have invested heavily in their digital infrastructure have definitely developed an edge to thrive in this highly competitive banking environment.
Driven by the focus of the UAE banks, we see three major trends evolving in the region in the last couple of years. On the demand side, there is a strong shift from cash to digital payments among customers; on the supply side, banks are equipping customers with new digital solutions; and on the regulatory side, regulators are focusing on aligning the country’s digital vision with the banking industry. As a result, the country has become the hub of innovation for the regional digital banking industry.
The Central Bank of UAE has taken several initiatives to make it the world’s most secure, advanced, and innovative digital banking industry. Some of the steps include the mBridge Platform to enhance the processing of cross-border payment transfers, the National Payment System Strategy (NPSS) to modernize the payments infrastructure, an SME funding platform, and the Financial Services Cloud Infrastructure. These initiatives are helping banks to develop innovative digital banking solutions for customers.
Source: Company Filing, Evalueserve Analysis
Digital banking is set for growth in the Middle East, driven by a transformative impact of highly innovative technologies and increasing demand for digital banking solutions. Amid the soaring demand, banks are finding innovative ways to differentiate themselves. Both conventional and Islamic banks are aggressively investing in building digital capabilities to provide an engaging digital experience to a new generation of tech-savvy customers.
Banks in the UAE have taken the lead in adopting digital solutions compared with their counterparts in other regions. They are continuously reinforcing their digital infrastructure to enhance both customer experience as well as operations by integrating advanced analytics and AI technologies. Mindful of the transformation, most leading banks continue to disrupt industry paradigms to offer intuitive banking experiences to customers.
Nevertheless, digitalization does present challenges and complexity as it places several crucial demands on core banking operations. As digital banking systems continue to evolve across the region, the respective central banks and regulatory authorities are likely to closely work with market players to set strong grounds for a next-generation banking ecosystem. However, banks will need to recalibrate their digital strategies to reduce risks and deliver improved profitability margins. Offering a strong value proposition to millennials with competitive pricing, combined with innovative digital architecture, is a major strategic business imperative for banks to defend and grow their footprint across the region.
The information contained in this report has been obtained from reliable sources. The output is in accordance with the information available on such sources and has been carried out to the best of our knowledge with utmost care and precision. While Evalueserve has no reason to believe that there is any inaccuracy or defect in such information, Evalueserve disclaims all warranties, expressed or implied, including warranties of accuracy, completeness, correctness, adequacy, merchantability and / or fitness of the information.