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Burgeoning M&A in the Islamic Finance Sector
Taking a viewpoint from an Islamic Finance position, Mujtaba Khalid Head of the Islamic Finance Centre at the Bahrain Institute of Banking and Finance (BIBF) points to the expected high growth in this sector and describes why we could see increased M&A activity in the regions Islamic Banks, noting that increased Sukuk and bond issuing could be a forerunner to an uptick merger activity
Mujtaba Khalid, Head of the Islamic Finance Centre at the Bahrain Institute of Banking and Finance (BIBF)
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M&A deal value for the Middle East in FY 2021 grew nearly 60% over the previous year. Can growth in the regional M&A market be sustained?
A recent study by law firm Baker McKenzie stated that the Middle East recorded strong M&A activity with 665 deals in FY 2021, from 439 witnessed in 2020. As the COVID restrictions start to ease in many jurisdictions within the Middle East, a lot of cross border travel as well as economic activity will resume, further catalyzing M&A activities.
Although economic activity has picked up, there might still be a lag in dealing with the impact of COVID related difficulties. From an operational perspective, there are certain challenges faced especially by Islamic banks in the region that could act as a catalyst for increased merger activity; as a response to the COVID situation, all regional regulators responded to lessen the impact on the public. There were many stimulus packages announced,
regulatory capital requirements were reduced, and financial consumers were allowed to reschedule their interest/ profit payments. This was a well-received measure from the perspective of bank customers; however, it left the challenge of uncertainty for banks. Even though many banks have increased their loan provisioning ratios, there is no sure way for banks to know the amount of non-performing Loans (NPLs) on their books. This will be apparent once customers start making their interest/ profit payments. Coupled with the fact that Islamic banks will not be able to “benefit” from late payment charges (as all such fees must be written off to charity), Islamic banks face uphill operational challenges. Therefore, a merger between financial, especially Islamic financial entities could help shore up capital adequacy as well as consolidate resources to have sufficient buffers. Bigger entities could potentially serve a larger client base (especially cross border regional mergers) diversifying country exposure of certain Islamic banks.
Will current M&A activity contribute to the long-term growth of the region’s capital markets?
This could be an interesting outcome of the current increase in M&A activities. There could be increased bond and Sukuk issuances to facilitate M&A activity as well as post-acquisition integration. We could see that regional PE space further mature and portfolios geared at acquisitions, especially in the FinTech space.
Another interesting potential could be the use of SPACs, especially for attracting investments from the US. A SPAC is an investment vehicle that raises capital by selling shares in an entity that is not yet operational. ‘Blank-check firms’ as they are also known, list on the stock market and place raised capital in a trust. They then generally have two years to merge with a company, or a combination of companies that have been identified prior to their launch. SPACs must either take companies public or return raised capital to their shareholders in the event of deal failure or their dissolution.
These flagship MENA SPACs include National Energy Services Reunited (NESR), which was the first energycentric MENA SPAC to list on the Nasdaq more than three years before the 2020 SPAC boom. Thus, becoming the first
company to successfully list several GCC companies from Saudi Arabia, Oman, Qatar, and the UAE on the Nasdaq via a SPAC.
Which industry sectors are experiencing the most M&A activity in the region?
I believe there is a lot of potential for M&As in the energy as well as the financial sectors. The Middle East, specifically the GCC is already overbanked, given the number of institutions relative to the population. Especially in Islamic banking, just within Bahrain, we have seen Ahli United Bank takeover Citi Bank’s retail portfolio and we have also seen Al Salam Bank take Ithmaar Bank’s retail portfolio.
Is the regional banking sector ripe for increased M&A activity?
We need to zoom out and look at the Islamic finance industry as a whole and its prospects – the Islamic finance industry in the past has seen considerable growth. Over the past decade, it has averaged double digit growth. However, we did see this growth slow down to single digit in the past two or so years. Going forward, according to different reports including the Islamic Finance Development Report 2020, the industry is poised to grow by at least 50% in the next 5 years. I believe that there is a case for the Islamic finance industry to see more than 100% growth over the next 5 years - The
last time the Islamic Finance industry was at its peak was around 2009, just at the culmination of last the global commodity super-cycle. Many countries which feed the growth of Islamic finance are dependent on commodities - be it the GCC with crude oil, Malaysia with Palm oil or countries like Pakistan and Indonesia with agriculture. There has always been a strong correlation between commodity prices and the growth of the Islamic finance industry. Some can argue that the correlation might not be as strong, none the less, it is very much there. Given the current geo-political circumstances, as well as record oil prices, one can argue that the commodity super-cycle has already started. This will in-turn have a positive spill-over affect on the Islamic finance industry.
Flush with liquidity, many Islamic banks will opt for either acquiring FinTech companies to accelerate their digital transformation strategy or merge/acquire existing Islamic banking operations, to shore up their retail consumer book size.
