According to S&P Global Ratings, a new wave of mergers and acquisitions may occur in the GCC banking sector as profit margins are squeezed by pandemic-related headwinds.

There is a need for recapitalization as bad loan provisions increase and asset quality is also declining. It supports the case for financial institution consolidation in the area, according to Mohamed Damak, senior director of financial institution ratings.

“Ultimately, lower profitability could cause a new wave of M&A. If it does, this wave will be different from what we've seen so far,” Mr. Damak said in a webinar on Wednesday. He also adds that It may require consolidation across different GCC countries or different UAE emirates.

Many regional lenders' profits shrank last year, as did their foreign counterparts. They proactively allocated funds to cover potential loan losses. Also, loan book growth has slowed, and margins have been squeezed by low-interest rates.

Following the three-year oil price downturn that started in the middle of 2014, GCC banks have already seen substantial M&A operations. Shareholders with numerous lenders – usually state governments and associated agencies – pressed for restructuring, resulting in stronger financial institutions with more sustainable balance sheets that could withstand tough operating conditions.

In 2017, the National Bank of Abu Dhabi and First Gulf Bank merged to create First Abu Dhabi Bank, UAE's largest lender. In 2019, Abu Dhabi Commercial Bank merged with Union National Bank and Al Hilal Bank to form Abu Dhabi Commercial Bank. Dubai Islamic Bank completed the acquisition of competitor Noor Bank last year, resulting in an Islamic lender with total assets of over Dh275 billion ($75 billion).

National Commercial Bank, the kingdom's largest lender, is absorbing smaller rival Samba Financial Group in Saudi Arabia, establishing a lender with a 31% market share by assets.

Cross-border merger talks between Kuwait Finance House and Bahrain's Ahli United Bank were supposed to happen, but they were put on hold in April of last year.

Mr. Damak predicted that it would certainly take a more proactive approach by management to overcome barriers, persuading boards or shareholders, to consider being diluted.

Smaller banks, according to Moody's Investors Services, are more in need of restructuring because they are being "crowded out" by larger rivals. According to S&P, banks are experiencing a “lower-for-longer profitability” pattern due to the challenging operating environment faced by the region's corporate sector.

As regulators gradually remove forbearance measures, Mr. Damak expects a rise in non-performing loans from 3.6 percent on average last year to about 5-6 percent in the next 12-24 months. Real estate, manufacturing, hospitality, and consumer-related businesses are all likely to place strain on bank asset quality in the future.

Mr. Damak said, "We are yet to see if there is any additional interference from governments to reduce the danger of banks' balance sheets."

More than Dh388 billion in local and federal support programs have been put in place in the UAE to help cushion the effect of Covid-19 on the economy. According to the UAE Central Bank, liquidity in the financial system has already recovered to pre-pandemic levels.