How can MENA banks pursue transformational growth amid uncertainties?

Rising need for ESG frameworks

COP28 in Dubai was the largest climate change summit to date, emphasizing a shift from fossil fuels to renewables and sustainable practices, with significant private sector involvement. The UAE consensus called for a rapid shift from fossil fuels to renewable energy and sustainable infrastructure, creating investment opportunities and promoting responsible investment practices.

A key achievement of COP28 was the establishment of a global fund for loss and damage, supporting developing countries affected by climate change with financial pledges from several nations. The conference also saw commitments from 116 countries to triple renewable energy capacity by 2030, requiring substantial investment to reach a target of 11,000 gigawatts globally.

The Central Bank of UAE (CBUAE) is mobilizing US$270b in sustainable finance by 2030, with significant contributions from local banks. The CBUAE's finance day event and the COP28 UAE TechSprint highlighted the role of digitalization and technology in advancing sustainable finance, although scaling these solutions remains a challenge.

As for the climate solutions investment platform, Investcorp launched a US$750m platform in partnership with the “Innovate for Climate Tech” coalition to support climate technology ventures. Looking ahead, COP29 will focus on advancing UNFCCC and Paris Agreement goals, including establishing a new collective quantified goal on finance and finalizing the first enhanced transparency framework.

SME banking: driving innovation

SMEs are crucial to the MENA region's economy, comprising over 90% of businesses and contributing significantly to non-oil GDP. However, they face financing challenges, with less than 10% of lending going to SMEs. Banks are now innovating to better serve SMEs by simplifying onboarding, using digital platforms and offering personalized services through data analytics and AI. They are also fostering ecosystems for collaboration and providing mentorship and financial advice to help SMEs grow and make informed decisions.

Alternative funding methods like crowdfunding are gaining traction and there is a focus on supporting SMEs in sustainability efforts. Banks are evolving from mere financiers to strategic partners and advisors, with relationship managers using digital tools to offer tailored advice. The future of SME banking includes digitization, leveraging technology for personalization, strengthening "beyond banking" solutions through ecosystems and exploring embedded finance and Banking as a Service (BaaS) to unlock new revenue streams.

Mergers and acquisitions (M&A)

Bank mergers in the MENA region are increasing as local institutions aim to become global players and address home market challenges like slow growth and saturation. International expansions are also on the rise, with MENA banks looking to emerging markets for growth opportunities, especially as some European banks exit these regions. However, not all international ventures have been profitable, with one in three MENA banks experiencing losses abroad. Successful international operations require addressing factors such as unclear long-term strategies, sub-scale operations and limited differentiation.

Mergers offer cost and revenue synergies, but require careful planning and execution, with considerations for strategy, finance, regulatory issues and operations. The benefits of mergers include increased funding potential, improved credit ratings and operational efficiencies. Banks are now focusing on optimizing their international portfolios, which may involve merging or investing in new markets to create greater shareholder value.

Talent agenda, nationalization and learning

The financial services sector in the MENA region is experiencing rapid growth and transformation, driven by digitization, AI, sustainability and nationalization goals. Organizations are adapting by investing in workforce development to meet these challenges. Nationalization targets are significant, with countries like the UAE, Kuwait and Saudi Arabia setting ambitious goals for local employment in the financial sector. Skills displacement due to automation is being offset by new job creation, requiring upskilling in areas like machine learning, AI, blockchain and customer experience. Regulatory changes, particularly in ESG, are prompting large-scale learning initiatives within organizations.

Leadership in the financial sector must evolve to manage these changes, balancing human-centric skills with technical knowledge. The demand for skilled professionals is high and success depends on nationalization efforts, skill development and effective leadership. Organizations that navigate these aspects well will be better positioned to execute their strategies and thrive in the evolving MENA financial services landscape.

Decoding digital assets

Digital assets, leveraging distributed ledger technologies like blockchain, are gaining traction in the financial world. These assets include cryptocurrencies, which are known for volatility, and more stable options like digitally-native securities and tokenized assets, including real estate and commodities. Regulatory attitudes vary, but initiatives like the Dubai Virtual Assets Regulatory Authority (VARA) provide frameworks for digital asset regulation. MENA banks are exploring Shariah-compliant tokenized assets and non-fungible tokens (NFTs) are emerging as a potential mass-market tool.

Central Bank Digital Currencies (CBDCs) are a focus in the MENA region, with pilots and live implementations aimed at innovating payments, reducing costs and improving financial inclusion and transparency. While banks are cautious about the impact of CBDCs on their deposit base, mobile money operators see CBDCs as an opportunity to expand services and revenue.

EY teams are assisting financial institutions in understanding and exploring digital assets through the EY Digital Assets, Insights and Analytics (DAIA) platform. This platform helps track digital asset developments, assess risks and adapt financial models. Banks are encouraged to establish digital assets labs for knowledge development and governance, utilizing tools like the EY Tokenization and Starlight platforms for exploring use cases and managing privacy and security. EY is also involved in industry alliances and collaborations to help clients operationalize digital asset lab infrastructures.

Role of AI in MENA banking

AI is revolutionizing banking in MENA, enhancing customer experiences and risk management. AI technologies are being widely adopted in retail, consumer, corporate and SME banking, offering personalized services, efficient customer support and enhanced security through fraud detection systems. By 2030, AI is expected to make significant contributions to the GDPs of countries like the UAE and KSA, with government initiatives such as the UAE’s National AI Strategy and Saudi Arabia’s Vision 2030 driving this growth.

Both the UAE and KSA are leading the region in AI adoption and development, with strategies in place to attract foreign investment and foster innovation. The regulatory landscape in MENA is rapidly evolving to address the ethical and practical aspects of AI, with some countries developing policies and regulations that align with international standards.

The EY organization has developed a comprehensive framework for responsible AI adoption that addresses risks and establishes controls across key areas such as explainability, accountability, reliability, privacy, fairness, inclusiveness, transparency, safety and environmental impact. This framework helps organizations navigate regulatory and ethical challenges, promoting trust in AI technologies.

Looking ahead, the MENA banking sector is moving toward GenAI models, which will further enhance capabilities in risk assessment, fraud detection and customer service. This progress positions MENA banks to lead in innovative AI-driven banking solutions that meet the changing needs of customers.

Key tax trends in banking

The banking sector in the MENA region is adapting to a dynamic evolution characterized by growth, new market entries, regulatory pressures, non-traditional competitors and the ESG agenda. Tax authorities in the region are responding with rapid changes, presenting both challenges and opportunities for banks. Key tax trends, summarized as the "5 T's": transparency, transition, transfer pricing, technology and talent. Banks are building solid foundations by reviewing their tax cost base, compliance models, governance, and reassessing their technology and talent mix to navigate the complex fiscal landscape and seize opportunities for growth.

New regulations and regulatory changes

The MENA region's banking sector is evolving amidst global concerns over bank failures, geopolitical risks and the need for regulatory reforms. The Financial Stability Board (FSB) and the Basel Committee on Banking Supervision (BCBS) are addressing these issues, focusing on cross-border payments, cyber resilience, crypto-assets and climate change. The MENA banks maintain strong balance sheets and are leaders in new finance areas, but face heightened geopolitical risks that could impact trade routes and economic stability.

Regulators are increasingly emphasizing stress testing for loan portfolios and are investing in conduct of business risks and digital transformation. Areas like AI, cyber risk, cross-border payment platforms, CBDCs, cryptocurrencies, digital assets and FinTech are gaining attention. Regulators are creating new organizational structures to foster financial innovation while ensuring stability and consumer protection. They are preparing to address AI's growing role in finance and risk management. Sustainable finance is another focus, with regulators discussing climate risk disclosures and transition finance, especially following COP28. The EY ESG MENA Bank Tracker Report indicates that most MENA banks have developed ESG strategies, highlighting the region's commitment to sustainability and responsible banking practices.

New legal frameworks in MENA banking

Over the year, the MENA region's financial sector saw significant regulatory reforms, particularly in the KSA and the UAE, to adapt to market changes and investor needs. These reforms aim to enhance market stability, protect investors and stimulate business growth, aligning with long-term strategic goals like the Saudi Vision 2030.

In the KSA, the Capital Market Authority (CMA) and the Saudi Arabian Monetary Authority (SAMA) introduced key amendments and new rules to attract foreign investment, improve governance, and encourage innovation in financial products such as Buy Now Pay Later (BNPL) services and savings products. The CMA also simplified regulations for Qualified Foreign Investors (QFIs) to boost market liquidity and international investment, particularly in the real estate sector of Makkah and Madinah.

The CBUAE launched the Financial Infrastructure Transformation (FIT) initiative to drive digital transformation, focusing on financial inclusion, anti-money laundering (AML), counter-terrorist financing (CTF) and consumer protection. The Securities and Commodities Authority (SCA) worked on opening markets to foreign investors and integrating new technologies.

Both countries are promoting regulatory sandboxes, open banking and emerging technologies, with a focus on new finance activities and financial institutions. They are also tightening regulations on foreign funds while incentivizing domestic funds and making virtual assets and foreign securities investment more accessible. Overall, these legal frameworks are part of a broader effort to modernize the financial sector, attract foreign investment and position the MENA region as a leading financial hub.

Strategic outlook for 2024

Despite several global and local challenges and risks, the outlook for 2024 is positive, based on market indicators and consistent investor interest. The primary drivers are ambitious plans, projects and supportive governments’ budgets across the region. The MENA is seen as an alternative safe haven from an investor’s perspective, compared to major global economies that are contending with several issues, including high inflation and high energy prices. The key focus for banks will be on several aspects and themes, which include digital assets and digital currencies, climate risk assessment, the utilization of AI and ML, asset optimization, expense consolidation, the continuous revision and improvement of banks’ fundamentals with respect to funding, FTP, optimal balance sheet management and risk-adjusted pricing. Some MENA regulators may consider initiating projects for the implementation of IRB regulatory capital provisions in their respective countries. Once and if implemented, this could provide a significant opportunity for MENA banks to align with global banks operating under the IRB Capital Regime, optimizing their (expected) capital relief for further growth and enhanced financial performance (i.e., RoE).