Fintech and Banking Sector Development in Gulf Countries: New Frontiers
 
The environment of higher inflation and higher key rates in the U.S. and eurozone casts a shadow over the banking sector of Gulf countries. Dollar liquidity is tight for an unknown period of time, and the financial sphere of the region must cope with this reality.
 
Increased Liquidity
 
Recent data show that Gulf banks have increased their assets. The Central Bank of the UAE has taken a decisive step, injecting local currency into the financial system. This initiative has led to a remarkable increase of 32.5% in the regulator's assets, elevating them to AED 747.6 billion by the conclusion of winter 2024.
 
As a direct consequence of this liquidity injection, local banks have seized the opportunity to expand their lending activities. This expansion has driven a substantial 12% year-on-year increase in the sector's total gross assets, culminating in a staggering AED 4.2 trillion as of February 2024. Lending growth among banks is outpacing deposits, indicating that the banking sphere relies more on additional liquidity in local currency.
 
A similar situation can be observed in other regional countries. Saudi banks extended their credit loans up to SAR 2.67 trillion in March 2024, demonstrating an 11% year-on-year growth. This uptrend goes in hand with a rise in the assets of the Saudi Arabian Monetary Authority, nearing SAR 1.85 trillion during the same period.
 
Within Saudi Arabia, real estate financing experienced a notable surge of 27% in March 2024, marking the most fascinating performance since the summer of 2023, with figures reaching SAR 275.2 billion. Almost every fourth Saudi Riyal in all loans provided by local banks went into the real estate sector.
 
The balance of Qatari banks also showed significant growth, by 5.6% to QR 1.99 trillion in March 2024, primarily due to new projects in the real estate sphere.
 
In Oman, local banks’ loan operations expanded by 2.7%, up to OMR 30.6 billion at the end of winter 2024. The expanding real estate sector, coupled with the active monetary policy of the local central bank, enabled this outcome, with credit extended to construction firms exceeding the overall growth rate of loans.
 
A significant increase in the assets of central banks in the region indicates a proactive monetary strategy designed to supply liquidity, even amidst the quantitative tightening in the U.S. and eurozone. Nonetheless, these measures must be judiciously controlled to avoid problems such as inflation or asset bubbles.
 
The Banks' Risk of Focusing on the Real Estate Sector
 
Local regulators need to monitor the growth of Gulf bank assets to ensure that lending and investment practices are sustainable, and that banks maintain sufficient capital and liquidity buffers to withstand potential economic shocks. As we can see, the main area of lending operations in Gulf countries is mortgages, as banks heavily invest in the real estate sector. However, problems in the commercial real estate market in the leading world economy, the U.S., can create depressive pressure on this market in Gulf countries.
 
U.S. commercial real estate prices fell 7.5% year-on-year. Commercial real estate values by category since the 2022 peak: Multifamily: almost -27%; Office: about -19%. Commercial real estate loans account for about 30% of total assets for U.S. regional banks.
 
Exchange-traded funds (ETFs) oriented toward the stock of U.S. regional banks showed a negative return, on average -4% year-to-date for the first four months of 2024. In May 2024, the stocks of small regional banks in the U.S. experienced a significant decline in comparison to the stocks of larger banks, marking their lowest point since November 2009.
 
Concerns among investors in the U.S. are growing, as they begin to lose confidence in the performance of local small banks. This is a bad omen since such small institutions play a crucial role in driving fintech innovations at the regional level and in moving toward raising financial inclusion.
 
The downward trend in commercial real estate prices in the U.S. shows a dramatic shift not only in the leading world economy but everywhere. People are working more remotely, transacting more online, and this is putting the demand for offline stores and office premises on a track of resilient decline.
 
Gulf banks have been accustomed to investing in the real estate sector, but they have to swiftly refocus their investments to avoid falling into the same problematic situation as U.S. regional banks.
 
The Diversification of Investments: Fintech, AI and Data-Centers
 
Fintech, artificial intelligence, and data centers are currently in the spotlight for investments. Gulf countries are pursuing strategies to create special investment funds aimed at actively participating in the aforementioned spheres.
 
In 2023, Saudi Arabian startups attracted $2.6 billion, with the majority of this financing (about 55%) coming mostly through domestic investment programs. In 2024, Saudi Arabia's Public Investment Fund is striving to extend their investment facilities aimed at investing in AI-related projects, including those in the finance sphere, with up to $40 billion. The specific interest in AI is connected with the trend toward the development of banking-as-a-service.
 
The Startup Qatar Investment Program, managed by Qatar Development Bank, operates a $100 million investment structure. The program is primed to release up to $500,000 for new startups in the country, and up to $5 million for seasoned entrepreneurs.
 
These investment vehicles aimed at the development of fintech startups underscore the need for special structures to promote digitization. In this case, the Gulf region has chosen its specific path. European fintech startups tend to rely on risk-averse bank loans for funding, while U.S. fintech small businesses leverage financing opportunities provided by risk-seeking venture funds and rely heavily on financing provided via the stock market, with bank loans as only a third option. In contrast, Gulf startups tend to rely on financing provided via local incentive programs and state-sponsored investment vehicles.
 
Indeed, we witness how the state industrial policy in Gulf countries focuses on driving innovations through fintech startups with significant support from central banks, state investment programs, and state-backed funding. Government policies in the region also focus on onboarding foreign talents and capital by creating an attractive business climate through relevant amendments to immigration laws and other regulatory statutes. In this direction, Gulf countries are poised to create more competition for European and U.S. labor and capital markets.
 
Central Banks' Partnership with Fintech
 
In their pursuit to feed the market with liquidity, central banks of the region came to the conclusion of the need for the development of digital financial channels in their economies. In this case, collaboration with fintech has become an important step forward.
 
For example, in April 2024, the National Bank of Oman struck a direct deal with one of the local fintech startups to play a role as a custodian bank for this enterprise. This contract underscores the trend when central banks start playing a more important role in the digitization of financial processes, including the movement into the design and development of central bank digital currencies (CBDCs).
 
This case only shows that in the movement into a more diversified and decentralized world of finance, the role of centralized institutions is important. The central banks are enhancing their potential in driving financial innovations by extending cooperation between themselves. Thus, in May 2024, the central banks of Qatar and Saudi Arabia penned a partnership agreement aimed at deepening the exchange of practical experience in driving digital innovations in the financial sphere.
 
The Fintech Transformation: Disrupting Traditional Banking
 
In the past, brick-and-mortar banks ruled financial lives. From saving to getting loans, they called the shots. Now, fintech is cracking this monopoly. The 2008 world financial crisis, COVID-19, and the 2023 U.S. regional banking drama all fueled a fintech firestorm. These tech-savvy finance companies are on a tear, wielding serious power and changing how we handle our money.
 
These transformative moments have reshaped consumer financial needs, driving individuals to seek alternative solutions beyond the conventional banking realm. The trust in traditional banks also decreased significantly during these key points in recent global financial history. This shift enabled new generations of financial companies to emerge, resulting in increased competition for the legacy banks.
 
The Most Promising Fintech Trends in Years to Come
 
In the coming years, the competition and collaboration between legacy financial institutions and fintech startups in the Middle East will be fostered and guided by regulators in the Gulf countries. The key sphere to watch is the digital payments sector, which will preserve its role as the most prominent part of fintech. Concepts such as embedded finance and open banking, which allow more people and businesses to access this sector, will be in demand.
 
Financial robo-advising is going to strengthen its power despite the ongoing discussion that AI-driven financial advice can be more effective than investment recommendations provided by humans.
 
Automated financial advisors, more often AI-based, differ somewhat from human investment advisors. They offer a personalized and low-cost service. In comparison to human investment advisors, they vary in terms of skills and cannot be influenced by emotions, biases, and specific interests.
 
Meanwhile, human investment specialists can build higher trust with consumers by reducing perceived uncertainty and anxiety and showing empathy for clients. In the years to come, the paramount concern for banks and fintech companies will be the ever-looming danger of data breaches. They will dedicate their efforts towards devising effective strategies to tackle these risks head-on.
 
Although financial technology has made remarkable strides, the undeniable importance of human connection persists. The all-new fintech can bring more comfort in doing business in the investment sphere, but even the high-end advanced AI advisor won't make up for human emotions and interaction. However, it can help make the investment journey more exciting.
 
By Konstantin Tserazov, former Senior Vice President of Otkritie Bank.