An Analysis of Productivity Change: Are UAE Banks Operating Efficiently When Compared to GCC Banks?

INTRODUCTION Efficiency analysis of commercial banks is particularly needed in a region dominated by bank-intermediated finance. A well developed banking sector was found to bear a positive relationship to economic growth (Levine and Zervos, 1998). It was further suggested that the legal environment within which banks operate can significantly affect economic growth through its effect on bank behavior (Levine, 1998). The economies of the Gulf Cooperation Council (GCC) have gone through periods of peaks and troughs, mainly because of their dependence on oil revenues and the volatility of oil prices. After a period of economic slump due to declining oil prices during most of the 1990s, GCC countries have been witnessing breathtaking growth thanks to skyrocketing oil prices since 2000. The surge in oil revenues has led to a lifting of the region's economy and the accumulation of large amount of liquidity. This has stimulated an unprecedented investment boom, especially in the property market, and increasing demand for bank services. The question becomes whether banks are well poised to meet the challenges and take advantage of the new opportunities presented to them. Banks in the region are generally small in size, preventing them from participating fully in the financing of energy-related and other local infrastructure projects. They have long benefited from the protectionist policies of the local governments. Entry and branching restrictions have limited the ability of foreign banks to capture a material share of the local loan and deposit market, even when outnumbering the local ones. Bank regulators, however, have expressed intentions to, or starts of, changes, which, once completely implemented, would confront the banks--specially the local ones--with serious challenges. To start with, all the GCC member countries are signatories of the WTO agreement, which should result in further liberalization of their economies, in general, and the financial sector in particular. Indeed, most of these six countries have already revised, or are in the process of revising, their "company and investment laws" to allow for higher level of foreign ownership of banks and presence of foreign investors in the local stock markets. It is these changes that made Kuwait, Oman and Saudi Arabia extend new licenses to foreign banks in 2004. The UAE recently indicated its intention to adopt a reciprocal treatment to foreign banking presence when issuing new banking licenses. Further, the GCC countries are envisioning a monetary union by the year 2010. This not only assumes the removal of all barriers towards the flow of capital between the member countries. It may also lead, through mergers and acquisition, to a wave of consolidation that would unveil hidden inefficiencies that were only made viable because of government protectionist policies. One salient feature common to all GCC countries is the emergence of Islamic banking and finance. It all started with the establishment of Dubai Islamic Bank which was able to bring about a marriage of faith and finance that many thought could not coexist in modern times. While the Islamic finance sector has been growing at a faster rate than its conventional counterpart, it still is far from capturing a sizable market share of the banking industry. During 2001-2005, the UAE Islamic Banks outperformed their GCC counterparts in terms of growth of their asset base (20.5%), loan portfolio (21.6%), and deposit mix (21.2%) compared to GCC's growth rates of 7%, 6% and 4% respectively. Islamic banks in Bahrain lead in terms of market share: viz., 38% of the country's banking sector real assets, 28% of real loans, and 36% of real deposits in 2005 compared with 12.4%, 16.1% and 13.6% respectively in the UAE. With these scenarios, the efficiency and/or over-the-time efficiency gain of each bank in the system would play a major role in their competitiveness and survival as an independent entity, for the less efficient firms have traditionally been the prime target of well-functioning competitors. …