How many local banks does your country have? Hong Kong has 23 licensed banks and Singapore six -- run-of-the-mill numbers for countries with around seven million and five million residents apiece.
Shift gears to the Middle East. The United Arab Emirates (UAE), the financial and logistics hub of the region, has more than 50 banks. Admittedly half of these are locally incorporated subsidiaries of foreign banks, but that still leaves around 25 local banks -- both conventional and Islamic -- to serve the country's 4.5 million residents.
"That to us is an over-banked market," said Kamran Butt, director and head of Middle East equity research for Credit Suisse Private Banking in Dubai. "We definitely expect consolidation in the banking sector to be kick-started in 2009 on the back of, one, a declining earnings pattern and, two, the fact that it's a highly competitive environment and everyone is chasing fewer customers."
The UAE's banking sector was ripe for consolidation to start with and the economic downturn is making the need even more obvious.
"In the current environment, scale brings resilience to organisations," said Sanjay Uppal, chief financial officer for Emirates NBD, the biggest banking group in the UAE by assets. "The UAE has more than 20 local banks and the largest bank has a $77 billion balance sheet. By the time you come to bank number eight the balance sheet is under $10 billion so I'm not even going to guess what bank number 15 has as a balance sheet. When you look at that kind of a scale you suddenly realise that, at times like these, scale matters."
Still, few observers are optimistic that consolidation will start soon. For years, local financiers have been talking about rumours of this or that bank merger but to date only one -- between the Emirates Bank International and National Bank of Dubai -- has ever come to fruition. More recently, two Islamic mortgage houses also merged. But that's it.
Even with today's tumultuous market, consolidation remains uncertain. "Banking consolidation is typically catalysed by times of crisis, difficult times and distress," said Michael Helou, Rothschild's Dubai-based co-head of investment banking. "If you're a smaller player and you have capital or liquidity issues it makes sense then to move into a bigger balance sheet and bigger umbrella. Today [in the UAE], there doesn't seem to be any signs that the level of distress will cause that."
But whether consolidation happens this year or in five years, it is an inevitable evolutionary step for the UAE's local banks.
Why consolidate?
"Emirates NBD came out of the commercial need of Dubai to fund its growth," said Helou. "If you have more [smaller] banks you can only do so much, but one bigger bank can do more."
As multinational banks go to all corners of the globe, competition is even more fierce. "Incumbents will need to develop sharper positioning and coherent business models in order to defend their home markets," according to a recent Boston Consulting Group (BCG) report. "Most future winners will have to be strong acquirers and integrators ... prepared to initiate at least one or two major mergers or acquisitions over the next five to 10 years."
So far, Citi, HSBC and Standard Chartered have all received local banking licences and operate within the domestic UAE market, adding to the competition. And that makes the need for local bank consolidation even more pronounced.
But these things take time. Malaysia took close to a decade to consolidate its banking sector. Prior to the financial crisis, the country of nearly 28 million people had 55 domestic financial institutions. During the crisis central bank governor Ali Abul Hassan bin Sulaiman said the country's fragmented banking system increased the "vulnerability of the economy as a whole" and a consolidated banking sector would be able to support the financing needs of Malaysia's future growth. Slowly, banks started merging and today Malaysia has nine local banking conglomerates.
Obviously banking consolidation alone is not responsible for Malaysia's banks coming out of the crisis. But it is clear that consolidation allowed the local banks to expand regionally and
internationally. Last year, Maybank purchased stakes in Indonesia's Bank Internasional Indonesia and Pakistan's MCB Bank while RHB Capital, a division of the RHB group, purchased 49% of the Vietnam Securities Corporation.
A consolidation of the UAE's banking sector would produce domestic champions and could produce regional champions. Emirates NBD, the result of the country's first and only banking merger since the 1980s, is a domestic champion that set the groundwork for all future mergers in the country's finance sector.
The lone bank merger
"As much as we were trying to grow on our own steam, we were impeded by a whole host of other banks we were competing with within the country," said Emirate NBD's Uppal. "Immediately with the merger, we created a banking leader within the country and the region."
The merger of Emirates Bank International and the National Bank of Dubai was done under the government's urging, creating the largest bank in the UAE by assets, which totalled Dh165.2 billion ($45 billion) in July 2007. Prior to the merger, the National Bank of Abu Dhabi was the country's largest bank with total assets of Dh101 billion.
"Emirates NBD was a good merger," said Georges Makhoul, Morgan Stanley's managing director and president for the Middle East and North Africa. "It was good for shareholders, depositors, Dubai and the markets."
Uppal agrees that the merger was beneficial to shareholders and customers of both companies. "On a whole host of metrics, the merger came together pretty well," he said. "The overlaps we had helped us create cost synergies but at the same time helped us integrate those businesses to create revenue synergies."
From the outset, the merger was seen as one that would set precedents. Though the actual mechanics of the integration were far from unique -- one analyst calls it an "off the shelf"
merger -- it created the basic structure for future bank combinations in the UAE.
The most significant issue the merger faced was the national company law. The merger stipulated that shareholders of Emirates Bank International and National Bank of Dubai would have their shares swapped for an equivalent number of shares in the new company. But according to the law, the new Emirates NDB would need to make an initial public offering to be considered a public company in the UAE. Emirates NBD succeeded in circumventing the stipulations of the company law by getting an exemption from the Federal National Council.
Merge to strengthen
Since the onset of the economic crisis, loans on local banks' balance sheets have surpassed deposits, pushing the average national loan-to-deposit ratio to more than 1.1%. At this level, banks are unable to make new loans under the country's depositary requirements and have an unenviable exposure to the country's imploding property market.
"There was a period of time when a lot of international money came into the market here to speculate on the de-pegging of the currency," said Morgan Stanley's Makhoul. "When that clearly was not going to happen and the credit crisis started, international money started flowing out. Deposits dropped and, even if your loans held constant, the loan-to-deposit ratio mushroomed." According to Morgan Stanley research, nearly two-thirds of net foreign assets held by UAE banks left the country in 2008.
To protect the banks, last autumn the UAE central bank backed all deposits and pumped Dh70 billion ($19.1 billion) of liquidity into the system.
"In the past 12 to 18 months, there was sufficient growth to cater to every participant and each was individually able to meet their ambitions," said Uppal at Emirates NBD. "The picture is different now, some institutions see [the economic crisis] as an opportunity to consolidate."
But not everyone agrees the sector will consolidate in the near term. "Nobody today wants to merge under duress," said Makhoul. "Everybody wants to merge for growth. The mergers will happen when the system calms down a little bit and people are able to tackle the strategic questions of future growth."
Don't miss the moment
"As you look at the [Gulf Cooperation Council] region, its needs for infrastructure investments are immense. These sorts of needs will develop further as we come out of this crisis and there is going to be a need for more capital and banks to support that growth. This posits the question, are the regional banks big enough to support the regional economy?" said Rothschild's Helou, who notes that the government should push for bigger banks to help spur the region's growth.
And to a certain extent, the government is encouraging mergers. Last fall, when two Islamic mortgage finance institutions, Amlak and Tamweel, were on the verge of insolvency after losing more than 80% of their value, the government stepped in and organised a merger between the two.
"The government can play an important part in getting management from different banks to sit at one table and push for consolidation," said Credit Suisse Private Banking's Butt.
But others would prefer private sector-driven consolidation rather than a government-led solution. As Helou puts it, free market decisions make for overall "better results".
Unfortunately, the UAE's web of family business involvement and government ownership in the country's banking sector puts merger decisions in the hands of a few. These core shareholders will ultimately decide the final when, where and how of local financial industry consolidation and, perhaps, who will be the future champions of the Middle East banking industry.
Regional ambitions
The UAE's banks have ambitious plans. As they operate in the region's financial hub they have the opportunity to become the future leading regional financial institutions. However, other Middle Eastern banks are also vying for the regional champion title and national interests stand in the way of cross-border banking mergers.
Analysts say regional consolidation is the next step in the evolution of the Middle East's financial markets. "What we would hope to see are country champions emerging," said Helou. "Dubai has more or less achieved that with Emirates NBD, which would then go regional and eventually move international."
Other country champions include Saudi Arabia's Al Rajhi and Samba, and Kuwait's National Bank of Kuwait and Kuwait Finance House.
The biggest hindrance to cross-border consolidation is national interests. "There are no particular legal restrictions [to cross-border mergers] but both governments would need to agree," said Butt.
Though cross-border mergers may still be a few years away, the GCC has ambitious plans to introduce a monetary union and single currency by 2010. Five of the six currencies -- GCC members include Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE -- are already pegged to the dollar, making cross-valuations simple to determine. But other issues may impede the process, such as national inflation rates, a central monetary authority and harmonised economic reporting standards.
"A monetary union, as we saw in Europe, [would] make it a lot easier for people to think about cross-border mergers," said Helou. "A GCC monetary union can only be a positive but I'm not convinced it could be a catalyst." 
