- International Monetary Fund
- Published Date:
- November 1997
During the 1970s and the early 1980s, the GCC countries made significant progress in financial deepening and in building a modern financial infrastructure. Abundant oil revenue led to the accumulation of sizable official foreign assets and private wealth, part of which were intermediated by GCC financial institutions. Moreover, the GCC countries, which were net providers of savings to the rest of the world until the early 1990s, had little constraint in mobilizing resources for the financing of domestic investment projects, most of which were undertaken by governments. However, activity of the GCC financial intermediaries continued to be centered around their traditional niche consisting mainly of short-term lending to trade, building and construction, and small manufacturing. It was not until the early 1990s that the process of rapid development of financial intermediation and integration with international financial markets started to take hold under the effects of profound changes in the economies of the region, stemming, in particular, from the impact of the Gulf war and the economic reforms that have been initiated thereafter.
With the end of the Gulf war and the return of confidence, banks strengthened their deposit base, and improved productivity by acquiring new technology and developing lucrative consumer-based services (e.g., credit cards, automatic teller machines, consumer lending). Increased capitalization, higher profits, and government assistance, in Kuwait, for example, allowed the banks to compensate for the bad loan problems that had plagued a number of them. Other segments of the financial sector, however, have not made similar progress. Domestic money markets have remained underdeveloped, lacking depth and diversification. Stock exchanges have faced various constraints, despite the existence of a potentially large demand for equity investment; and corporate bonds and secondary markets for government paper have not emerged in a significant manner.
Looking ahead, the GCC financial systems face a number of challenges stemming from the need to adapt to the rapid globalization and support the policy changes that are currently shaping the region’s economies, namely (1) the increased role of the private sector; (2) the strong demand for new financial services and, more generally, the need to better manage domestic savings; and (3) the gradual opening up of activity to foreign participation. Increased competition at the domestic and international levels in the period ahead will put a premium on efficiency and productivity and require enhanced prudential regulation and bank supervision to reduce risks and preserve the soundness of the banking system. Equity markets would need to be developed further to help promote private sector saving and investment.
This paper reviews the structure and key policy issues in the financial systems of the GCC countries. After a brief overview of the main characteristics of the bank intermediaries and the financial system in general in Section II, the key challenges facing these systems are highlighted in Section III in relation with the ongoing changes in the region, including the economic reforms underway. This provides a basis for the subsequent presentation of the reforms needed in many GCC countries (Section IV) to strengthen capital markets; increase competition; open the markets to new entry, including by foreign institutions; and meet the challenges of fostering dynamic financial institutions and equity and bond markets.