Is Islamic bank consolidation picking up the pace?

Gulf Finance House, the troubled private equity company, is considering merging Khaleeji Commercial Bank (of which it owns 47%) with another bank to create a larger banking entity.  The development follows the three-way merger between Capivest, Elaf Bank and Capital Management House, where the combined entity has total assets of around $400 million.  Those banks were Islamic wholesale banks, while Khaleeji Commercial Bank (KHCB) is an Islamic retail bank

There has been a lot of chatter over the years on the need for consolidation in some of the GCC markets (particularly Bahrain and the UAE), but very little has been done in terms of actual M&A (something which expected to be spurred on by a merger between Al Salam Bank and Bahrain Islamic Bank, which ended up falling apart due to disagreements on the relative valuations of the two banks in the combined entity). Reuters' article on the possible KHCB merger cited a reluctance by "main shareholders, often powerful local familes [being] reluctant to cede control [and demanding] exaggerated valuations".

It is worth noting that there is some empirical research on the optimum bank size and one article by Abdullah Al-Obaidan (pdf) concluded that "small banks [under $1 billion in total assets] are 35% as technically efficient as large bank [,] 50% as scale efficient as large banks [and] 18% as economically efficient as large banks".  The empirical results "indicate that an efficient optimal bank size in the Gulf region has total assets, on average greater than US$5 billion". 

The study was focused on conventional banks within the GCC but the conclusion are likely to be applicable to Islamic banks as well since, for the most part, Islamic banks operate with changes to the product structures, but few differences in the overall operational structure as conventional banks.  There are few Islamic banks that reach $5 billion in total assets, but a bank does not need to reach $5 billion in assets to become more efficient.  The economies of scale for banks underneath this level means that a bank with BD 459 million ($1.2 billion), which is the total for KHCB (pdf) as of September 30 will, ceteris paribus, be less efficient than a bank with BD 918 million ($2.4 billion) in assets.

Consolidation may be difficult, as the scant history of completed Islamic finance M&A indicates, but with Islamic banks already trying to grow in markets where they face competition from larger domestic conventional banks and the Islamic banking windows of global banks, every bit can help the industry grow and become more competitive.