A potential merger between two of Abu Dhabi’s biggest banks may just be the start of consolidation in the industry.

That’s according to analysts from EFG-Hermes Holding and Emirates NBD, who say the UAE needs more tie-ups because too many banks are serving a relatively small population of 9 million and growth prospects are limited.

About 50 local and international lenders face declining government spending, slowing economies and falling asset quality after a slump in oil, the region’s principal export.

In what would be the country’s first major banking merger in almost a decade, National Bank of Abu Dhabi and First Gulf Bank said on Sunday that they’re in talks on a potential deal. Senior executives from the two banks are reviewing the commercial, structural and legal aspects of a possible combination, according to a statement.

“This merger could pave the way for more consolidation in the sector – Abu Dhabi Commercial Bank, Union National Bank and Abu Dhabi Islamic Bank,” EFG-Hermes Holding analyst Shabbir Malik said in a note Sunday. “The UAE.’s banking space is quite crowded, credit penetration is high at about 100 percent of gross domestic product, while the credit and macro growth outlook is soft.”

The banks confirmed a Bloomberg News story on June 16 that said they were in talks on a potential merger.

Bank Merger

A combination of NBAD and FGB would mark the country’s first major banking merger since National Bank of Dubai and Emirates Bank International combined to create Emirates NBD in 2007. The Dubai bank’s chief executive officer Shayne Nelson has called for further consolidation, saying too many banks are serving a relatively small population.

Bank liquidity in the six-nation Gulf Cooperation Council, which also includes Saudi Arabia, is tightening as the oil slump slows deposit growth and pushes governments to boost borrowing. GCC governments may rack up a combined budget deficit of about $140 billion this year if crude prices remain in the mid-$40s, according to Emirates NBD estimates.

In the UAE, banks’ loans-to-deposit ratio worsened to 101.1 percent in April from 98.6 percent a year earlier, according to central bank data. The three-month interbank interest rate earlier this month climbed to the highest in more than three years.

‘Too Fragmented’

"The current tightening liquidity in the banking sector due to lower oil price revenues has heightened the possibility of consolidation, particularly as the industry is seen to be too fragmented at present," said Anita Yadav, head of fixed-income research at Emirates NBD.

Shares of NBAD rose by the daily limit of 15 percent, the most in more than two years, to 9.2 dirhams on Sunday and FGB advanced 11 percent to 13.1 dirhams. Both banks reported a decline in first-quarter net income.

“Consolidation would be positive for UAE banks from a return generation perspective,” said Goldman Sachs Group analyst  Waleed Mohsin. “This is especially true given the fragmented nature of the market and the current challenging macro environment.” -Bloomberg