The Evolving Payments Landscape in the Middle East

The Middle East has some of the fastest growing economies in the world and possesses unique demographic characteristics. Due to this rapid development and a growing awareness of global trends, both companies and individuals are demanding faster and cheaper methods of making payments. To their credit, most of the central banks in the region are already taking the initiative of upgrading their payment and settlement systems.

Background

In the 1930s, as oil was first being discovered under the sands of the Arabian Peninsula, a unique conundrum was faced by the buyers and sellers of this increasingly valuable commodity. Standard Oil of California (Socal) had negotiated the first oil concession in 1933 with the newly formed Kingdom of Saudi Arabia, and had agreed to an initial payment of £35,000. The problem lay in the method of payment, as the Saudi monetary system only used chunky silver coins, alongside a variety of Ottoman, Indian and European coinage that were widely accepted in the local economy. Banks were considered un-Islamic and the only financial institutions were moneychangers.

It was therefore agreed that payment would be made in gold sovereigns and 35,000 of these coins were shipped from the Morgan Guaranty offices in London to the Persian Gulf abroad a P&O liner. On arrival, the shipment was carefully counted in front of the Saudi Finance Minister, and was then rumoured to have been safely stored in a chest under his bed. For years later, American oil companies shipped British gold sovereigns to the Saudis by boat and plane as payment for oil.¹

Since that time, the process of making payments in the Middle East has become considerably less laborious and time consuming. In a way, the relatively late adoption of modern banking principles by the Middle East oil economies has meant that they have been able to leapfrog the development curve and implement the latest tools and procedures.

Unique Characteristics of the GCC

While the Levant countries and Iran form an important part of the Middle East, their financial development is heavily over-shadowed by the fluctuating politics of the region. Therefore, this article will focus on the Gulf Cooperation Council (GCC) countries, i.e. Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and UAE. Among the unique characteristics of these countries are:

• Rapidly growing economies fuelled by rising oil revenues.
• A young (majority under 30) and technology literate population.
• High proportion of expatriate workers.
• Increased spending on infrastructure projects and non-oil industries and services.
• Growing availability and awareness of consumer finance.

All these factors impact the current status and future strategy of the payment systems in the region.

Among the key characteristics of the automated clearing systems in the GCC is the lack of distinction between high value versus low value payments and the adoption of SWIFT messaging standards.

In the Middle East, Saudi Arabia has been the pioneer in developing payment automation. The Saudi Arabian Riyal Interbank Express (SARIE) was started in 1997 as the region’s first real-time gross settlement (RTGS) system, for same-day value customer and interbank payments. The system provides for both single and batch payments, as well as a direct debit capability. Over the last decade, SARIE transactions have steadily replaced paper-based instruments and cash payments. In the period 2005-2007, the number of cheques declined by 5% while SARIE transactions increased by 30%. The monetary value of SARIE transactions is over four times the value of cheques.

Figure 1:Saudi Arabian Riyal Interbank Express Transaction Volumes

Source:Saudi Arabian Monetary Agency Quarterly Report Dec 2007

Another first for Saudi Arabia was the launch of the SADAD payment system in 2005. This is now a fully operational electronic bill presentment and payment (EBPP) system that is linked to all the major banks and billers in the country. Modes of payment available through SADAD are Internet and phone banking services of the banks as well as ATMs and bank branches. All the major utilities, insurance companies and government departments are members of SADAD.

Figure 2

Source: SADAD

The SPAN network in Saudi Arabia supports pin-based debit card payments on POS. The same network also supports ATMs and these can now be used for a variety of banking services, from bill payments to applying for IPOs.

An example of innovation in the Middle East is the GCCNET network which links the ATM switches of all the six GCC countries. Account holders in any of the countries are able to use ATMs across the region to withdraw cash and view account balances. Since the GCC currencies have a fixed exchange rate between each other, the ATM transactions can be settled without the need for an intermediate currency. The Central Bank of Bahrain acts as the settlement bank.

Key to the success of these systems is the degree of adoption by the local population. Most commercial banks in the region now offer one or more ‘direct channel’ for payment transactions and the level of usage is steadily increasing. The factors that influence the growth of direct channels (ATM, phone banking, Internet banking) include:

• Availability of more than 11,000 ATMs across the GCC. In almost all cases, cash withdrawals are free of charge to the customer.
• Dual language (English and Arabic) availability across most of the direct channels.
• Increasing number of Internet users in the region.
• Lower transaction fees as incentive for use of direct channels.

Combined with the rollout of RTGS in the GCC countries, the use of direct channels for payments is greatly improving the straight through processing (STP) rates for commercial banks.

Regional Financial Centres

As the needs of the Middle East institutional and retail communities have expanded and become more sophisticated, regional financial hubs have developed to cater to these requirements. Unlike previous oil booms where capital flowed to Western financial centres, the governments of the region are trying to ensure that they offer investment opportunities within their national borders. The Dubai International Finance Centre (DIFC), Qatar Financial Centre (QFC) and Bahrain Financial Harbour (BFH) are the most prominent examples of these and offer business and taxation incentives to both local and foreign financial institutions.

All the financial centres have been able to take advantage of the growth in private equity, asset management and Islamic banking in the region. However, development of payment, clearing and settlement systems has seen less focus and the centres have depended on their respective central banks to upgrade this infrastructure. An exception is DIFC, which is looking at either outsourcing these services or developing its own independent systems.

The DIFC is proposing to launch an ‘offshore’ euro and US dollar RTGS based on the Hong Kong example. The basis and benefits for this system are still being debated, since most of the local GCC currencies are pegged to US dollar and the time difference issue (Herstatt risk) for US-based clearing is less of a factor. There are also increasing measures by the US government to monitor US dollar transactions worldwide and the availability of dollar clearing systems that bypass US jurisdiction may lead to increased concerns on money laundering.

GCC Common Currency

A common currency framework for the six GCC countries has been under discussion for years but has often been subjected to the differing political and economic priorities of the member states. The case for a common currency is quite logical, due to the US dollar-based peg of all currencies (except Kuwaiti dinar) and the similar oil-based economies. However, political considerations ranging from the financial (should the common currency be pegged to the US dollar or a basket?) to the nationalistic (where would the GCC Central Bank be based?) are leading to a possible delay from the deadline of 2010 for the single currency. Oman has already stated its inability to meet this deadline. It is likely that the question of de-pegging or revaluing the US dollar peg will be decided before a decision is made on continuing with a common currency. A recent development that will aid the progress to a single currency was the launch of a GCC Common Market in January 2008. This goes beyond the existing customs union between the GCC countries and allows for free movement of labour and capital in addition to goods and services.

From a payments system perspective, the delay in the GCC common currency may give time to the member countries to complete the upgrade of their local clearing systems. The rapid rollout of ACH capabilities in the region will make it easier for integration and networking among the individual systems. Rather than follow the European example of a significant gap between single currency adoption and launch of a single payments area, the GCC countries may be in a position to provide both at the same date. However, the GCC central banks are still debating the options for implementing a common payments infrastructure that will be similar to the single euro payments area (SEPA) in Europe. The first option is to build a single regional RTGS system that integrates all the national clearing systems. The second option is to build a semi-centralised system that acts as a switch between each of the national RTGS systems. The third option is to build bilateral links between the country RTGS system and decentralise the settlement and liquidity management process.² Given the recent investments in building local RTGS systems, the second option may end up being the preferred choice.

The other factor that would aid a rapid rollout of a common GCC payment area is the adoption of International Banking Account Numbers (IBANs). This project has already started in Saudi Arabia and the banks are expected to convert to IBAN by 2009.

The GCC single payments system is also expected to incorporate GCCNET and handle securities and money market settlement transactions between the financial institutions in the region. Among other initiatives, this will facilitate the formation of a single interbank Islamic money market across the region and possibly a single securities exchange. SWIFT standards are widely used in the region and will be the standard for the GCC payments system.

Worker Remittances

As the discovery of oil rapidly transformed and modernised the GCC states, it became necessary for them to import both skilled and unskilled workforces from Asian and European countries. The skilled workers bought in expertise and knowledge for all parts of the economic sector, while the unskilled workers were responsible for building and servicing the new infrastructure for these countries. The consequence of this steady inflow of expatriate workers is that more than one-third of the population in the GCC is now composed of foreigners. The proportion of expatriate workers differs by country and they form an overall majority in the UAE, Kuwait and Qatar. Despite the efforts of the GCC governments to limit the number of foreign workers and impose rules for hiring of nationals, economic imperatives have made it necessary to continue hiring foreign workers. The local population in these countries does not yet have the required skill sets and training for the more complex jobs and does not have the financial need or motivation to carry out unskilled work.

The estimated population of 12-13 million foreign workers in the Gulf are mostly from poorer Asian countries, such asIndia, Pakistan, Bangladesh, Sri Lanka and the Philippines. The unskilled labour force from these countries is attracted by the relatively high wages in the Middle East as well as the absence of personal income tax. However, they need to continue supporting their families back home and generally remit a portion of their income on a regular basis for this purpose.

The total outflow of worker remittances from the GCC countries is estimated at between US$35-40bn per year. The absence of confirmed data is due to the portion of remittances being sent through informal channels known as ‘hundi’ or ‘hawala’. These operate as a parallel payment method based on unofficial networks of moneychangers and are favoured by workers because of their low cost and knowledge of home markets. It is important to note that a large percentage of the beneficiaries in the worker’s home countries do not have banking accounts and therefore require cash or a demand draft as payment. The increased focus on money laundering has led to a shift from these unofficial channels to regular banking methods but they remain an important component of worker remittances.

The GCC countries are the second largest source of outward worker remittances after the US. Although sizable in aggregate, the average remittance size is only about US$250. The main concerns of the remitter are pricing, speed of delivery and reliability. Across the Middle East, a wide range of exchange companies and moneychangers have traditionally handled the bulk of these transactions. However, commercial banks have recognised the lucrative nature of this business and have setup special brands and branches to handle remittances. Non-banking players, such as Western Union, have also made an aggressive entry into the market.

Worker remittances in the Middle East are a low margin, volume-based proposition for banks and other service providers. Therefore, an increased focus is taking place on automating transactions through the use of a various technologies. The main impediment in using sophisticated tools like Internet banking is the low literacy rates of most expatriate workers. However, most of the workers are knowledgeable about the use of mobile phones.

Mobile banking is growing in popularity in the Middle East with the young local population. At the same time, it provides one of the most convenient methods for worker remittances. It has also been proven to work in less developed countries such as India, Kenya and Philippines. One of the main impediments for mobile banking is that it shifts the remittance method from being cash-based to account-based transaction. Due to their low monthly income, most commercial banks had been unwilling to open accounts for workers in the past. With the added value of remittance transaction fees, the banks may reconsider their positions and provide ‘virtual accounts’ that have low maintenance costs.

Another direct channel that is poised for growth in handling worker remittances is the ATM and POS network in the region. This development is linked to the launch of ‘smart cards’ using chip technology that can act as a virtual wallet and also store payment data. Unskilled workers can have their salaries loaded on to the cards and then use ATMs or POS terminals to remit money to pre-designated beneficiaries. Chip reading technology is already being deployed in the GCC as part of the effort to increase card security.

The expatriate skilled workers form an important target market for banks due to their higher disposable incomes and cross-border investment and banking needs. The large global banks have set up offshore banking centres in the region to tap this market and provide them the convenience of banking in their home countries. Using Internet banking tools, these expatriates can manage their finances, make investments, buy property and make payments on a worldwide basis.

Payments Outlook for the Middle East

On the corporate front, there is a growing awareness of the efficiencies provided by direct banking systems. All the major banks in the region provide Internet banking services with sophisticated encryption and user authentication security. The earlier reluctance of older family managed businesses to adopt new banking technology is giving way to the new generation of professional managers, who understand the value of maximising productivity and outsourcing financial back office functions. Some of the largest corporations in the region have adopted SWIFT’s Member Administered Closed User Group (MA-CUG) while direct debits and EBPP have improved the receivables management process. Middle East companies are also aiming at global expansion and will therefore need financial service providers who can not only handle their domestic payment needs but can also manage their global liquidity and currency positions.

On the retail front, the increased use of direct channels instead of bank branches, the availability of direct transfers instead of paper instruments and the spread of new technologies such as mobile payments and smart debit/credit cards will significantly change consumer behaviour. Cash will be used less often and may not even be allowed in some forms of government payments. Expatriate workers will be able to deliver funds to their families in home countries within 24 hours and at minimal cost.

On the regulatory front, the GCC common currency and single payments area will be the focus of the region’s central banks. They will continue to support the automation of financial transactions and the expansion of financial services to the un-banked segments of the population. This will in turn enable a higher degree of scrutiny on financial transactions, which is a major compliance concern in the region. The regional financial centres will strive to find niche opportunities such as foreign currency RTGS and Islamic products.

On the banking front, the number of new entrants is increasing and the subsequent competitive pressure is forcing banks to adopt new payments products. The new domestic banks being formed are able to implement cutting edge technology, without the concern of legacy system migration. Similarly, new foreign players in the region are bringing their expertise and solutions in other markets to the Gulf. Commercial banks will have to focus on service quality and delivery for payments, in order to effectively compete with exchange companies and non-banking institutions.

These developments highlight the fact that the Middle East has not only caught up with the rest of the world in its financial systems but is poised to become a benchmark for other emerging markets.

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