Kuwait boasts one of the most respected Islamic finance markets in the world. But ever keen to move with the times, the country is establishing a capital markets authority law designed to develop the domestic sukuk market, one of many recent boosts the industry has received.

When the International Monetary Fund (IMF) co-hosted its first ever conference on Islamic finance in 2015, it did so along with the Central Bank of Kuwait in Kuwait City. The IMF’s choice of partner and location is telling. Though Kuwait’s sharia-compliant finance market may have been overshadowed by more illustrious regional peers in recent times, it is nevertheless one of the oldest and most well established in the world. 

Kuwait Finance House, the country’s largest Islamic bank by both Tier 1 capital and total assets, was one of the first to be created in 1977, with the backing of the country’s government and private sector. But in recent years, this strong pedigree has been matched by the introduction of innovative products and services, as well as the global growth story of Kuwait's Islamic banks. Taken together, this has elevated the country’s Islamic finance market to new heights.

A central role 

As Kuwait moves towards its vision of becoming a trade and finance hub, it is expected that its sharia-compliant finance sector will play a sizeable role in this transition. “The high growth of the Islamic finance industry provides excellent opportunities for [Islamic banks] to expand their business due to their low-cost funding structures. These developments stem from the vision to transform Kuwait into a financial and trade hub, with a vision that Islamic finance plays an important role in this centre,” says Hamad Al Hasawi, secretary-general of the Kuwait Banking Association. 

New regulations, including a capital market authority law encouraging the development of a domestic sukuk market, as well as a supportive government spending environment, point to the positive outlook for Kuwait’s Islamic finance sector in the coming year. 

“It’s an important time for Kuwait’s Islamic finance market. The country’s sharia-compliant banks have the capabilities and expertise to develop the sector and participate in the government’s vision of creating a true hub for Islamic finance,” says Ahmed Zulficar, deputy chief executive of Ahli United Bank, the country’s sixth largest lender by total assets.

Sukuk moves add to mood of optimism for Kuwaiti Islamic finance

Slower growth? 

Kuwait’s five Islamic banks have carved out a meaningful space in the wider financial services sector in recent years. As of June 2015, sharia-compliant lenders accounted for 38.5% of the country’s gross financing and 39.1% of total assets. But in doing so, they have also built up a sizeable exposure to the country’s real estate sector, which accounts for 30.3% of total sharia-compliant financing. 

Given the requirements for underlying assets in Islamic finance, banks’ financing books are typically geared towards real estate. As Kuwait’s real estate market cools, the potential for higher-than-average impaired financing ratio is increasing. 

“The sector's impaired financing/gross financing ratios are historically weaker than conventional peers, mainly due to high real estate exposure, which is a key asset class in Islamic financing. While it is positive that the banks have been reducing legacy problem loans over the past three years, these trends could reverse due to slowing domestic and regional economies,” says Bashar Al Natoor, global head of Islamic finance at Fitch Ratings. 

In addition, there is evidence that sharia-compliant loan growth is beginning to normalise, in line with conventional peers. As Fitch Ratings’ Kuwait Islamic Banks Dashboard from February 2016 notes, the growth of gross loans among sharia-compliant lenders in the country has marginally declined from high single digits since the middle of 2014 to about 5% today. 

This is partly a reflection of the changing domestic economic environment as lower oil prices begin to bite. But it also mirrors changes at the global level, as the Islamic finance industry matures and overall growth indicators slowly converge with conventional peers. This trend can be seen in The Banker’s latest Top Islamic Financial Institutions report, which registered a marginal decline. 

Even so, most of Kuwait’s sharia-compliant lenders enjoyed a highly successful year in 2015. Kuwait Finance House’s (KFH's) net profits were up 15% for the year, increasing from Kd126.5m ($419.9m) to Kd145.8m. Meanwhile, Ahli United Bank saw its net profits reach Kd42.8m as operating profits grew by 12.9%. Meanwhile, Boubyan Bank, a subsidiary of the National Bank of Kuwait, saw its total assets jump by 18% in 2015, while net profits also increased for the year. 

“KFH succeeded in achieving growth across all its financial indicators in 2015. This confirms the bank’s success in increasing profitability, enhancing service quality and business excellence, and boosting customers’ confidence,” says Mazin Al-Nahedh, the bank's chief executive.

Sukuk boost 

Meanwhile, the outlook for Kuwait’s Islamic banks has been given a boost by the introduction of new regulations around sukuk issuance. In November 2015, the country's Capital Market Authority (CMA) released comprehensive legal guidelines governing the conditions in which sukuk can be considered tradable, as well as an outline of the specific sukuk instruments that can be used. 

Under these rules, both the CMA and the Central Bank of Kuwait must now approve all sukuk issuance in Kuwait. The move follows a serious decline in local currency corporate sukuk issuance in recent years. 

“As well as the lack of a regulatory regime, corporate sukuk issuance has also been limited due to the sector's heavy reliance on bank lending, helped by strong liquidity. This resulted in the almost complete absence of corporate sukuk issuance in 2014 and the first three quarters of 2015,” says Mr Al Natoor. 

The new regulations are expected to facilitate a new wave of corporate issuance by providing a firmer legal basis for sukuk transactions just as liquidity in the banking sector is beginning to tighten. As a result, most of Kuwait’s Islamic banks are gearing up for the new potential this could bring to the wider market. 

“Whether it’s sukuk or conventional bond financing, there is a more supportive regulatory environment in place. Here, the banks can help corporates to tap the debt markets. We hope this will help to spur the creation of a local currency sukuk market,” says Mr Zulficar. 

Meanwhile, KFH is continuing to play an important role in the global sukuk market. In 2015 alone, the bank traded more than $4.4bn in sukuk globally, representing a 46% increase from the previous year. KFH has also participated on some of the more ground-breaking deals of recent times, taking a leading role in the government of South Africa’s debut issuance. 

“Sukuk help banks to boost their capital adequacy ratio so they can grow and enhance their presence in the international markets. KFH is a pioneer in this product. One of the largest issuance in the past year was the $500m sukuk issue for Sharjah Islamic Bank through bank’s subsidiary KFH-Capital,” says Mr Al-Nahedh. 

"We will continue our efforts to attract a broad base of investors to the sukuk market, be it governments, financial institutions or investment funds, which allows Islamic finance to gain considerable momentum locally and globally,” he adds.

Positive future 

Looking ahead, Kuwait’s Islamic banks, like their conventional peers, are expected to benefit from strong government spending as well as a booming consumer finance sector in the domestic market. In particular, the country’s youth bulge lends itself to targeting new graduates and the recently employed. The Central Bank of Kuwait’s relaxation of rules around the prohibition of banks buying out consumer financing from one another is a further incentive for investment in retail financing. 

“In 2016 we intend to prioritise our retail financing offerings. We see this as an important growth driver. The central bank’s new regulations will help in this regard, given that it will encourage greater competition between banks while providing the consumer with more choice,” says Mr Zulficar at Ahli United Bank. 

While offering strong growth potential, this sector is similarly driving innovation in sharia-compliant products and services. Kuwait Finance House recently launched its ‘Gold’ account to enable customers to buy and sell gold ‘biscuits’ (100 grams of gold) certified by the bank and the ministry of finance. These accounts contribute to the customer’s deposit base and can also be used for saving or investment purposes. 

“KFH is keen to continually innovate when it comes to sharia-compliant products, and this includes our Gold account. [Innovation] contributes to the growth of KFH at the group level,” says Mr Al-Nahedh. 

While potential risks remain for Kuwait’s Islamic banks, including exposure to the real estate sector, deteriorating asset quality and moderating financing growth, the outlook as a whole remains strong. For one, the country’s local currency sukuk market is likely to generate new growth opportunities over time. But for now, Islamic banks can count on the country’s booming project market, as well as its favourable demographics, to support their continued growth. 

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