For more than three decades, Bahrain has played a leading role in the Gulf’s financial development. As an offshore banking centre in the 1970s, Bahrain acted as the main conduit for the hordes of suitcase bankers streaming into Saudi Arabia and for placing the billions of petrodollars from the region’s first oil boom into Europe and the US.
Without the massive hydrocarbon revenues of the other five Gulf Co-operation Council (GCC) states, Bahrain has been forced to develop its non-hydrocarbon potential. With nominal gross domestic product (GDP) in 2007 at $16.7bn, according to the Washington-based Institute of International Finance, compared with Saudi Arabia’s $376.8bn and the United Arab Emirates’ (UAE) $188.8bn, Bahrain’s relatively smaller economy has fought hard to build its financial sector and with considerable success.
Speaking recently, Central Bank of Bahrain (CBB) governor Rasheed Al-Maraj explained that the financial sector had surpassed the oil sector as the largest contributor to the national economy, representing 25.5% of GDP (in real terms) in 2006, compared with the oil sector’s 15.5%.
New challenges
Bahrain managed to tough out the turmoil of the considerable oil price and financial volatility of the 1980s and 1990s in the Gulf, but the 21st century has brought new challenges and significant new financial competition in the region as surrounding countries have sought to take advantage of the Gulf’s enormous wealth and potential.
Not surprisingly, the dominant economy in the region, Saudi Arabia, has begun a major transformation of its financial services capability. Since the end of 2004 and the creation of the Capital Market Authority, 83 investment companies have been licensed along with a dozen new foreign banks and a number of insurance companies. The number of Saudi financial providers has risen from 11 at end 2004, including one insurance company, to more than 120 financial service providers at the end of 2007, including more than 14 insurance companies.
In the UAE, the creation of the Dubai International Financial Centre (DIFC) has helped to develop another regional financial hub with some unique features, which at the end of 2007 had attracted more than 500 registered firms. The UAE can also claim increasing strength in the growth area of Islamic banking. Dubai Islamic Bank and Abu Dhabi Islamic Bank rank third and fourth among Islamic institutions in the GCC respectively, according to The Banker’s Top 500 Islamic Institutions listing (November 2007). In January a new giant, Noor Islamic Bank, was launched in Dubai with a paid-up capital of $1bn and a staff of 400, and the Abu Dhabi government has launched plans for a similar giant, Al Hilal Islamic Bank.
With the development of the Qatar Financial Centre (QFC) and its specific strategy built around large-scale project finance and Qatar’s financing needs, it is clear that the region’s financial requirements are evolving and will continue to change.
Centre of gravity
Also, with oil prices at $100 or more a barrel, and the growing importance of India and China, many analysts are convinced that the global financial centre of gravity is moving east, away from the US and Europe, and placing ever greater importance on the Gulf and its financial and natural resources.
As the McKinsey report in January, The Coming Windfall in the Gulf, noted, oil export revenues from the six GCC states will add up to $6200bn in the next 14 years (at $70 a barrel), more than triple the amount they earned in the previous 14 years. And those oil revenues would rise to $9000bn at $100 a barrel.
McKinsey noted that in the lower forecast, the GCC would have $3500bn of new funds to invest in global capital markets between now and 2020, almost twice as much as their foreign wealth today. With the GCC’s total foreign wealth estimated to expand to $8300bn, the growth of the Gulf’s financial resources look huge.
What does this oil wealth bonanza mean for the existing financial centres in the region and, in particular, Bahrain? Although the region’s history of volatility can play havoc with forecasts, it is reasonable to suggest that the outlook is for significant growth in Gulf hydrocarbon revenues, with Saudi Arabia accounting for almost two- thirds of the cumulative total followed by the UAE (14%) and Kuwait (13%).
Financial prospects
So what role will Bahrain play in the Gulf’s financial future? At the end of March, Bahrain had 404 licensed financial institutions, the Middle East’s largest critical mass of financial services providers, made up of a broad range of international, regional and local players.
Bahrain may represent the largest critical mass of institutions and the most mature financial centre in the region but how can it maintain a competitive edge, especially as neighbouring states expand their own financial infrastructures?
Bahrain has always emphasised the strength of its regulatory framework as a critical success factor and key attraction for institutions operating in the region. CBB’s Mr Al-Maraj notes: “At the core of our regulatory development and enhancement programme is the CBB Rulebook, which is providing the momentum for financial services providers to structure and offer a new generation of products.”
The CBB notes that Bahrain’s attractiveness as a jurisdiction of choice has been bolstered by the implementation of a new, modernised licensing framework that now defines licence categories by regulated activity rather than institution type, providing a new, more flexible and inclusive framework. The five basic licence categories under the new integrated framework are: conventional banking, Islamic banking, insurance, investment business and specialised licensees.
Under the new framework, the previous onshore and offshore banking categories have been simplified, allowing greater flexibility, and new developments have emerged such as the private banking licence, created last year, which encourages international and regional banks to offer more sophisticated wealth management services.
Bahrain also emphasises its pioneering role in Islamic banking, being the first country to implement a regulatory framework for Islamic banks in 2001, and a regulatory framework for Islamic insurance and reinsurance in 2005. While the CBB has been instrumental in constructing a strong regulatory environment for Islamic finance, other significant institutions have emerged to support the claim that Bahrain is the world’s leading Islamic finance centre.
Besides the Manama-based Accounting and Auditing Organisation for Islamic Financial Institutions, which is the industry’s leading accounting authority, supported by 160 institutions from 30 countries, the International Islamic Financial Market (IIFM) is fast becoming another important part of Islamic finance’s global infrastructure. Founded with the mandate to establish, develop and promote Islamic capital and money markets, the Manama-based IIFM is making important progress not only in standardising Islamic financial structures but also in integrating them into mainstream global financial markets.
Talking to The Banker, IIFM chief executive Ijlal Ahmed Alvi explains that the organisation is finalising three key initiatives to help stimulate Islamic financial markets. The first is the master agreement for Islamic treasury placement or commodity murabaha, which will provide a standardised benchmark document for the industry, thereby simplifying and lowering costs. The commodity murabaha market is estimated to be worth $100bn.
Second, the IIFM is working with the International Swaps and Derivatives Association to create a framework document covering Islamic hedging, a new area for Islamic finance. And third, IIFM is working with the International Capital Market Association to develop an Islamic repurchase agreement that will provide the industry with a badly needed, efficient liquidity management tool that will also help in the development of the secondary market in sukuk (Islamic bonds). With support from shariah scholars, the CBB and 40 other institutions, the IIFM is developing the much-needed tools for an expanding Islamic capital and money market infrastructure.
Regulatory authority
As well as achieving double-digit growth in insurance, Bahrain has been demonstrating its regulatory authority and concerns over risk management with extensive consultation and training on Basel II. The pillar 1 regulations (of Basel II) came into effect in January, and pillars 2 and 3 are scheduled for later in the year. The CBB notes that it already has a capital adequacy ratio of 12% and under Basel II will not go lower than 10%.
Concerned about maintaining its regulatory reputation in the wake of the US subprime crisis and anxious to avoid the emergence of a real estate bubble in Bahrain, the CBB issued a consultation paper to banks in early December regarding exposure limits to real estate. Hussain Ali Sharaf, director of the CBB’s wholesale banking supervision, tells The Banker that the paper proposed a limit on the aggregate credit concentration to real estate in the overall gross loan portfolio to 25%. In addition, and to avoid land speculation, the paper called for 150% collateral for real estate loans.
As in other Gulf states, real estate is a prime investment product in Bahrain and also a key vehicle for Islamic financial institutions, given their asset-centric structures. Therefore, the CBB’s wariness about a real estate bubble and caution in limiting real estate exposure to 25% may strike some institutions with considerably higher exposures quite hard.
Banks’ reaction to the consultation paper has been muted so far but the initial closure date for comments in January has long passed and a further consultation paper by the CBB is likely towards the summer. While the CBB’s rationale is clear – no bubbles – the outcome of the process is critical for institutions, especially the Islamic houses. Mr Sharaf emphasises: “Let the banks do banking; let the real estate companies do real estate.” The institutions may see it slightly differently.
International outlook
So what is the outlook for Bahrain as an international financial centre? In the past two years, Bahrain’s banking system has averaged 25% year-on-year growth. The consolidated balance sheet of Bahrain’s banks stood at an all-time high of $233.2bn at end-October 2007, an increase of 33% on the same period in 2006. The consolidated assets of Bahrain’s retail and wholesale banks have grown by nearly one-third over the previous year alone and had more than doubled in the previous five years.
Wholesale banks represent 80% of the overall total assets at $185.9bn at end-October, up 20%, and Islamic banks – although relatively small with assets totalling $18.8bn at end October – showing strong year-on-year growth of 85%.
Bahrain can point to healthy growth in assets, an innovative and well-respected regulator and strong growth in new licences. According to the CBB, 38 new licences were awarded in 2007 compared with 33 in 2006. The 38 included nine banks, among them two major Indian banks, Bank of Baroda and HDFC Bank, and six Islamic banks. The new entrants also included 12 insurance companies and 17 other financial institutions.
Just as Bahrain is expanding, other centres are expanding, too. Aggregate banking assets in Saudi Arabia, for example, were up 27.4% in 2007 to $286.1bn. As McKinsey forecasts, the financial pie in the region is growing significantly. But for financial centres in the Gulf, it is not a winner takes all game. With so much wealth and oil revenues sloshing around, there is room for more than one financial centre and clearly room for more specialisation and competition.
Bahrain may have been the first Gulf financial centre but it is certainly not the last. The prospects for all, whether the King Abdullah Financial District in Riyadh, the DIFC, the QFC, Bahrain or others, are neither set in stone nor guaranteed. Many factors go into creating a viable, attractive, well-respected financial hub and those factors can change. But Bahrain has understood well that innovation and good regulation are fundamental to success.
Looking ahead at the financial windfall to come in the Gulf, the opportunities are there, and Bahrain can maintain its financial role if it can continue to be flexible, build up sectors such as Islamic finance and insurance, and keep its focus on good regulation.
