Kuwait's CBG looks to stability and sukuk

Q: What actions has the Central Bank of Kuwait [CBK] taken to maintain the competitiveness of the Kuwaiti dinar in recent months?

A: Fundamentally sustainable economic performance and appropriate macro policies – both fiscal and monetary – constitute the pillars of exchange rate stability. More specifically, the maintenance of the competitiveness and attractiveness of the Kuwaiti dinar as the store for domestic savings and investments is the highest priority for the CBK, which remains committed to being vigilant and ready to take all action necessary to safeguard the competitiveness of the national currency.

In that pursuit, the basket peg employed by the CBK in the determination of the dinar exchange rate since the mid-1970s and the relative flexibility it provides continues to serve the Kuwaiti economy as a framework for monetary policy and achieving price stability. 

Volatility in the foreign exchange market in recent months is a challenge that the CBK is addressing from a point of strength and confidence, utilising the various monetary and supervisory tools at its disposal. An important part of that toolkit is the interest rate policy of the CBK, which seeks to balance domestic conditions as well as developments in interest rates on international currencies. In line with the recent rise in interest rates on the US dollar, the CBK decided in December 2015 to raise the domestic discount rate to maintain the alignment of dinar interest rates with those of major international currencies.

The CBK continues to closely monitor developments through various indicators and stands ready to take necessary action to maintain the competitiveness and attractiveness of the dinar. 

Q: To what extent is Kuwait’s banking sector exposed to a downturn in real estate prices? What are the implications of a cooling real estate market for Kuwaiti banks? 

A: The banks in Kuwait are comparatively well diversified in terms of their loan structures, while they also benefit from strong capital adequacy ratios, stable funding and adequate liquidity levels. The banking sector’s consolidated real estate exposure at the end of 2015 reached 22% of the entire credit portfolio, which is lower than in recent years. Moreover, the use of real estate as collateral accounts for only one-fifth of overall banking system collaterals and indicates a significant level of asset-class diversification within banking sector.

The non-performing loan [NPL] ratio for the real estate sector is among the lowest in the economy – NPLs stand at a mere 0.7% with a coverage ratio of 190% – and is a true reflection of the state of the real estate credit portfolio of Kuwaiti banks. The real estate sector has shown resilience to the current macro-economic shock and remains robust. 

Nonetheless, we recognise that within this region, there can be a significant price correlation between oil prices and real estate. This in turn may have knock-on implications. We are therefore mindful of these trends and to counter such situations, we have already put in place proper safeguards by continuously updating macro-prudential tools to preserve the financial stability of Kuwaiti banks. Thus, we intend to keep the effect of cooling real estate values upon the financial condition of Kuwaiti banks well under control. 

Q: What macro-prudential measures has the CBK taken to mitigate the prospect of real estate-related risks to the banking sector? 

A: We have several macro-prudential tools to monitor and manage systemic risk, including risk arising out of the real estate sector. For real estate-related banking book asset classes we strike a fair balance between robust capital adequacy levels by using a range of risk weights commensurate with the systemic risk involved on the one hand, and the availability of funding to the sector on the other. 

For many years, we have ensured that our banking system has built a strong capital base. At present, it has a capital adequacy ratio of 16.5% and substantial loan-loss absorption capacity with Tier 1 capital constituting 90% of banks’ total capital. Moreover, our progressive regulatory reforms over the past few years have been notable, including the early implementation of Basel III capital requirements, as well as leverage and liquidity buffers for the Liquidity Coverage Ratio and Net Stable Funding Ratio standards. Nevertheless, the regulatory reform agenda ahead remains formidable. These measures highlight the capacity of our banking system to remain stable even under challenging macro-economic conditions. 

Using macro-prudential tools, not only have we differentiated risk weights between various classes of real estate investments, but we have continuously monitored market trends, including real estate price trends, and dynamically adjusted the risk weights, loan-to-value ratios, and debt services to income for the real estate sector. Consequently, we have restricted banks’ lending to required real estate sub-sectors, while conservative tools restrict over-exposure to riskier real estate transactions in a more prudent manner. 

Q: To what extent will new regulations around the issuance of sukuk support both corporate and sovereign transactions in the future? 

A: A suitable legal framework for sukuk issuance has been implemented through the coordinated efforts of the CBK, the Capital Markets Authority, the Ministry of Finance and other related parties. It is intended that this legal framework will help us in issuing sovereign sukuk, as and when deemed appropriate. With this regulation we have addressed several impediments and legislative issues for the development of the local sukuk market – a long-term alternative instrument for sovereign financing, corporate financing, infrastructure financing and for achieving the sustainable development of the economy through diversifying funding products.   

Sovereign bond and sukuk issuances encompassing different maturities will provide a useful yield curve, which can act as benchmarks for the pricing of corporate debt; therefore, sovereign issuance can assist corporate borrowers in tapping the sukuk and bond market. This has the potential to enhance banking activities in Kuwait in general and act as a strategic funding tool for economic growth. 

Furthermore, from a regulatory perspective, sovereign sukuk have the potential to serve as high-quality liquid assets, which is of increasing importance in the implementation of Basel III liquidity and capital adequacy frameworks. 

Having said this, further concerted and coordinated efforts are in the process of being put in place – within regulatory institutions and government bodies for the development of stronger market infrastructure — including developing a credible secondary market for trading sukuk issues in more systematic manner. 

Q: To what extent will Kuwait’s banking sector benefit from the government’s continued commitment to capital spending? 

A: Higher capital expenditures by the government for infrastructure projects will certainly help to support healthy non-oil growth. Large infrastructure-related projects tend to stimulate construction activity, and thus support diversification and growth in the non-oil sectors. In turn, we envisage this will support normal credit growth of the banking sector and permit a more open and diverse operating environment for banks. 

Q: What are the CBK’s priorities for 2016? What is the CBK’s outlook for growth and the performance of the banking sector in 2016? 

A: The CBK’s priorities for 2016 and beyond relate to its dual mandate of monetary policy and banking regulation and supervision. In the area of monetary policy, the CBK will maintain its vigilance and readiness to take necessary action to sustain healthy monetary conditions that support sustainable growth with stable prices. In the area of banking regulation and supervision, [specifically] the CBK will implement the very best global standards in order to ensure the resilience and soundness of the banking system, and sustain financial stability in general. 

The outlook for growth and the performance of the banking sector in 2016 will undoubtedly depend on a great many factors – not all of which are domestically driven. We envisage that the government’s economic reform plans will do much to bolster domestic growth and demand for credit, as well as spurring much-needed growth in the non-oil sector. 

Banks operating in Kuwait are expected to maintain their strong financial condition, and be alert and prompt in capturing new business that will be to the country’s long-term benefit in terms of economic development and diversification. We acknowledge the challenging conditions that exist in many regional and international markets but, as in the past, we foresee the domestic financial sector poised to develop and expand in a well-controlled and financially secure manner.

Mohammad Al-Hashel is the governor of the Central Bank of Kuwait.