Q How did the banking sector perform in 2004?
A The banks registered the highest level of profits since their establishment. Every year in the last four the banks have recorded record profits and 2004 was the highest. They are in an excellent condition, in my opinion. The average capital adequacy of the banking system is about 18% and the minimum [capital adequacy] we have set is 12%, well above the minimum of 8% set by Basel. They are in excellent condition and the level of liquidity is tremendously high in the system and, with the advancement of technology over the past 10 years, this has had a big impact on profitability.
Q Islamic banking is expanding not only in the Gulf but globally. How do you view this trend and the prospects for Kuwaiti institutions?
A There has been a trend over the past decade to have more Islamic finance institutions that serve the demand of a considerable percentage of our community here. Since 1992 we have provided licences for investment companies working on an Islamic basis. At present, we have 16-17 Islamic investment companies with $6bn in assets under management.
We worked for four years with parliament to establish a law on Islamic banking; the Central Bank of Kuwait drafted that law and it was passed in 2003. At that time, Kuwait Finance House (KFH) – established in the 1970s – was the only Islamic bank in existence. With the passing of this law, KFH came under the supervision of the central bank and, according to the law, it has the right to adjust its operations within three years of the law. I can say that it has now almost adjusted to the central bank requirements.
At the same time, we have allowed the establishment of a new Islamic bank, Boubyan Bank, and we have also allowed a conventional bank, Kuwait Real Estate Bank (KREB), to be converted in to an Islamic bank. That will take place this year with the final conversion requirements expected to be finished in July. Boubyan began operating last November.
Q Following the increase in the number of Islamic banks, will the existing conventional banks be able to enter this market?
A An Islamic bank should work as an Islamic bank completely, a conventional bank should do the same, you cannot have mixtures. According to Islamic Sharia you cannot mix Islamic and conventional funds. We reached an understanding with the parliament, and it was mentioned in the law, that conventional banks can establish Islamic banks and own a majority of their shares but they have to be separate legal institutions. These Islamic institutions will be considered as subsidiaries.
At present, at the central bank, we have not allowed the conventional banks to set up Islamic subsidiaries. The first stage of Islamic banking practice has been to issue and have three Islamic banks, KFH, Boubyan and KREB. After these three institutions are working on an Islamic basis in the system and we can evaluate this phase, then we can move to the next phase.
This next phase will be the allowance of existing conventional banks to establish Islamic banks. We have to take care of the availability of human resources able to operate on an Islamic basis. It takes time to have the proper training and structures in place.
Q How do you see the international interpretation of Islamic financial instruments, such as the growing use of sukuks? And how should we view supervision of Islamic banks?
A What is religiously accepted in country X may not be religiously accepted in country Y. That is the major obstacle facing Islamic financial instrument development. Islamic financial institutions are in a dilemma, they want to acquire such instruments but the religious interpretations may not be in their favour so they are staying away. That is why we are not seeing a huge advancement in new Islamic financial instruments.
We are trying in the Islamic Financial Services Board to have a common understanding on interpretations and to reach a consensus. The second important issue is that what is recognised as an international standard of supervision for a conventional bank must be applied [for Islamic banks]. We should not differentiate on supervision in my opinion.
Q How do you view Kuwaiti banking developments in Iraq and the future prospects?
A One Kuwaiti bank has bought a bank in Iraq and is participating in a joint venture with foreign banks but we are not encouraging or discouraging banks to buy in Iraq. There is a flow of trade with Iraq but, as regards huge projects there, it has not crystallised so far and that is related to the security issue in Iraq. While the lack of some laws and guarantees makes investing in Iraq difficult at present, we do believe that there will be a lot of opportunities there.
As we are geographically very close, Kuwait will be a gateway in the future for providing trade and services to Iraq. At present, trade flows are high but the expectations of large investments in Iraq have not yet crystallised.
Q What are the prospects for foreign banks in Kuwait?
A Last year, an amendment was made to the law that allowed foreign banks to be present here. We have been tackling that issue since 1998 and, as we are a member of the WTO, we are fulfilling our requirement. We want foreign banks here to add to competition and to add to Kuwait as a financial centre for the future.
At present we have licensed three: BNP Paribas, National Bank of Abu Dhabi and HSBC. We are concentrating on high calibre foreign banks not just any foreign bank, as a first stage. Then we will move to a second stage and see what other banks will be allowed. This is in addition to the licensing of any national Gulf bank from the GCC countries. The foreign banks have full banking licences, BNP Paribas became operational two months ago and the others are not operational yet.
As regards other foreign licences, we have rejected six foreign banks but one international bank is still under consideration.
Q Do you have any concerns over the growth of consumer or mortgage lending in Kuwait?
A While this area has seen high growth in the last two years, it has slowed. The main focus of growth has been in housing, rather than consumer, as the government provides KD70,000 for those wanting to buy or build and the banks are approached for additional funding. In the whole of the consumer area, the ratio of non-performing loans is less than 0.5%. This is largely due to the fact that 92% of the national labour force are employed by the government and the salaries are transferred to the banks. So it is no problem at all.
Q How do record high oil prices and revenues impact on the budget, government expenditure and plans for the future?
A The budget has been growing for the last four years consecutively on the expenditure side and it has been very noticeable that allocations for investment or capital expenditure have also been growing during that period. It is obvious from the oil price increases that the budget is registering huge surpluses and that will add more to the funds for future generations in terms of transferring the surpluses to that fund. This will strengthen the external balances of Kuwait and it is clear that the balance of payments for 2004 also registered a surplus. This adds to a more comfortable cushion for the country.
But, when we dissect the components of the revenue and expenditure in the budget, there is still a structural imbalance in the budget. We are still depending heavily on oil revenues which comprise 90%-92% of our revenues and, on the expenditure side, the majority – 67%-68% – is on current expenditure, mainly salaries and wages.
We need to tackle that issue and have a more balanced type of budget in terms of the composition of both sides, and to be well monitored and controlled as well. This means that we need to change our approach to both sides of the budget. We must look at taxes, fees and the pricing of services – electricity prices are very cheap and indirect subsidies have to be examined. The government is considering proposing a draft law to the parliament on income tax. We have to be careful about jumping in to a system of taxation because we do not have any at present. We need to look at the level of taxation. The approach should be gradual and will take time to be adopted.
Q How do you see the overall macroeconomic picture and do you have any concerns?
A When you look at the macroeconomic fundamentals in Kuwait, there are surpluses in the budget, current account and balance of payments. Trade and inflation is under control at 2%.
Everything is rosy but that is not enough. We need to have structural economic reforms. One of these reforms is the budget, how to tackle the restructuring. Second will be the dominant role of the public sector, we need to have the private sector playing a bigger role. Third is the national labour force: 92% is employed in the public sector and this issue needs to be strongly addressed. We need the ability to create more jobs in the private sector for newcomers to the labour market.
This means more privatisations as well as the philosophy of education. Schools in Kuwait must change their philosophy of teaching so that new graduates will be much more attracted to the private sector. On privatisations there needs to be a law passed by parliament. Such laws have been under discussion for four or five years. Although all the banks are private sector, there are plenty of options for sale such as the port, the power stations, Kuwait Airways and the hospitals.
Q How do you see oil prices progressing and the ability of suppliers to meet increasing demand, especially from areas such as India and China?
A A lot depends on the assumptions you make in reaching the level of oil prices. Most analysis supports a higher level of prices but it also depends on the supply side as well as demand. Will supply be increasing to support an upward momentum of prices or not? This also relates to world economic growth, if there is more growth then there will be more demand for oil and upward pressure on prices. Different analyses point to different levels of prices.
In terms of Kuwait, to my knowledge we have almost reached, at 2.4m barrel per day, the maximum production level. Unless we discover more reserves, we will be at this existing level of oil production.
