Bahrain advances with caution - Banking, Regulation & Risk -

Though flat oil prices are having an effect on Bahrain’s economy, the country’s banking sector continues to perform well, in spite of calls for consolidation. Kit Gillet reports.

NBB

Reduced global oil prices are still impacting economic growth in Bahrain, even as the Gulf state continues to diversify its economy. However, an influx of money from the country’s neighbours, in the form of long-term, interest-free loans – not to mention a fiscal reform policy put in place by the government in 2018 – has helped Bahrain and its banking sector continue to show forward momentum.

“Two-thousand and nineteen was a bit of a year of consolidation. It wasn’t outstanding, but I would say it was cautiously positive,” says Jean-Christophe Durand, CEO of National Bank of Bahrain (NBB). “I think a very important factor has been the implementation of the fiscal reforms, which has given clarity. Confidence of investors has been boosted. Also, the fact that all the large projects we’ve been talking about for the past two or three years are under way is a positive element.”

Fiscal reforms

In December 2019, ratings agency Standard & Poor’s revised its outlook for Bahrain from ‘stable’ to ‘positive’, following the implementation of budget deficit reducing measures and other reforms. “The positive outlook primarily indicates that we expect the government to implement further reforms to keep fiscal deficits on a decreasing trajectory,” it said, adding that budgetary consolidation is being supported by the introduction of a 5% value-added tax (VAT) in 2019 and a voluntary retirement programme for public sector workers, which has seen more than 8000 civil servants opt to retire.

In 2018, Saudi Arabia, the United Arab Emirates and Kuwait agreed a $10bn long-term interest-free programme to support Bahrain, to be disbursed between 2018 and 2023. This came as Bahrain’s public debt ballooned to almost 93% of gross domestic product (GDP) in 2018, with the money helping to restore external market access and stabilise public finances.

Bahrain’s budget deficit fell to 4.7% of GDP in 2019, from 6.3% a year earlier, according to preliminary fiscal results. This fits with the country’s goal of delivering a balanced budget by 2022. The primary budget deficit, excluding interest payments, decreased by 85% year on year in 2019, while non-oil revenues increased by 63% and government spending dropped by 3%.

At the same time, Bahrain is predicting economic growth of 2.7% in 2020, up from an estimated 2.1% in 2019. The non-oil sector grew by 2% in the third quarter of 2019, while the oil sector was almost flat, shrinking 0.1% year on year in that time. Manufacturing grew by 4.1% over that same period. Even so, oil continues to make up the bulk of Bahrain’s revenue stream and exports.

In November, Aluminium Bahrain, one of the Middle East’s largest aluminium smelters, inaugurated its $3bn Line 6 expansion project, which raised its annual production capacity to 1.54 million tonnes, up from about 1 million tonnes. Bahrain and Saudi Arabia also signed a $2.9bn contract in October for part of the King Hamad Causeway project connecting the two countries, with plenty of other construction projects on the go.

Bahrain also returned to the bond market in 2019, issuing $2bn of bonds in late September.

Room to grow

The banking sector continues to play a prominent role in Bahrain, with financial services contributing about 17% of the country’s GDP and functioning as a key driver of growth. Still, reduced oil revenues have had an impact on the banks.

“The fact that the breakeven oil price [in Bahrain] is the highest of all the Gulf Co-operation Council countries creates a challenging operating environment and lower growth prospects for the banks, as the banking system relies on government-led projects,” says Redmond Ramsdale, head of Middle East bank ratings at Fitch Ratings.

However, he points out that Bahraini banks have strong financial metrics, high levels of liquidity and sound levels of capital and profitability, as well as reasonable asset quality metrics. “The banks, because of this high level of liquidity, are pretty well placed to grow their credit books in 2020, if the opportunities arise,” says Mr Ramsdale, who adds that their estimate for credit growth in 2020 is about 5%, a modest pick up from 2019.

Bahrain’s banking sector had total assets of $206bn as of November 2019, up from $192bn a year early. Overall lending grew by 3.6% over that period, while the average impaired loans ratio was 4.8% as of December 2019, down from 5.2% in September 2019. The average capital adequacy ratio of the banking sector hit 19.4% in December 2019, significantly higher than the regulatory requirement of 12.5%, with a loan-to-deposit ratio of 71.4%.

“The banking sector has shown resilience against a slow regional economic background, with all critical metrics showing improving trends,” says Khalid Hamad, executive director for banking supervision at the Central Bank of Bahrain.

Ripe for mergers

Bahrain has a high number of financial institutions, 385 in total, including 30 retail banks, 68 wholesale banks and 16 branches of foreign banks. Many industry insiders believe that the country, which has a population of just 1.5 million, would benefit from greater consolidation in its banking sector.

“Our view is that Bahrain’s banking system is ripe for potential mergers and acquisitions [M&As] as a result of slow growth,” says Fitch’s Mr Ramsdale. “Bahrain is over-banked – there is a lot of fragmentation in the banking system, more so than regional peers.”

However, he adds that what has been driving M&A elsewhere in the region is common ownership of financial institutions. “In Bahrain we don’t see the common shareholders, so we don’t see as much in tie-ups. I don’t think that the willingness among shareholders is there. I think it would have already started happening if it was. I think we would have started seeing things even as early as 2015 or 2016.”

At least one important merger is in the pipeline, however. In September 2019, the boards of Kuwait Finance House and Bahrain’s Ahli United Bank announced that they had agreed on a share swap ratio, a key step towards a long-discussed merger that would create a combined Islamic banking operation with $96.7bn in assets. Talks have previously stalled over differences in valuation. However, the final decision is subject to approval from shareholders of both banks, as well as the central banks and other authorities in Kuwait and Bahrain.

Meanwhile, in January 2020 NBB raised its stake in Bahrain Islamic Bank, from 29% to 78.8%, as it looks to further develop its Islamic banking activities. “It is a market that is growing quicker in this region in general than the conventional markets,” says NBB’s Mr Durand, who adds that through the majority acquisition the bank has acquired a new portfolio of clients with different banking requirements. NBB has said that the two banks will continue to operate independently.

According to Mr Durand, NBB did not look at the acquisition purely as a domestic decision. “We have a branch in Saudi Arabia and we are very keen to develop our business in Saudi Arabia in a more dynamic manner, and of course in Saudi Arabia we need Islamic financing structures.”

These deals are seen as important for Bahrain’s financial services sector, especially when it comes to expanding the role of Islamic banking, but they seem unlikely to be followed by other similarly sized mergers.

“Kuwait Finance House, when fully acquiring Ahli United Bank, is likely to become the largest Islamic bank in the world,” says Mr Hamad. “The acquisition of Bahrain Islamic Bank by NBB will enhance the status of Islamic banking in Bahrain. There is definite scope for further consolidation in the banking sector but not of the same size as the two already mentioned.”

Islamic banking pioneer

Bahrain has long been considered a pioneer when it comes to sharia-compliant finance, and authorities in Bahrain continue to be highly supportive of the Islamic banking sector, which operates under separate rules and regulations to its conventional counterpart.

Islamic banking in Bahrain has continued to grow in recent years, with an increase in profitability of almost 19% in 2019. The introduction of new risk management regulations has also resulted in better liquidity and profitability for the sector. Meanwhile, “the introduction of the Sharia Governance Module in 2018 was a milestone towards better governance and sharia compliance”, says Mr Hamad.

There are currently 21 Islamic banks operating in Bahrain, along with 14 Islamic windows of conventional banks, six takaful companies and two re-takaful companies. The market share of Islamic banks has increased from 1.8% of total banking sector assets in 2000 to 15% in 2019.

“The growth in the Islamic banking sector has been significant, as total assets in this sector jumped from $1.9bn in 2000 to $31bn in November 2019,” says Adnan Ahmed Yousif, president and chief executive of Al Baraka Banking Group, an Islamic wholesale bank listed on the Bahrain Bourse and Nasdaq Dubai.

Digital growth

Bahrain also continues to push to establish itself as a leading player in the region when it comes to digital financial services, though it faces stiff competition from the likes of the UAE.

“The Bahraini central bank and general authorities are all very proactive when it comes to fintech,” says Fitch’s Mr Ramsdale. “They really engage with the banks and talk about ways to move it forward. That creates an open environment for the banks to develop their capabilities and test these. I think other regulators are a bit more reactionary,” he adds.

The launching of Bahrain Fintech Bay, a joint-venture incubator managed by Bahrain’s Economic Development Board and international incubator Fintech Consortium, has been one of the key government-led initiatives. Since its establishment in February 2018, Bahrain Fintech Bay has expanded to cover 42 early-stage fintech companies and has helped to put Bahrain on the map when it comes to fintech hubs. In January it was announced that Standard Chartered had entered into a partnership with Bahrain Fintech Bay to help foster fintech innovation.

The country also established a regulatory fintech sandbox in 2017, and in December 2019 Sprinkle Holding, a capital markets-focused fintech company, became the first to list on the Bahrain Investment Market.

Individual banks in Bahrain also continue to push forward with their own digital offerings, with the arrival of mobile banking apps and other services aimed at the younger and more digital native population. In November 2019, Bahrain-based Bank Arab Banking Corporation launched ‘ila Bank’, its mobile-only banking app, as it looked to better compete with its rivals.

“The banking sector in Bahrain has seen major development driven by the digitalisation and fintech transformation,” says Al Baraka’s Mr Yousif. “The advent of open banking, mandated in 2019, is one of the major steps in Bahrain’s leadership role in the fintech sector,” he adds.

Open banking launch

In December 2018, Bahrain’s central bank issued rules for open banking, which would allow customers to access all of their bank account information in an aggregated manner through a single platform. A year later, NBB became the first bank in the Middle East to launch an open banking solution. “As the national bank we need to invest and be the first to be able to offer that,” says Mr Durand. “Other banks will have to join us because there are certain requirements by the central bank to be at least open banking compatible. At the end of the day, all the banks will have to abide by the rules.”

In February 2019, Bahrain’s central bank also published its rules regarding the trading of digital currencies, though developments in this area, as well as in digital-only banks, are likely to be more cautious.

At the same time, in November 2019 Al Salam Bank-Bahrain announced that it was partnering with China-based MSA Capital to launch a $50m venture capital fund that aims to use Bahrain as a gateway into the larger Middle Eastern region for innovative Chinese technologies and business models.

Optimistic future

While banks in Bahrain are still operating in a challenging environment – and it is unlikely that oil prices will return to the heights of a few years ago – there are plenty of positives for the banking sector. In fact, financial institutions in Bahrain appear to be on a strong footing and are in a good position to grow further.

“The operating environment is tough, but when you look at the financial metrics, liquidity, capital and profitability, they’re quite solid metrics,” says Fitch’s Mr Ramsdale. “Which means the banks are well placed to weather the challenges of the operating environment and the pressures coming from real estate, contracting and other sectors.” 

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