After being hit hard in the early days of the pandemic, Bahraini lenders are cautiously optimistic about growth prospects for 2022.
The Bahraini banking sector, like its counterparts around the world, has played an important role in supporting the general economy over the past two years, both as a partner to government-led coronavirus relief initiatives but also directly assisting the business community and individuals.
At the same time, banks have managed to maintain key growth metrics. Total local deposits grew by 4.2% to BD14.1bn ($35.5bn) in 2021, with outstanding loans to residents increasing by 4.7% to BD10.9bn, according to the Central Bank of Bahrain (CBB). Return on assets (ROA), meanwhile, stood at 1.1% as of December 2021, up from 0.7% from end-2020, with return on equity (ROE) increasing to 7.8%, up from 2.6% over the same period.
“Overall, 2021 was another successful year for the Bahraini banking sector in terms of both financial performance and their continued role in the economic recovery plan,” says Waheed Al Qassim, chief executive of the Bahrain Association of Banks (BAB).
Growing despite the pandemic
According to the latest financial stability report issued by the central bank, the banking sector in Bahrain had total assets of $217.5bn as of end-2021, the equivalent of almost 6.5 times gross domestic product (GDP), with retail banks accounting for $99.4bn and wholesale banks $118.1bn. The country’s Islamic banking sector is worth $34.6bn.
Yet, while the country’s domestic economy grew by 1.5% in the first three quarters of 2021, compared to the same period in 2020, the financial services sector saw a contraction of 2.7%, according to Bahrain’s Information and eGovernment Authority.
“We expect the operating environment to remain broadly the same in 2022 as in 2021, i.e. still relatively challenging,” says Redmond Ramsdale, senior director and head of Middle East bank ratings, financial institutions, at Fitch Ratings.
“We are seeing a general recovery and economic growth, and that will play into revenue and growth opportunities for the banks,” he adds. “We’re expecting real GDP growth of about 3% this year, slightly up from last year, and a lot of that is going to be driven by real non-oil GDP growth. For the banking sector’s credit growth, we’re forecasting about 3.5% growth this year, which is not strong, but it’s okay. Liquidity ratios are pretty reasonable, and that in itself is quite supportive of growth.”
“It’s definitely a supply and demand story – maintained higher oil prices and strong confidence will likely lead to an increase in demand for credit,” he concludes.
Key role to play
The financial services sector continues to be the largest non-oil sector in Bahrain, accounting for 17.9% of GDP, according to the Information and eGovernment Authority, ahead of manufacturing with 14.1% and government services at 12%.
“Ten percent of all Bahrainis working in the private sector work for financial services and it’s one of the highest paying sectors,” says Khalid Humaidan, chief executive of the Bahrain Economic Development Board (EDB).
Ten percent of all Bahrainis working in the private sector work for financial services and it’s one of the highest paying sectors
Mr Humaidan adds that the participation rate for Bahrainis in the sector is also high, despite the fact that there are no required Bahraini quotas, unlike in some other industries. “Any financial institution is allowed to hire whoever they want. They choose to hire Bahrainis because we spent a lot of money, time and resources training Bahrainis to make sure that they are at the calibre needed,” he says.
He believes that ultimately the sector could account for more than 20% of economic activity in Bahrain within the next five years. “As a sub sector in the financial services, we think there are opportunities in insurance, and that’s one of the things that we think will be a growth driver when it comes to increasing the contribution of financial services,” he adds.
Non-performing loans
One area of continued uncertainty is what will happen when the country lifts its loan deferment scheme, put in place during the early days of the pandemic.
Bahraini authorities initially put in place a freeze on repaying bank loans back in March 2020, in order to help businesses and individuals weather the crisis. It has since extended the scheme four times, most recently in December, when authorities extended loan deferments until the end of June 2022 at the earliest.
While the ratio of non-performing loans (NPLs) dropped from 4.2% in December 2020 to 3.2% in December 2021, there remains a lot of uncertainty about what will happen when the moratorium is lifted.
In 2020, several banks in Bahrain issued additional capital bonds to strengthen their capital adequacy ratios, which for the banking sector as a whole stood at 18.3% in 2021, according to BAB.
“The fact remains that with the loan deferment scheme being extended until June 2022, it will make it difficult to assess credit quality, and business may struggle considering the financial implications of Covid-19, which directly affected businesses, especially on the retail side,” says Hassan Jarrar, chief executive of Bahrain Islamic Bank (BisB), one of the country’s leading sharia-compliant banks.
“What we do foresee is that the majority of risk will come from small businesses rather than individuals,” he adds. “At BisB, we don’t have grave concerns, especially in light of the fact that we have already carried out the requisite stress testing and scenario analysis and planning. Still, the reality of what will unfold in the future remains to be seen.”
While the risk is there, others also do not expect to see a big drop in credit quality.
“We’re not expecting a big spike in NPLs or a big deterioration,” says Fitch’s Mr Ramsdale. “A lot of that is to do with the recovery we’re seeing, the higher oil prices, the support that’s come from the central bank, and the fact that these corporates and retail individuals are being given time to recover.”
Looking to the future
At the same time, the Bahraini central bank is busy implementing a five-year strategy, starting from this year, to develop the financial services sector as part of the kingdom’s economic recovery plan and to sustain growth, says BAB’s Mr Al Qassim. “This strategy will enable the sector not only to play a larger role in financial services across the region, and globally, but also to develop the financial services as being one of the government priority economic sectors.”
“Bahrain’s banking sector remains a key pillar of Bahrain’s efforts to diversify the economy,” says Adel El-Labban, chief executive and managing director of Ahli United Bank (AUB).
Bahraini banks continue to have a strong footprint outside of the country. AUB, which recorded double-digit growth in terms of profitability in the first three quarters of 2021, was among the top-performing banks in the region in terms of ROA, but saw around 86% of its profits coming from outside of its home base. In March 2021, AUB increased its stake in its subsidiary Commercial Bank of Iraq from 75% to 80.3%.
Meanwhile, in September 2021 investment bank Citi launched a global tech hub in Bahrain, where it ultimately aims to employ 1000 coders over the next 10 years.
“The choice followed an internal elaborate process which included review of the labour market, labour laws and local regulations along with the fact that we have significant support for this launch from the EDB and Tamkeen,” says Michel Sawaya, country officer and corporate banking head of Citi Bahrain. “We have been properly leveraging what Bahrain has to offer in terms of a conducive infrastructure in order to develop regional capabilities serving the rest of the bank in the region and beyond.”
Towards a digital world
While Bahrain has the Gulf’s smallest economy, it has been one of the region’s earliest adopters of fintech solutions and digital assets.
In recent years, the central bank has promoted a strategy aimed at fostering a local fintech industry and encouraging innovation in financial services. As in neighbouring Saudi Arabia, regulatory sandboxes in Bahrain are also helping to provide infrastructural and regulatory support for the development of fintech start-ups.
Bahrain was the first country in the world to issue open banking guidelines that included Islamic finance, and in September 2021 the central bank directed retail banks and financial institutions in Bahrain to implement the requirements for the second phase of the country’s Open Banking Framework by June 30, 2022.
In December, Financial Services and i2c jointly launch Beyon Money, Bahrain’s first open banking super app, and the following month Bahrain became the first country in the Middle East to grant cryptocurrency exchange Binance approval in principle to establish itself as a crypto-asset service provider within its border. Last year, the country’s monetary authority also granted a license to Manama-based CoinMENA, a sharia-compliant crypto exchange.
“The authorities are clearly very supportive of fintech and digitalisation, and through supportive regulations they are allowing fintechs and banks to test capabilities, build their solutions, and do it in Bahrain first,” says Fitch’s Mr Ramsdale. “The downside for Bahrain is that it’s quite a small market, and that could hinder progress.”
Earlier this year it was announced that Bahrain Telecommunications Company had become the first telecom provider in the Gulf Co-operation Council (GCC) region to receive a license for open banking, after receiving the necessary licenses from the central bank. The telecom giant is now able to provide consumers and small and medium-sized enterprises with services including digital wallets, cards issuance services, bank accounts aggregation on behalf of clients and third parties.
Meanwhile, in January it was announced that the central bank had successfully completed a digital currency instantaneous cross-border payment test, using JPMorgan’s JPM Coin system, which saw funds transferred between Bahrain and the US via Bank ABC and on behalf of Aluminium Bahrain.
Islamic banking thrives
Another sector showing strong growth is sharia-compliant financial services. In June 2021, Fitch Ratings predicted that the market share of Islamic banks, including Islamic windows, in Bahrain would continue to grow throughout 2021 and 2022, after reaching 37.1% of domestic banking system assets as of end-2020, up from 35.4% in 2015, and 17.2% of total assets. Total Islamic banking sector assets reached $34.6bn as of the end of 2020, roughly equivalent to Bahrain's annual GDP.
Throughout 2021 and 2022, growth in Islamic banking will be driven by bank mergers and acquisitions, suggested Fitch, as well as the recovering economic environment, rising public awareness of Islamic products and greater use of fintech solutions. Conventional banks in Bahrain have been increasingly looking to acquire Islamic banks; in 2020, National Bank of Bahrain increased its stake in BisB from 29% to 78.8%.
Global trends are clear; the overall Islamic finance industry is projected to reach $4.9tn by 2025, according to Refinitiv’s 2021 Islamic Finance Development Report, with global assets for the sector having maintained double-digit growth in 2020, rising by 14% to hit $3.4tn.
Too many banks
At present, Bahrain is home to around 360 licensed financial institutions, including 90 banks, which are a combination of local, regional and international lenders.
“There’s a lot of fragmentation in the banking sector, much greater than in other countries in the region,” says Fitch’s Mr Ramsdale. “Asset quality pressures, and profitability pressures, as well as potential capital pressures depending on what happens with asset quality, is likely to drive more tie ups this year into next year.”
In recent years there have been some significant mergers and acquisitions (M&As) taking place, with banks seeking strong synergies and opportunities to expand into new geographies or verticals. This trend has been supported by the authorities.
“Regulators in Bahrain have been encouraging M&As in Bahrain’s banking industry over the past years in order to cement the country’s position as one of the world’s leading financial centres,” says BAB’s Mr Al Qassim.
He adds that many of the banks are relatively small, and given the huge capital needs to fulfil Basel III requirements and keep up with digital transformations, there are increased incentives to consider consolidation, both from smaller and bigger players.
In January, it was announced that Al Salam Bank had entered into an agreement to purchase the consumer banking business of Ithmaar Bank, as well as Ithmaar Holdings’ ownership stake in both Bank of Bahrain and Kuwait and Solidarity Group Holding, one of the major takaful (Islamic insurance) groups.
Meanwhile, the long-discussed acquisition of AUB by Kuwait Finance House, which would create the sixth largest bank in the GCC with more than $100bn in assets, was postponed in 2020 and has shown little outward sign of progress.
Bahraini banks are also continuing to seek opportunities further afield, with Bank ABC completing its purchase of the Egyptian subsidiary of Lebanon’s Blom Bank for $480m in August 2021.
With hopes that the worst of the pandemic is now behind us, Bahraini banks are likely to continue to seek out ways to expand their businesses, organically or otherwise.
