Largely robust: the banks at Bahrain Financial Harbour have shown resilience in the global crisis
Bahrain has had to deal with its fair share of problems on the back of the global economic downturn, but a sound regulatory and supervisory structure and deft handling of the crisis by the central bank has ensured it will emerge as a stronger, more confident nation as a result. Writer Charlie Corbett
Former UK prime minister Harold Macmillan once responded to a reporter who asked him what could possibly blow his government off course, by saying "events, dear boy, events". The Kingdom of Bahrain has had to deal with its fair share of events over the course of the past 12 to 18 months. Largely originating off its own shores, the country has had to cope with the impact of the global economic downturn, the collapse of two substantial Saudi Arabian investors in the region and the wider Gulf Arab property crash precipitated by the Dubai World debt standstill.
The effects of these events have reverberated down through the country's financial system, which although adversely affected, has weathered the storm. The Central Bank of Bahrain's (CBB) governor, Rasheed Al Maraj, has won international praise for his handling of events and sound regulation, combined with a cautious approach to growth, ensuring that Bahrain did not go the same way as Dubai.
Steady performance
In terms of Bahrain's future as an international financial centre, it is unlikely that its current troubles will put potential investors off. The difficulties the country faces originated largely off Bahrain's shores, and the CBB has won praise for its deft handling of events. It cut interest rates, reduced reserve requirements and introduced a new swap facility that allowed banks to exchange US dollars for Bahrain dinar at no penalty. Mr Al Maraj says that the country's long track record as a regional financial hub has held it in good stead during the downturn.
"I should stress that we have not considered it necessary to take any exceptional measures to support our financial system. For example, we did not introduce a blanket guarantee of deposits and the government has not been required to recapitalise any Bahraini banks," says Mr Al Maraj. "We have overcome previous episodes of instability, whether owing to wars or economic downturns. This experience of sound economic and financial management in bad times as well as good is one of our greatest assets."
Bahrain remains a popular destination for foreign investors on account of its established regulatory practices, transparency and adherence to international standards, says Kamal Ahmed, chief operating officer at the Economic Development Board in Bahrain. "We have an open, transparent system in Bahrain that is business friendly. In the CBB, we have a single regulator that is widely recognised as the best in the region, which means that banks can be confident that regulation will be strong and, because the regulators consult with the financial community, effective," says Mr Ahmed.
The impact of the collapse in late 2009 of Bahrain-based banks Awal Bank and The International Banking Corporation, which were owned by failed Saudi Arabian conglomerates the Saad Group and Ahmad Hamad Al Gosaibi and Brothers, respectively, has been limited. "These have been isolated cases and thus far have had no impact on the rest of the financial sector in Bahrain," says Mr Ahmed. "The domestic banking sector remains strong and there has been no need for bank bailouts. The wider banking sector remains robust and we are confident of future growth," he adds.
Jamal Hijres, chief executive of Capinnova, a sharia-compliant investment bank established in January 2009, agrees. "This case came as a shock to most people, but I don't think it has unduly shaken confidence in the system or the regulator. Just as the crisis in the West, there are lessons to be learnt by the entire financial sector across the region and the globe," he says.
External threats
Bahrain has also had to deal with difficulties emanating from Dubai. The wider Gulf Arab property crash that was precipitated by the Dubai World debt standstill has affected Islamic finance particularly hard, due to its broad exposure to the real estate sector. Bahrain is a hub for Islamic banking in the region, which has led to some internal difficulties.
As The Banker went to press, the Bahrain-based Islamic bank Gulf Finance House (GFH) narrowly escaped default on $300m of its debt after last-minute talks with lenders. The news came on the back of an operating loss of $607m for the fourth quarter of 2009. GFH now plans to sell off $250m-worth of assets, which could include its stake in Bahrain's Khaleeji Commercial Bank. The bank's chief executive, Ted Pretty, says that GFH has made mistakes in the past, but that efforts are under way to repair the damage. "The old business model of GFH became severely fractured and was in need of repair. Our large cost base has been significantly reduced and we are in the process of disposing of non-core assets," he says. "As a result, a new, more refined business model has been developed which will allow GFH to emerge from the crisis in a smaller but healthier form," he adds.
Elsewhere in Bahrain, United Gulf Bank last month postponed a planned bond sale due to unfavourable market conditions, as did Bahraini trade and investment firm Esterad Investment Company, which scrapped plans for its $16.8m convertible bond on the back of weak demand. It must also be remembered, however, that the country's banks' exposure to Dubai World amounted to just 1% of total assets.
Mr Al Maraj is keen to put the country's recent problems into context. "The economic downturn has not affected Bahrain to the same extent as some other parts of the region since we did not, for example, experience the same levels of real estate speculation that have been seen elsewhere," he says. "In addition, Bahrain entered the financial crisis with the benefit of the solid foundations laid by our conservative economic and financial policies over the preceding years."
Wholesale difficulties
Bahrain's economy has not, however, escaped unscathed. It relies heavily on income from oil and financial services, the two sectors arguably the most affected by the global economic downturn. As a result, ratings agency Moody's rated its 12- to 18-month outlook for Bahrain as 'negative' in August last year, based on the likely weakening of its banks' financials.
Wholesale banking in the country has been adversely affected by tight global credit conditions and events in Dubai will make it even harder for the Bahrain's banks to access liquidity in global markets. The over-reliance of Islamic banking on property investment has shown to be a somewhat flawed strategy in the light of collapsing property prices across the region and is particularly acute in Bahrain, given its 27 Islamic banks with $25.5bn in assets.
The CBB's most recent stability report, issued towards the end of 2009, suggests that the Bahraini financial sector, while fundamentally sound, is suffering from "significant second-round effects" from the global financial crisis. This has manifested itself in the form of ever-increasing non-performing loan (NPL) ratios. This is a particular problem in Islamic wholesale banks, where NPLs now account for 10.7% of total facilities. The report is not overly sanguine on the prospects for 2010. "While Bahraini banks presently have ample capital cushions to cope with any loan losses, further deterioration in asset quality may impose much greater pressure on bank balance sheets, further delaying the resumption of normal lending activities to the private sector," says the report. "In a typical vicious cycle, the lack of lending to the private sector could keep economic activity sluggish, possibly creating further delinquencies on outstanding loans."
Rasheed Al Maraj, Central Bank of Bahrain's (CBB) governor
The bigger picture
Outside of banking, a combination of slow job creation and a decrease in average wages mean that the household sector will struggle to meet debt obligations. The country's real estate and construction industries also show no sign of resurrecting themselves any time soon. The number of construction permits issued between the first and third quarters of 2009 fell by 31%, according to figures from the CBB.
The Bahrain Economic Development Board's Mr Ahmed remains confident, however, that Bahrain will experience continued growth. "Bahrain continues to see strong growth in its financial sector and we have seen particular growth in our role as a regional leader in Islamic finance," he says. "The insurance industry in Bahrain has also been growing steadily and strongly in recent years, demonstrating double-digit growth." Bahrain's insurance sector saw a 34% increase in premium values in 2008, according to Mr Ahmed, and total gross premiums reached $486m in 2008, up from $362m the previous year.
Islamic edge
With increased competition from other international financial centres in the region, however, the country will have to work hard to maintain its competitive edge.
Most people who The Banker spoke to in Bahrain emphasised the country's standing as an Islamic finance hub as a means of staying ahead. Bahrain has a long history of Islamic finance and was one of the first financial centres in the region to embrace sharia-based banking. It licensed its first Islamic bank, Bahrain Islamic Bank, in 1978.
Despite a dent on the back of the Gulf's real estate collapse, Islamic banking is soaring in popularity across the Middle East and beyond. "There has been a resurgence of interest in Islamic finance in the wake of the financial crisis and we are finding that regulators from all over the world are keen to tap our expertise in this field," says Mr Al Maraj.
Bahrain is well placed to rise to the challenge. It has the highest concentration of Islamic institutions in the region and assets in the sector have increased from $1.9bn in 2000 to more than $25bn today. Islamic banks now have a market share of 11% in the Bahraini financial sector, up from 1.8% in 2000.
"Bahrain was already emerging as the prime location for financial services in the Gulf region [in 2000] and was identified as the natural location to develop Islamic banking and finance," says Mr Hijres. "Regional economies have helped to raise the level of competition, but Bahrain is still at the forefront and aptly retains its title as one of the largest financial centres in the region," he adds.
Kamal Ahmed, chief operating officer at the Economic Development Board, Bahrain
Jamal Hijres, chief executive of Capinnova
Lessons learnt
Efforts will need to be made in future to further diversify Bahrain's economy away from its reliance on oil and financial services. The case of GFH highlights one of the biggest threats facing the country, namely, the danger that the failure of a large wholesale bank could infect the rest of the economy. GFH's decision to shed $250m-worth of its assets will undoubtedly have an impact on Bahrain's economy and on the perception of its financial stability overseas.
Mr Al Maraj admits that lessons can be learnt from the crisis, but also stresses that Bahrain is taking a proactive approach. "We are taking measures to tighten up our regulatory framework in areas where the financial crisis has shown this to be necessary. An important issue that we are already addressing is on liquidity standards, where we issued a paper for consultation last year and will be following this up in the next few months," he says. Mr Al Maraj says that he is also looking at corporate governance and the role and responsibilities of boards of directors. "A number of the high-profile failures during the crisis were the result of weaknesses in corporate governance and as a regulator we aim to emphasise that the board and management of a firm has the primary responsibility for ensuring that it is prudently managed," he says.
Trump card
The problems Bahrain has faced over the past 18 months should be seen in the context of the wider region. All GCC economies have been affected negatively in one way or another and Bahrain's robust and transparent regulatory system protected it from the worst excesses of the financial crisis. Any doubters should look no further than the CBB's announcement at the end of February that its BD25m ($66.3m) issue of Government Treasury Bills were oversubscribed by nearly 500%. This can hardly be described as an indication of a loss of investor confidence in the country. Bahrain also recently announced plans to issue a $1bn, 10-year sovereign bond this year. This comes on the back of a $750m sukuk issued in June 2009.
Plans for the construction of a new economic city in the north-west of the country, which will include a port, an airport, an environmentally friendly energy network as well as natural gas supply and distribution facilities, also indicate confidence for the future.
Despite a series of negative events that have affected Bahrain over the past 18 months, it has yet to be blown off course. "Overall, 2009 will not be a year that is likely to be remembered fondly by bankers across the globe, but the CBB has worked hard to restore confidence in the long term, with continuous upgrades to the regulatory framework," says Mr Hijres. "As the overall economy diversifies and the CBB guides the entire financial sector, Bahrain could confidently emerge as one of the strongest global financial centres."
