Once a relatively cosy outpost of domestic banks dominated by a few large players, Kuwait is at last opening up to foreign competition. The banks, many of which produced record profits in 2004, are embarking on new strategies. For some – National Bank of Kuwait (NBK) and Kuwait Finance House (KFH), in particular – expansion abroad is important but, for most, the domestic market remains the key driver.
There is a lot to play for, thanks to increased government expenditure on the back of oil prices in excess of $50 a barrel, and with what Shaikha Khaled Al Bahar, head of NBK’s corporate banking, describes as “too many mega deals”. She estimates that Kuwaiti projects in the pipeline exceed a mammoth KD20bn ($69bn). This is besides the already huge – and still growing – trade with Iraq, for which Kuwait acts as the prime gateway. Although accurate trade figures with Iraq are not known, reports suggest, for example, that Kuwait imported $1.3bn of cars in 2004, mainly bound for Iraq. The re-export business will continue to thrive due to Kuwait’s key geographic position and, as NBK’s chief economist, Randa Azar-Khoury, explains: “The reconstruction phase (in Iraq) has not moved as fast as expected and opportunities will grow bigger when security is under control.”
While booming economic conditions, deregulation and growing confidence provide a strong platform for banks, the Central Bank of Kuwait (CBK) has been anxious to curb excesses. It remembers well the devastating Souk Al-Manakh crisis of the early 1980s and is keen to avoid asset “bubbles” around both the vibrant Kuwait Stock Exchange and the burgeoning real estate market.
Although liberalisation is taking place in terms of new entrants and new legislation, the CBK has been keen to maintain a tight grip on the sector. In July last year the CBK imposed an ‘80-20’ rule that has had a sharp impact on bank lending. The rule, limiting bank lending to 80% of customer deposits, immediately led to a tightening of credit available in the market as most banks were above the limit. Banks were given until July 2005 to comply and the average for loans-to-deposits for the sector was down to 84% at the end of 2004 as they reduced lending growth. While most have now complied, credit growth has suffered significantly from the CBK directive.
According to the NBK March Economic Brief, credit facilities were largely flat in February and “growth in lending has been relatively slow since September 2004 at an annualised rate of 1.9% compared with 19.3% during the first nine months of 2004”. With limits on lending for the stock exchange to 15% and boundaries on overall consumer lending, the CBK is keeping a tight rein on the banks – which, unsurprisingly, have not been enthusiastic about the directive to say the least.
Now, as a recent banking report from Kuwait-based Gulf Investment Corporation (GIC) notes: “Banks’ ability to grow portfolios will be limited by their ability to grow deposits. New market entrants, on the other hand, will be able to grab sizeable market share as their initial asset funding will come from equity, and it will be some time before the loans-to-deposits cap becomes a problem for them. Growth will come at a cost for all market participants though, as the lending limit is expected to increase the price of deposits.”
The 80-20 rule and other changes to consumer lending have, analysts say, eliminated all reciprocal interbank lending and created an asset crunch for some banks. This has combined to produce slow asset growth as total assets of the nine banks in the sector reached only $64bn at the end of 2004, a mere 1.7% increase over 2003.
Joining in
What real effect will the new entrants have? At this stage France’s BNP Paribas, National Bank of Abu Dhabi and HSBC have licences and will be able to have one branch each. One other bank is under consideration at the CBK and is believed to be Citigroup. With limited retail capacity of one branch initially, the new banks don’t look particularly threatening to the domestic retail market even if they wanted to be active. But the newcomers will increase competition for core deposits and will be more of a concern in corporate and wholesale markets where they are more likely to operate and will be able to use their international financial muscle.
Despite the CBK controls, the local banks are still buoyant, the market is highly liquid and the real estate and stock market sectors are booming. While some might suggest Kuwait is an “over-lent society”, GIC remarks that there is ample spare capacity in the banking sector with the loans-to-GDP ratio at a modest 73% compared with an average of 109% for global peers. Furthermore, it adds that risk-adjusted returns are quite high with return on average equity (ROAE) in 2004 coming in at 23% despite an average capital adequacy ratio of 16%. In addition, non-performing loans are just 4.76% of gross loans with provisions coverage rising to a healthy 151% in 2004. With this underlying positive structure, it is no surprise that Moody’s Investor Services has upgraded the sector’s Financial Strength Rating (FSR) to C- from D+ last year, reflecting the banks’ adequate intrinsic financial strength.
Market domination
NBK dominates the sector with 29.5% market share by assets and the largest branch network of 55 branches. In 2004, the bank produced another record performance with profits up 24% to $515m and a 29.9% return on equity (ROE). Profits are double that of its nearest Kuwaiti competitor, Gulf Bank, and the highest in the Middle East.
NBK is at the forefront of the changes sweeping Kuwaiti banking and over the past year has launched a number of major initiatives that look set to help it maintain its market dominance. Veteran CEO Ibrahim Dabdoub stresses three main thrusts: regional expansion, investment banking and the upgrading of all services.
Ibrahim Dabdoub: wants NBK to have a pan-Gulf investment bank covering the region
With recent acquisitions in Iraq and the Gulf and entry into Saudi Arabia, Jordan and Iran, NBK’s regional expansion strategy is running full steam ahead, with further regional and international moves are in the pipeline. Part of Mr Dabdoub’s regional ambitions is in the investment banking area where he wants NBK to have a pan-Gulf investment bank covering the region. The establishment of a new investment banking subsidiary for the bank (see box) is a key part of this strategy and is likely to prove highly successful given the huge demand for investment banking services emerging both in Kuwait and throughout the Gulf Cooperation Council (GCC) states.
Islamic monopoly
KFH is the second largest bank with a 17% market share by assets and a 33-branch network. As the only Islamic bank in Kuwait until recently – when Boubyan Bank was licensed and Kuwait Real Estate Bank was reconstituted as an Islamic institution – KFH had a virtual monopoly in this area. In 2004, it again produced record net profits of KD74m, an ROE of 25.3%. It is the world’s most profitable Islamic bank.
KFH is also expanding abroad with a large $100m investment in a Malaysian subsidiary and is benefiting from the surge of interest in Islamic finance across the globe and particularly in the Gulf. With $5bn in funds under management and a strong position in the market, KFH has little to fear from its new Islamic competitors in the short term.
Given that the CBK has not allowed the conventional banks to establish Islamic subsidiaries until the new Islamic banks are fully established – much to the displeasure of the conventional banks – KFH looks likely to continue to enjoy its virtual monopoly in a growing market segment.
Record profit
Gulf Bank is the next of the top-tier banks, with a 12% market share and a 32 branch network. Gulf, which has undergone a complete transformation since 2001, saw profits grow by 54% in 2004, the highest growth rate of all the Kuwaiti banks, to reach a record total of KD74.6m, just ahead of KFH. Also, a strong ROE of 28.4% has been followed by further record increases in first-quarter results this year.
With highly respected banker Yousef Al-Awadi returning last year as CEO, the bank has strengthened its overall banking platform, particularly in retail. And with the lowest cost-income ratio of 18.1%, Gulf Bank is the most efficient bank and – based on all performance ratios – it is well placed for the increasingly competitive domestic banking battles ahead.
Commercial Bank of Kuwait is the smallest of the top-tier banks with 10% market share and 38 branches. Like others, it has produced strong results in 2004 with profits reaching KD62.3m and a healthy ROE of 25.6%. Commercial Bank treasurer May Muhalhel Al-Mudhaf is optimistic about the real estate and project finance sectors, with licences approved to build 70 new residential and commercial towers and lists of projects in excess of KD20bn.
Smaller players
Burgan Bank is one of the three smaller second-tier banks with a 9% market share by assets and 19 branches. Nonetheless, 2004 was a very successful year with profits up 45% to reach a record KD29.6m and an ROE of 14.8%. With a strong capital adequacy of 17.8%, new CEO Jonathan Lyon is focusing on organic growth and expanding retail as well creating synergies with its main shareholder, Kipco, which has a network of financial holdings across the Gulf and the Arab world.
Bank of Kuwait and the Middle East (BKME), another smaller bank with 9% market share and 18 branches, has also performed well. Profits in 2004 were double those of 2002 at KD22.8m, producing an ROE of 12.4%. BKME, 46%-owned by Bahrain’s expanding Ahli United Bank, expects to double its branch network over the next three to four years, according to CEO Michael Fuller, and focus on consumer and trade, reflecting growing business confidence and the strong belief that Kuwait is the gateway to Iraq.
Al-Ahli Bank of Kuwait (ABK) is the third of the second-tier banks with 9% market share and a 14-branch network. Despite the drag of low-earning, relatively large, government development bond holdings (dating back to the 1990 invasion by Iraq) and a small retail network, ABK performed well with net profit up 23.1% to reach a record KD27.2 and an ROE of 14.4%. With help from KPMG and McKinsey, ABK has significantly improved its asset quality and reduced its post-liberation non-performing loans. General manager Ibrahim Ibrahim hopes to expand the important retail network to 18 branches by year-end and strengthen corporate banking where lending increased by 22.9% last year. ABK also intends to expand opportunities from its one external branch in Dubai.
NBK’S NEW INVESTMENT STRATEGY
Reflecting the huge amount of liquidity in the Gulf and the huge opportunities in the private equity, advisory and equity and debt raising areas, National Bank of Kuwait is planning to spin off its investment banking activities into a separate subsidiary. Under CEO Ibrahim Dabdoub’s strategy of creating a truly pan-Gulf investment bank, the new entity, to be known as NBK Investment Company, will be capitalised at $50m and be owned 90% by the bank.
As George Nasra, group general manager of investment banking, asset management and treasury, explains: “Investment banking is a different culture and needs different compensation and a different set of skills.”
The new separate entity, which has been approved by the government and the Central Bank of Kuwait, will be located in a different building and will enable NBK to have the right structure and hire the right people to serve the increasing demand for private equity, mergers & acquisitions advisory and fund raising – which has exploded not only in Kuwait, but across the Gulf. The new company is expected to be operational by the end of the year.
